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FIN 3403
Module 9  Chapter 11
Page
1
CHAPTER 11
The Basics of
Capital Budgeting
Capital Budgeting
FIN 3403  Business Finance
Basics
Other Topics
Internal Rate of
Return
Payback
Net Present
Value
Profitability
Index
NPV Profiles
NPV versus IRR
Methods
Capital Budgeting
±
Capital budgeting is how the firm
determines what additions it
should make to its fixed assets.
±
Involves longterm decisions.
±
Involves large expenditures.
±
Critical to the survival of the firm.
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Module 9  Chapter 11
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2
Capital Budgeting Classifications
±
Replacement
z
Maintenance
z
Cost Reduction
±
Expansion
z
Existing Product/Markets
z
New Products/Markets
±
Safety/Environmental Projects
±
Other Projects
Capital Budgeting Procedures
±
Estimate cash inflows/outflows.
±
Assess riskiness of the cash flows
and determine r (WACC on a
riskadjusted basis)
±
Find NPV and/or IRR
±
Accept if NPV > 0 and/or IRR >
WACC
Capital Budgeting: Cash Flows
Project A
Project B
Year
Cash Flow
Cash Flow
0
$100.00
$100.00
1
$10.00
$50.00
2
$30.00
$60.00
3
$60.00
$30.00
4
$80.00
$20.00
Total
$180.00
$160.00
FIN 3403
Module 9  Chapter 11
Page
3
Payback Period
±
Number of Years to recover the
initial cost of the investment:
PB
Ö
$100 = $10 + $30 + $60
A
$100
=
$10 + $30 + $60
PB
A
=
3 years
PB
B
Ö
$100
=
$50 + ($60)(5/6)
PB
B
= 1 + 5/6 years
=
1.83 years
Present Value Payback
P
r
o
j
e
c
t
AP
r
o
j
e
c
t
r
o
j
e
c
t
BP
r
o
j
e
c
t
B
Year
PV at 8%
PV Total
1
$9.26
$9.26
$46.30
$46.30
2
$25.72
$34.98
$51.44
$97.74
3
$47.63
$82.61
$23.81
$121.55
PVPB
A
=
3.30 years
($17.39/$58.80)
PVPB
B
=
2.09 years
($
2.26/$23.81)
4
$58.80
$141.41
$14.70
$136.25
Total
$141.41
$141.41
$136.25
$136.25
Net Present Value
±
Present value of inflows minus the
present value of outflows (costs).
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This note was uploaded on 01/11/2012 for the course FIN 3403 taught by Professor Tapley during the Fall '06 term at University of Florida.
 Fall '06
 Tapley
 Finance

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