09-Capital-budgeting - Capital Budgeting 1 Capital...

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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. Long-term 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 risk-adjusted 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. Non-normal 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 & Non-Normal Project CFs Capital Budgeting 7 Cash Flows for Project L and Project S 10 80 60 1 2 3-100 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 3-100 CF t Cumul-100-90-30 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.

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09-Capital-budgeting - Capital Budgeting 1 Capital...

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