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Lecture 5_Student_6slides

Lecture 5_Student_6slides - Reminder FIN 221 Lecture 5 CH10...

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1 1 FIN 221 Lecture 5 CH10 Fundamentals of Capital Budgeting 2 No classes next week – Recess week No classes in Week 6 – School of Accounting and Finance reading week Mid-Session Exam to be held on Saturday, 17 th April Materials covered in Lectures 1-4 will be examinable. 40 Multiple Choice Questions (100 min) Formula sheet will be provided. YOU NEED TO USE A PENCIL to fill in Multiple choice question answer sheet. Reminder 3 Mid-Exam Locations Batesman Bay: Seminar Room 1 Bega: Room 3 Loftus: G06 Moss Vale: T1 Shoalhaven: UG04 Wollongong: Uni Hall 4 Relevant Reading Chapters • 10.1 Importance of capital budgeting Classification of investment projects Independent projects Mutually exclusive projects Basic Capital Budgeting Terms • 10.2 • 10.3 • 10.4 • 10.5 When IRR and NPV methods agree When NPV and IRR method disagree IRR vs NPV: A Final comment • 10.6 5 Cash Flow Cash Flow Cash Flow PV PV PV (1+i) n R (1+k) n Cost of capital 6 Mutually exclusive vs independent Critical to make an optimal investment decision Objective: To select investments in real assets that will increase the value of the firm Q: How do you know whether the investment will create value or not? We need some tools and techniques. Mutually exclusive project A set of projects where only one can be accepted • Independent projects Projects whose cash flows are not affected by the acceptance or non-acceptance of other projects Capital Budgeting
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2 7 Basic Capital Budgeting Terms Cost of capital (k) – the minimum return that a capital budgeting project must earn for it to be accepted – Opportunity cost since k reflects the rate of return investors can earn on financial assets of similar risk Capital rationing – A situation where a firm does not have enough capital to invest in all attractive projects and must therefore ration capital 8 Net Present Value 20 + 30 + 70 (1+ k ) 1 (1+ k ) 2 (1+ k ) 3 = - PV(COST) + PV(Future CFs) Uses discounted CFs valuation technique to adjust for time value of money NPV represents the “$increase in the value of firm”
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