Chapter 13 Lecture Notes
Capital Budgeting Decisions
CAPITAL BUDGETING—PLANNING INVESTMENTS
Screening decisions
Project must meet a minimum requirement to be acceptable
Required rate of return is the
minimum rate of return
(hurdle rate, cutoff rate, or cost of
capital) the project must yield.
The minimum rate of return is used as the discount rate in NPV to determine if the
project passes the screening decision.
Preference decisions
Best choice of all alternatives
The Time Value of Money
“A dollar today is worth more than a dollar a year from now.”
DISCOUNTED CASH FLOWS—THE NET PRESENT VALUE METHOD
(p. 581.)
1.
The length of time of the investment.
2. When cash flows occur.
3. Amount of cash flows.
4.
The discount rate.
Positive NPV
return is greater than the discount
rate
Zero NPV
return is equal to the discount rate
Negative NPV
return is less than the discount rate
Emphasis on Cash Flows
Typical cash outflows
:

Investment required
(is the
total net cash outflow at the investment inception

cash paid for initial investment reduced by salvage value of old equipment sold plus any
increased need for working capital, see next),
Increased need for working capital (CA – CL), and
Increased operating costs (including repairs and maintenance).
Typical cash inflows
:
Increased revenue or decreased costs,
Salvage value at the end of the useful life of the asset, and
Working capital released at the end of the investment.
NPV method automatically provides for return of the original investment.
Chapter 13
Spring 2012
Page 131
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View Full DocumentSimplifying Assumptions
1. All cash flows occur at the end of a period (except for the original investment
which occurs at the beginning).
2.
All cash inflows from the investment are immediately reinvested at the discount
rate.
Choosing a Discount Rate
Cost of capital
Format for NPV
Using Present Value Factor Tables
Time
Cash flow
PV Factor (@ discount
%)
Present Value
Now ‘0’
(investment, cash outflow)
1.000
($ investment)
n
Single cash flow
PV$1 @ (n, %)
Cash flow x PV factor
n
Annual cash flow
PVA @ (n, %)
Cash flow x PVA factor
NPV =
Summation of PV of (investment)
+ PV of cash flow
Or with the TI BAII+ Financial Calculator
Use the manual that came with your Texas Instrument BAII Plus to understand how to
use the NPV program.
CF key
, is used to enter the cash flows.
Key
CF
(to clear old CF, press 2
nd
CLR Work)
CF
0
is the initial investment, key in (amount)(±), then press (enter), and (↓) down arrow
C01 is the first occurring cash flow: amount (enter) (↓) F01 is the number of times the
cash flow will occur in a row: amount (enter) (↓)
C02 is the second occurring cash flow…follow the steps for C01.
Enter all cash flows in
order of receipt.
If a cash flow is a single cash flow, then the F is 1.
Once all cash flows have been entered press the
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 Spring '11
 giron
 Net Present Value

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