L03 Capital Budgeting

L03 Capital Budgeting - Capital Budgeting The I in Vfirm =...

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1 Copyright ©2003 Stephen G. Buell Capital Budgeting ) , , ( in The D F I f V I firm = Copyright ©2003 Stephen G. Buell Capital Budgeting • Process of deciding which long-term investments to make • Current outlay followed by cash inflows beyond one year in the future – New equipment, plants, new products – Often replacing old equipment with new • Expected return = required return? Copyright ©2003 Stephen G. Buell Temporary assumption • Required return is given and is the same for all projects • k 0 = required return or the hurdle rate • Assumption will be relaxed in the next chapter when we consider risk
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2 Copyright ©2003 Stephen G. Buell 5 steps to capital budgeting 1. Generation of investment proposals 2. Estimation of expected cash flows 3. Evaluation of expected cash flows 4. Selection of proposals 5. Continual reevaluation of proposals after acceptance We are mainly concerned with 2, 3 and 4 Copyright ©2003 Stephen G. Buell Estimation of expected cash flows • Incremental L CF of the firm with proposal vs. CF of firm without proposal • After-tax L what actually affects the common stockholders (available for retention or payout) • CF = Net Income + Depreciation Copyright ©2003 Stephen G. Buell Incremental cash flows rate tax marginal s firm' t on depreciati in change ?D costs operating in change ?C revenue sales in change ?S ) 1 )( ( = = = = + - - - = D t D C S CF
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3 Copyright ©2003 Stephen G. Buell Horizontal income statement D t D C S CF t D C S t D C S D C S + - - - = = - - - = - - = - - ) 1 )( ( profits) tax - after ( ) 1 )( ( then taxes ) )( ( if profits) tax - before ( ) ( : Given Copyright ©2003 Stephen G. Buell Replacement example Old equipment: original cost= 60,000 SV = 0 15 yr original life currently 5 yrs old with a MV = 8,000 New equipment: Cost = 40,000
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This note was uploaded on 02/07/2011 for the course FIN 125 taught by Professor Buell during the Spring '08 term at Lehigh University .

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L03 Capital Budgeting - Capital Budgeting The I in Vfirm =...

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