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1
FIN 221 Lecture 5
CH10
Fundamentals of Capital
Budgeting
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•
No classes next week – Recess week
•
No classes in Week 6 – School of Accounting and Finance
reading week
•
MidSession Exam to be held on Saturday, 17
th
April
•
Materials covered in Lectures 14 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
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MidExam Locations
•
Batesman Bay: Seminar Room 1
•
Bega: Room 3
•
Loftus: G06
•
Moss Vale: T1
•
Shoalhaven: UG04
•
Wollongong: Uni Hall
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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
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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
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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
nonacceptance of other projects
Capital Budgeting
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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
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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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 Spring '10
 ala
 Net Present Value, PAYBACK PERIOD, Internal rate of return

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