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4 Capital Budgeting.iLearn.fall09

# 4 Capital Budgeting.iLearn.fall09 - Capital Budgeting...

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Capital Budgeting Professor Peter Chung

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Capital Budgeting I How to appraise a capital project? (Investment Decision) II. Net “incremental” Cash Flow III. How to measure Cash Flow? 1. Initial outlay 2. Differential of C/Fs 3. Terminal C/Fs 4. C/F Diagram IV. Methods of evaluating project 1. NPV 4. PP 2. PI 5. AROR 3. IRR 6. a comprehensive example (Table 10.6)
I. Investment Decision Capital budgeting = investing on long term assets, and involves:

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II. Net Incremental CFs The difference between CFs for the firm with AND without the projects 1. What are the elements of the co’s CFs that would be affected if the proposed project is accepted? 2. What would be the expected level of these CFs in each period with the project? 3. What would be the expected level of these CFs in each period without the project?
III. How do we Measure CFs? 1. Initial outlay C/O = C/I = C/I or C/O = 1. Differential after tax CFs each year C/I = C/O = C/I - C/O = 1. Terminal CF C/I = C/O =

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Handout Example: Measuring Cash flows for Capital Budgeting Decision BC company is considering the purchase of a new machine for \$30,000, which will be depreciated over the five years. The new machine will replace an existing machine originally purchase for \$30,000 ten years ago and currently has five years of expected useful life. The existing machine will generate \$2,000 of depreciation expenses for each of the new five years at which time the book value will be equal to zero. In order to put the new machine in running order, it is necessary to pay shipping charges or \$2,000 and installation charges of \$3,000. Because the new machine will work
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