Chapter-11

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

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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. ± Very important to firm’s future. 11-2 Steps to Capital Budgeting 1. Estimate CFs (inflows & outflows). 2. Assess riskiness of CFs. 3. Determine the appropriate cost of capital. 4. Find NPV and/or IRR. 5. Accept if NPV > 0 and/or IRR > WACC. 11-3

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What is the difference between independent and mutually exclusive projects? ± Independent projects – if the cash flows of one are unaffected by the acceptance of the other. ± Mutually exclusive projects – if the cash flows of one can be adversely impacted by the acceptance of the other. 11-4 What is the difference between normal and nonnormal cash flow streams? ± Normal cash flow stream – Cost (negative CF) 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), then string of positive CFs, then cost to close project. Nuclear power plant, strip mine, etc. 11-5 Net Present Value (NPV) ± Sum of the PVs of all cash inflows and outflows of a project: 11-6 = + = N 0 t t t ) r 1 ( CF NPV
What is Project L’s NPV? NPV S = \$19.98 11-7 Year CF t PV of CF t 0 -100 -\$100 1 10 9.09 2 60 49.59 3 80 60.11 NPV L = \$ 18.79 Solving for NPV: Financial Calculator Solution ± Enter CFs into the calculator’s CFLO register. ± CF 0 = -100 ± CF 1 = 10 ± CF 2 = 60 ± CF 3 = 80 ± Enter I/YR = 10, press NPV button to get NPV L = \$18.78.

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This note was uploaded on 02/27/2011 for the course FINANCE 3320 taught by Professor Wigmans,f during the Spring '08 term at Texas Tech.

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

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