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FNAN 301
Financial Management
Capital budgeting criteria

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Topics Covered
Overview of capital budgeting
Evaluating capital budgeting opportunities
Net present value (NPV)
Internal rate of return (IRR)
Payback period
Discounted payback period
Accounting rate of return

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Overview of Capital Budgeting
Patriot Theaters owns and operates 145 movie
theaters in the Mid-Atlantic Region
The firm’s managers think that expanding into
New England may be a good move for the
company
The managers will conduct capital budgeting
analysis to help them decide whether or not to
expand

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Overview of Capital Budgeting
Capital budgeting is the process whereby a firm
decides how it is going to spend money on
projects
Examples of potential projects include
•
Buying or building a factory to increase production of an
existing product
•
Opening stores in a new region
•
Buying equipment to be used to offer a new product or
service or to offer an existing product or service in a new
geographic area

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Overview of Capital Budgeting
Projects involve two types of expected cash
flows
Investment-related expected cash flows
•
These are the expected cash flows associated with making
the investment in the project and are often associated with
buying, building, etc.
Almost always negative
Project-related expected cash flows
•
These are the expected cash flows produced by the project
Can be negative, zero, or positive

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Overview of Capital Budgeting
A project with conventional cash flows involves
An initial negative investment-related expected cash flow
• C
0
< 0
•
Reflects the cost of the investment
•
Is the only cash flow associated with the investment
•
Investment = -C
0
•
Is the only negative expected cash flow associated with the project
Subsequent non-negative project-related expected cash flows
with at least one positive
• C
1
≥ 0, C
2
≥ 0, …, C
t
≥ 0, with at least one positive expected cash flow
•
Can continue for a finite or infinite length of time
•
Reflect the expected cash flows produced by the project
•
Present value of these expected cash flows reflect the value of what is
created by the project
A project with non-conventional cash flows involves any
pattern that is not conventional
Key cases: has C
0
≥ 0 and/or a negative expected cash flow at
time 1 or later

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FNAN 301 Notes