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Unformatted text preview: 111CHAPTER 11The Basics of Capital BudgetingShould we build thisplant?112What is capital budgeting?Job descriptions of a financial manager:Fundraising:Raising short and longterm funds for the acquisitions of short and longterm assets as strategically determined;Investing:CFO helps the CEO and the board in deciding what longterm investment projects to undertake for longterm expansion purposes;CFO provides analyses on projects under consideration of their economic benefits.Investment projects typically are measured in terms of their NPV and/or (M)IRR.113What is capital budgeting?Analysis of the economic benefits of potential additions to fixed assets.Economic benefits of projects typically are measured in terms of their NPV and/or MIRR.Longterm decisions; involve large expenditures.Very important to firm’s future growth.114Steps to capital budgeting1.Estimate CFs (inflows & outflows) of the project under consideration.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.115What 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.116What 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.Nonnormal 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.117Net Present Value (NPV)Sum of the PVs of all cash inflows and outflows of a project:Inflows typically are those expected from the project, while outflows are the initial expenditures (investments) to undertake the project.∑ ∑=+=+=Nt1tt)1()r 1(CFNPVNttCFrCF118What is Project L’s NPV?Ex: Project A and B would cost $100 each to invest. Project A will generate $10, 60, and 80 cash inflows in year 1, 2, and 3. Project B will generate $70, 50, and 20 cash inflows in year 1, 2, and 3.If the required rate of return for the investment is 10%, what is the NPV for each of the projects? Which project you will like to invest? Question: The sum of cash inflows is $150 for project A and $140 for project B. Should you choose project A?...
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This note was uploaded on 11/11/2011 for the course FIN 350 taught by Professor Chen during the Spring '07 term at S.F. State.
 Spring '07
 Chen
 Finance, Investing

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