ch10_062005

# Ch10_062005 - CHAPTER10 Should we build this plant 101 fixedassets Longtermdecisions;involvelarge expenditures 102 1 2 3 4 5 E

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10-1 CHAPTER 10 The Basics of Capital Budgeting Should we build this plant?

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10-2 What is capital budgeting? Analysis of potential additions to  fixed assets. Long-term decisions; involve large  expenditures. Very important to firm’s future.
10-3 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.

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10-4 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.
10-5 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. Non-normal 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.

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10-6 What is the payback period? The number of years required to  recover a project’s cost, or “How long  does it take to get our money back?” Calculated by adding project’s cash  inflows to its cost until the cumulative  cash flow for the project turns positive.
10-7 Calculating payback Payback L = 2 + / = 2.375 years CF t -100 10 60 100 Cumulative -100 -90 0 50 0 1 2 3 = 2.4 30 80 80 -30 Project L Payback S = 1 + / = 1.6 years CF t -100 70 100 20 Cumulative -100 0 20 40 0 1 2 3 = 1.6 30 50 50 -30 Project S

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10-8 Strengths and weaknesses of  payback Strengths Provides an indication of a project’s risk  and liquidity. Easy to calculate and understand.
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## This note was uploaded on 09/05/2011 for the course FIN 4405 taught by Professor Cowan during the Spring '11 term at Fairleigh Dickinson.

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Ch10_062005 - CHAPTER10 Should we build this plant 101 fixedassets Longtermdecisions;involvelarge expenditures 102 1 2 3 4 5 E

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