Topic 6 - Topic 6 Fundamental of Capital Budgeting Capital...

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Topic 6 Fundamental of Capital Budgeting
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Capital Budgeting Process A capital budget lists the projects and investments that a company plans to undertake during future years. To create this list, firms analyze alternate projects and decide which ones to accept through a process called capital budgeting. This process begin with forecasts of each project’s future consequences for the firms such as the effect on revenues, or costs. Our goal is to determine the effect of the decision to accept or reject a project on the firm cash flows and work out NPV to assess the
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Capital Budgeting Process Ø Step by step: Forecast Incremental Earning Determine Incremental Free Cash Flows Identify other effects on Incremental cash flows Analyzing the project Real Options in Capital budgeting
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Forecasting Incremental Earning Earning are not actual cash flows Incremental earnings of a project is the amount by which the firm’s earnings are expected to change as a result of the investment decision. Example 1: You are considering whether to upgrade your manufacturing plant and increase its capacity by purchasing a new piece of equipment. The equipment costs $1million, plus an additional $20,000 to transport it and install it. You will also spend $50,00 on engineering costs
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Operating expenses vs. Capital expenditures Upfront investment: marketing survey, develop a prototype, and launch an ad campaign…We call they are operating expenses in the year that they are incurred. Investments in plant, property or equipment called capital expenditures, and they are not listed as expenses when calculating earnings. Instead the firm deducts a fraction of the cost each year as depreciation.
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Operating expenses vs. Capital expenditures In the below example, firm spent total $1,020,000 for purchasing, transporting and installing the equipment. Assume this equipment has a depreciable life of 5 years and this firm choose to use straight-line depreciation method.
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Topic 6 - Topic 6 Fundamental of Capital Budgeting Capital...

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