Lecture06_winter09

Lecture06_winter09 - CAPITAL BUDGETING DECISION CAPITAL...

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CAPITAL BUDGETING DECISION
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CAPITAL BUDGETING A Project will be characterized by a series of Cash Flows: {CF 0 , CF 1 , CF 2 ,…. ., CF t } Investment Projects: CF 0 <0 CF 1 ,…., CF t >0 Financing Projects CF 0 >0 CF 1 ,…., CF t <0
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CAPITAL BUDGETING Different Criteria Analyzed Net Present Value (NPV) Payback/Discounted Payback Profitability Index (PI) Internal Rate of Return (IRR)
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NET PRESENT VALUE Is the PRESENT VALUE of the Future Cash Flows of the Project NET of the INITIAL Cash Flow necessary to start it.   t t r CF r CF CF NPV 1 ... 1 1 0
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NET PRESENT VALUE Forecast the Cash Flows generated by the Project (CF 1 ,…., CF t ) Determine the appropriate discount rate. The discount rate must reflect the time value of money and also the risk of the project (r) Determine the PRESENT VALUE of the Cash Flows Determine the NET PRESENT VALUE by subtracting the INITIAL INVESTMENT necessary to start the Project
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NET PRESENT VALUE DECISION RULE Independent Projects Accept any Projects for which NPV>0 Mutually Exclusive Accept the Project with the highest NPV, provided it is positive.
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NET PRESENT VALUE Advantages Takes into account the Time Value of Money Uses Forecasted Cash Flows Uses a risk adjusted discount rate Independent of other Projects NPVs are additive
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Represents the minimum length of time necessary to recover your Initial Investment. Only applicable to Investment Projects
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This note was uploaded on 01/28/2012 for the course ECON 134a taught by Professor Lim during the Winter '08 term at UCSB.

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Lecture06_winter09 - CAPITAL BUDGETING DECISION CAPITAL...

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