capital - Capital budgeting Overview Multiperiod...

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Capital budgeting: Overview 8/5/98 Multiperiod decision-making Managers must make many decisions that have effects on their firm’s profits (and cash flows) over multiple time periods. Examples of such decisions include the decision to build a new production facility or purchase production equipment, and the decision to acquire an equity interest in another firm. These types of managerial decisions are most often termed capital budgeting . The capital budgeting process is the process where managers make decisions about how to allocate financial capital to various proposed plans (usually called “projects”) in order to maximize profits. Consider the following example of expected profits from two proposed plans: 1998 1999 2000 2001 Total Expected profits--Plan 3 ……… $10,000 $10,000 $10,000 $10,000 $40,000 Expected profits--Plan 4 ……… (10,000) 20,000 30,000 40,000 80,000 Difference …………………… $20,000 ($10,000) ($20,000) ($30,000) ($40,000) Note that a single-period decision model cannot adequately capture the complexity of the differences in the expected streams of profits: Plan 1 would clearly be preferred if only the first year after implementation (i.e., 1998) were considered since the profit differential relative to Plan 2 is a positive $20,000; however, over a four year horizon time Plan 2 is clearly superior to Plan 1. This suggests that it is necessary to analyze the changes in profits that are expected to result over multiple (future) time periods in order to make appropriate managerial decisions. Present value analyses
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This note was uploaded on 01/13/2012 for the course ACC 202 taught by Professor Sue during the Fall '10 term at Michigan State University.

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capital - Capital budgeting Overview Multiperiod...

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