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Unformatted text preview: Chapter 11 The Basics of Capital Budgeting Learning Objectives After reading this chapter, students should be able to: Discuss capital budgeting. Calculate and use the major capital budgeting decision criteria, which are NPV, IRR, MIRR, and payback. Explain why NPV is the best criterion and how it overcomes problems inherent in the other methods. Chapter 11: The Basics of Capital Budgeting Learning Objectives 5 Lecture Suggestions This is a relatively straightforward chapter, and, for the most part, it is a direct application of the time value concepts first discussed in Chapter 5. We point out that capital budgeting is to a company what buying stocks or bonds is to an individual—an investment decision, when the company wants to know if the expected value of the cash flows is greater than the cost of the project, and whether or not the expected rate of return on the project exceeds the cost of the funds required to do the project. We cover the standard capital budgeting procedures—NPV, IRR, MIRR, payback and discounted payback. At this point, students who have not yet mastered time value concepts and how to use their calculator efficiently get another chance to catch on. Students who have mastered those tools and concepts have fun, because they can see what is happening and the usefulness of what they are learning. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case solution for Chapter 11, which appears at the end of this chapter solution. For other suggestions about the lecture, please see the “Lecture Suggestions” in Chapter 2, where we describe how we conduct our classes. DAYS ON CHAPTER: 3 OF 58 DAYS (50minute periods) 6 Lecture Suggestions Chapter 11: The Basics of Capital Budgeting Answers to EndofChapter Questions 111 Project classification schemes can be used to indicate how much analysis is required to evaluate a given project, the level of the executive who must approve the project, and the cost of capital that should be used to calculate the project’s NPV. Thus, classification schemes can increase the efficiency of the capital budgeting process. 112 The regular payback method has three main flaws: (1) Dollars received in different years are all given the same weight. (2) Cash flows beyond the payback year are given no consideration whatever, regardless of how large they might be. (3) Unlike the NPV, which tells us by how much the project should increase shareholder wealth, and the IRR, which tells us how much a project yields over the cost of capital, the payback merely tells us when we get our investment back. The yields over the cost of capital, the payback merely tells us when we get our investment back....
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 Spring '08
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 Net Present Value, Internal rate of return, NPVs

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