Chapter 11 - CHAPTER11 TheBasicsofCapitalBudgeting Should...

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    11-1 CHAPTER 11 The Basics of Capital Budgeting Should we build this plant?
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    11-2 What is capital budgeting? Analysis of potential additions to  fixed assets. Long-term decisions; involve large  expenditures. Very important to firm’s future.
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    11-3 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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    11-4 An Illustrative Example Here are the projects’ net cash flows  (in thousands of dollars): 0 1 2 3 | | | | Project L -100 10 60 80 Project S -100 70 50 20 Which project(s) should we take up?   How should we analyze them?
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    11-5 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.
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    11-6 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. 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.
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    11-7 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.
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    11-8 Calculating payback Payback L = 2 + / = 2.375 years CF t -100 10 60 Cumulative -100 -90 50 0 1 2 3 = 30 80 80 -30 Project L’s Payback Calculation Payback L = 2.375 years Payback S = 1.600 years
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  11-9 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 01/15/2010 for the course PUBLIC Public rel taught by Professor Za during the Spring '09 term at Loyola Maryland.

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Chapter 11 - CHAPTER11 TheBasicsofCapitalBudgeting Should...

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