BADM 7090 IIIA 2011 - Capital Investment Decisions (Foundations of Net Present Value)

BADM 7090 IIIA 2011 - Capital Investment Decisions (Foundations of Net Present Value)

Info iconThis preview shows pages 1–9. Sign up to view the full content.

View Full Document Right Arrow Icon
BADM 7090 Financial Management Unit III.A Capital Investment Decisions: Foundations of Net Present Value Text material: GSM, Ch. 7 D. Chance
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Version: 1/3/11 D. Chance – BADM 7090 – Unit IIIA p. 2 of 49 Questions How is net present value used to analyze capital investment decisions? What are the alternative ways to analyze capital investment decisions? Why is net present value the best method for analyzing capital investment decisions?
Background image of page 2
Version: 1/3/11 D. Chance – BADM 7090 – Unit IIIA p. 3 of 49 Corporate Capital Investment Decisions In the ordinary course of business, companies must decide on the assets in which they will invest their resources. These assets are oftentimes thought of as physical assets, such as plant and equipment, but they also represent new products or expansions of existing products.
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Version: 1/3/11 D. Chance – BADM 7090 – Unit IIIA p. 4 of 49 Corporate Capital Investment Decisions (cont.) A company starts with an idea that is then developed into the concept of a project that can be characterized as an investment of capital that is expected to later generate cash flows. We typically assume that there is an initial outlay followed by a series of cash flows.
Background image of page 4
Version: 1/3/11 D. Chance – BADM 7090 – Unit IIIA p. 5 of 49 Corporate Capital Investment Decisions (cont.) -I0 C0 C1 C2 C3 C4 0 1 2 3 4 5 The objective is to determine if the company should invest the money at time 0, given the expectation that it will receive the series of future cash flows as shown. Patterns such as the above (initial outlay followed by series of cash flows, some of which could be negative) are common but not the only possible patterns. There can be initial inflows and outflows later. In addition, the future cash flows are usually only predictions. The actual cash flows that will occur are uncertain.
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Version: 1/3/11 D. Chance – BADM 7090 – Unit IIIA p. 6 of 49 The Payback Method The payback (period) is the minimum number of years over which the initial investment is recovered. The decision criterion often establishes a maximum payback. Letting C i represent each annual cash flow and I 0 be the initial investment: 0 1 N i i i C I Min = ÷
Background image of page 6
Version: 1/3/11 D. Chance – BADM 7090 – Unit IIIA p. 7 of 49 The Payback Method (cont.) Project C 1 C 2 C 3 C 4 1 $9,500 $2,000 $0 $0 2 $3,000 $4,000 $2,000 $7,000 3 $3,100 $6,500 $5,000 $0 4 $2,500 $5,000 $3,000 $6,000 Example Problem III.A(1) : Consider four investment projects, each with an initial outlay of $10,000. Which investments should be made if the payback method is used?
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
1/3/11 D. Chance – BADM 7090 – Unit IIIA p. 8 of 49 The Payback Method (cont.) Project 1: Recovers $9,500 in first year and $2,000 in second for $11,500. PB = 2 Project 2: Does not recover $10,000 until year 4. PB = 4 Project 3: Recovers $10,000 in year 3. PB = 3 Project 4: Recovers $10,000 in year 3: PB = 3 Suppose the maximum acceptable payback is 2. Accept Project 1 only.
Background image of page 8
Image of page 9
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 02/28/2012 for the course BADM 7090 taught by Professor Staff during the Fall '08 term at LSU.

Page1 / 49

BADM 7090 IIIA 2011 - Capital Investment Decisions (Foundations of Net Present Value)

This preview shows document pages 1 - 9. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online