L11-ch10 - CHAPTER 10 MAKING CAPITAL BUDGETING DECISION...

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Click to edit Master subtitle style CHAPTER 10 MAKING CAPITAL BUDGETING DECISION (Page 327 – 344) 11
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Capital Budgeting : The process of planning for purchases of Long-term assets . Guidelines Page 328 – 331 22
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Capital Budgeting Steps 1) Evaluate Cash Flows Look at all incremental cash flows occurring as a result of the project. Initial outlay Differential Cash Flows over the life of the project (also referred to as annual cash flows ) 33
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2) Evaluate the Risk of the Project For now, we’ll assume that the risk of the project is the same as the risk of the overall firm. Because of the above assumption, we can use the firm’s cost of capital as the discount rate for capital investment projects. Capital Budgeting Steps 44
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3) Accept or Reject the Project Calculate NPV NPV < 0 Reject NPV >= 0 Accept Capital Budgeting Steps 55
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The cost of the new machine is $127,000 . Installation will cost $20,000 . $4,000 in net working capital will be needed at the time of installation. The project will increase revenues by $85,000 per year, but operating costs will increase by 35% of the revenue increase. Simplified straight line depreciation is used. Class life is 5 years , and the firm is planning to keep the project for 5 years .
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L11-ch10 - CHAPTER 10 MAKING CAPITAL BUDGETING DECISION...

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