PWRT C12 Cap Budget - Chp 12 Capital Investments an...

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Chp 12: Capital Investments… an introduction to finance. WHEN you get money is critically important. The RISK of not getting money (or getting a different amount than expected) is critically important. We directly address the first issue in chapter 12.
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Capital Investment Decisions Capital Investment Decisions relate to “big projects” or “big expenditures” that you haven’t made yet. In this chapter, we analyze whether or not the “big expenditure” is worthwhile.
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Link to prior topics Many of the problems we have seen in this course relate to fixed costs (i.e., how should we account for them?) This issue is not a problem in Chapter 12 because fixed costs haven’t happened yet… we are typically considering whether fixed investment is worthwhile.
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Capital Investment: Three Phases of Capital Investment 1. Identification (a strategy issue) 2. Evaluation and Selection (key area) 3. Control (briefly mentioned, page 520)
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Evaluation and Selection In order to establish a consistent and reasonable basis for project selection (“new opportunity” or “big expenditure” selection), objective methods of evaluation and selecting new opportunities are used.
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Methods Discussed by Our Text 1. Payback Period 2. Accounting Rate of Return 3. Net Present Value 4. Internal Rate of Return
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The Very Easy One Payback Period measures how long it takes to get your money back. You prefer investments with fast payback periods relative to those with slow payback periods. For example, imagine that you make a $5,000 investment to buy a generic machine that will provide $1,000 worth of cash inflow for the next 10 years.
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Payback Period Formula Payback Period = Investment  net annual cash inflow Payback Period = $5,000  $1,000 = 5 years All else being equal, you’d prefer this investment to one with a 6-year payback period.
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Accounting Rate of Return VERY Similar to R.O.I. (from Chp. 10) We won’t ask Accounting Rate of Return questions on exam 3…(such questions duplicate ROI problems).
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Remaining Methods Consider the Time Value of Money…this is the finance intro. 1. Net Present Value 2. Internal Rate of Return
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Time Value of Money… when you get money is critical. Explains stories that my grandmother told me, like, “when I grew up, a cup of coffee cost 5 cents”. Even though I’m not that old, when I was a kid, a $100,000 house was a mansion. In ‘constant value ’ terms, gasoline is not as expensive as it was in the ’70s.
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Time Value of Money The basic thought is that having $1 now is worth more than having $1 one year from now. Why? If you have $1 now, at a minimum, you could put your money in the bank and earn interest. By next year, you’ll have more than $1.
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How Much More?
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