Chapter 11 - Chapter11 TheBasicsofCapital Budgeting...

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The Basics of Capital  Budgeting Chapter 11 Should we  build this plant? 11-1
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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
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Steps to Capital Budgeting 1. 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
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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
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Net Present Value (NPV) Sum of the PVs of all cash inflows and  outflows of a project: 11-6 = + = N 0 t t t )     1   ( CF   NPV 
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What is Project L’s NPV? 11-7 Year  CF t   PV of CF t   -100  -$100  10  9.09  60  49.59  80      60.11       NPV L  =  $  18.79 
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Financial Calculator Solution Enter CFs into the calculator’s CFLO register. 11-8
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Chapter 11 - Chapter11 TheBasicsofCapital Budgeting...

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