FFM CH11 - The Basics of Capital Budgeting Chapter 11...

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Unformatted text preview: The Basics of Capital Budgeting Chapter 11 Should we build this plant? 11-1 What is capital budgeting? Analysis of potential additions to fixed assets. Long-term decisions; involve large expenditures. Produces cash flows expected to last more than one year Very important to firms future. 11-2 Project categories Replacement needed to continue current operations Replacement cost reduction Expansion of existing products or markets Safety/environmental projects Other projects Mergers Does each decision require the same approval and evaluation process? 11-3 Evaluation Techniques 1. New Present Value (NPV) 2. Internal Rate of Return (IRR) 3. Modified Internal Rate of Return (MIRR) 4. Regular Payback 5. Discounted Payback 11-4 Steps to Capital Budgeting 1. Estimate CFs (inflows & outflows). 2. Assess riskiness of CFs. 3. Determine the appropriate cost of capital. 4. Employ an evaluation method 5. Make a project go/no go decision using one or all evaluation methods to assist. Accept if NPV > 0, IRR or MIRR > WACC, or payback within an acceptable period of time. 11-5 What is the difference between independent and mutually exclusive projects? Independent projects If the cash flows of one project are unaffected by the acceptance of the other. Can accept more than one project if evaluation method produces positive results Mutually exclusive projects If the cash flows of one can be adversely impacted by the acceptance of the other. Typically accept only one of the competing projects or none at all if none exceed the evaluation parameters 11-6 What is the difference between normal and nonnormal cash flow streams? Normal cash flow stream Cost (negative CF) at t=0, followed by a series of positive cash inflows. One change of signs. Nonnormal cash flow stream Two or more changes of signs. Most common: Cost (negative CF) at t=0, then string of positive CFs, then cost to close project. Nuclear power plant, strip mine, etc....
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FFM CH11 - The Basics of Capital Budgeting Chapter 11...

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