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Unformatted text preview: Capital Budgeting 1 Capital Budgeting Payback period Net present value (NPV) Internal rate of return (IRR) Profitability index (PI) Modified IRR (MIRR) Capital Budgeting 2 What Is capital budgeting? Analysis of potential additions to fixed assets. Longterm decisions Involves large expenditures Very important to firm’s future and growth. Capital Budgeting 3 Generic Steps 1. Generate ideas for new projects. 2. Estimate CFs (inflows & outflows). 3. Assess riskiness of CFs. 4. Determine riskadjusted discount rate R = WACC (adj.). 5. Find NPV and/or MIRR. 6. Accept if NPV > 0 and/or MIRR > WACC. Capital Budgeting 4 Mutually Exclusive Projects (Versus Independent Projects) BRIDGE VS. BOAT TO GET PRODUCTS ACROSS A RIVER Capital Budgeting 5 Normal Project Cost (negative CF) followed by a series of positive cash inflows. Nonnormal Project One or more outflows occur after inflows have begun. Most common: Cost (negative CF), then string of positive CFs, then cost to close project. Examples: Nuclear power plant, strip mine. Capital Budgeting 6 Inflow (+) or Outflow () in Year 1 2 3 4 5 N NN + + + + + N + + + + NN + + + N Examples of Normal & NonNormal Project CFs Capital Budgeting 7 Cash Flows for Project L and Project S 10 80 60 1 2 3100 Project S:100 Project L: Note : Project L has larger inflows later, and Project S has larger inflows earlier in the life of the project. Years: 70 50 20 Capital Budgeting 8 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? Capital Budgeting 9 Payback for Project L (Long: Most CFs in out years) 10 80 60 1 2 3100 CF t Cumul1009030 50 Payback L = 2 + 30/80 = 2.375 years....
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This note was uploaded on 10/04/2011 for the course FIN 6406 taught by Professor Sturm,r during the Spring '08 term at University of Central Florida.
 Spring '08
 Sturm,R
 Internal Rate Of Return (IRR), Net Present Value

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