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Unformatted text preview: The Basics of Capital Budgeting Chapter 11 Should we build this plant? 111 What is capital budgeting? Analysis of potential additions to fixed assets. Longterm decisions; involve large expenditures. Very important to firms future. 112 Steps to Capital Budgeting 1. Estimate CFs (inflows & outflows). 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. 113 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. 114 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. 115 Net Present Value (NPV) Sum of the PVs of all cash inflows and outflows of a project: 116 = + = N t t t ) r 1 ( CF NPV What is Project Ls NPV? NPV S = $19.98 117 Year CF t PV of CF t 0 100 $100 1 10 9.09 2 60 49.59 3 80 60.11 NPV L = $ 18.79 Solving for NPV: Financial Calculator Solution Enter CFs into the calculators CFLO register. CF = 100 CF 1 = 10 CF 2 = 60 CF 3 = 80 Enter I/YR = 10, press NPV button to get NPV L = $18.78....
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 Spring '11
 Risnit

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