MGT+3062+-+Ch+9_10+notes

MGT+3062+-+Ch+9_10+notes -...

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1 Capital Budgeting  & Capital Investment  Decisions
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2 Objectives Calculate the following values for a project Net Present Value Internal Rate of Return Profitability index Payback period (and discounted payback) Describe the benefits and drawbacks of each approach Recommended exercises: 1-11
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3 Capital budgeting  Corporate financial decision making involves the following decisions How to allocate capital budgets? How to deem a project to be worthwhile? What capital investments to undertake from multiple alternatives? Focus of this chapter:  What are the different criteria to “judge projects” Net Present Value Payback period Discounted Payback Profitability Index IRR Each of these approaches compares the cost of a project to the potential  gains in some fashion
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4 What’s used in practice?
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5 What makes a good decision criteria? A good procedure for evaluating proposed investments should: Not arbitrarily exclude any costs or benefits from the analysis. Allow for time value of money and for the risk involved.  If forced to choose among proposals, select the one that does  shareholders the most good.  
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6 Project types We generally encounter two types of projects in Finance: Mutually exclusive projects: There are several potential projects Only one project has to be chosen Either don’t need more than one  Not enough money Decision approach:  Rank all the alternatives and select the best one Independent projects Projects are not competing with each Free to choose multiple projects Accepting or rejecting one project doesn’t affect the other projects Project is accepted if it exceeds some minimum acceptance criteria
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7 Net Present Value The difference between the market value of a project and its  cost NPV = Total PV of future cash flows – Initial investment How much value is created from undertaking an investment? estimate the expected future cash flows. estimate the discount rate for projects of this risk level. Estimate initial costs
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8 NPV – Decision Rule Independent projects If the NPV is positive, accept the project Accept if NPV > 0 If mutually exclusive projects: Shortlist projects with NPV>0 Choose the highest NPV project A positive NPV means: the project is expected to add value to the firm  Increase shareholder value NPV is a direct measure of how well this project will meet our goal.
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9 Example Fuji software has the following projects ( r = 15%) Which project should be selected?
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MGT+3062+-+Ch+9_10+notes -...

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