NPV___handouts

NPV___handouts - Capital Budgeting Capital Decision...

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Capital Budgeting Capital Budgeting Decision Criteria Decision Criteria
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Capital Budgeting Capital Budgeting : the process of : the process of planning for purchases of long- planning for purchases of long- term assets. term assets. example : Suppose our firm must decide whether to purchase a new plastic molding machine for $127,000. How do we decide?
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The Ideal Evaluation Method should: a) include all cash flows that occur during the life of the project, b) consider the time value of money , c) incorporate the required rate of return (I.e., Risk) on the project. Decision-making Criteria in Decision-making Criteria in Capital Budgeting Capital Budgeting
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Payback Period Payback Period The number of years needed to recover the initial cash outlay. How long will it take for the project to generate enough cash to pay for itself?
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Payback Period Payback Period How long will it take for the project to generate enough cash to pay for itself? 0 0 1 1 2 2 3 3 4 4 5 5 8 8 6 6 7 7 (500) 150 150 150 150 150 150 150 150 (500) 150 150 150 150 150 150 150 150 Payback period = 3.33 years. Payback period = 3.33 years.
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Is a 3.33 year payback period good? Is it acceptable? Firms that use this method will compare the payback calculation to some standard set by the firm. If our senior management had set a cut-off of 4 years for projects like ours, what would be our decision?
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Drawbacks of Payback Period: Firm cutoffs are subjective. Does not consider time value of money. Does not consider any required rate of return. Does not consider all of the
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NPV___handouts - Capital Budgeting Capital Decision...

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