Table of Contents1. Capital budgeting – An overview2. Net present value technique (NPV)3. Internal rate of return (IRR)3.1 Advantages of IRR3.2 Difficulties of IRR approach4. The payback technique5. Average accounting rate of return (ARR)6. Which technique is used in practice?2
1. Capital budgeting – An overviewCapital budgeting–Is anAsset sidedecision making process•To choose those investments that maximize returnsto investments (shareholders)–The aim is to decide on the projects to invest in(or project evaluation) givenopportunity cost•Opportunity cost represents the next bestalternative–Key consideration: whether or not the projectprovides an adequate return to investors3
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•There are three stages in making capitalbudgeting decisions:–Stage 1•forecasting offuture cash flowsassociated with aproject–Stage 2•useinvestment evaluation techniquesto decidewhether a project is acceptable individually and isthe best set of alternative projects–Stage 3•decide whether toaccept or rejectprojects41. Capital budgeting – An overview