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Unformatted text preview: long-run performance goals? How much risk is to be undertaken in pursuit
of an opportunity? Managers naturally feel pressure to deliver in the near-term, for fear of not
keeping their jobs in the long-term. Be on guard, as this behavioral issue can potentially foster an
environment where the best long-run decisions are not always selected! 3.2 Logic Justification of Capital Decisions
Fortunately, a number of very helpful analytical tools are available to bring logical and rational
decision-making processes to bear on capital expenditure decisions. The remainder of this chapter
will focus on these tools. A good manager is well advised to understand and utilize these tools. They
can be most helpful in evaluating capital expenditure decisions. In addition, managers can use these
tools to clearly convey justification for making certain decisions, even if they appear to be illogical
in the near-term. Download free ebooks at bookboon.com
20 Compound Interest and Present Value Analytics for Managerial Decision Making 4. Compound Interest and Present Value
You have heard the expression that “time is money.” In capital budgeting this concept is measured
and brought to bear on the decision process. The fundamental idea is that a dollar received today is
worth more than a dollar to be received in the future. This result occurs because a dollar in hand can
be invested to generate additional returns; such would not be the case with a dollar received in the
In the context of capital budgeting, assume two alternative investments have the same upfront cost.
Investment Alpha returns $100 per year for each of the next five years. Investment Beta returns $50
per year for each of the next 10 years. Based solely on this information, you should conclude that
Alpha is preferred to Beta. Although the total cash returns are the same, the time value of money is
better for Alpha than Beta. With Alpha, the money is returned sooner, allowing for enhanced
reinvestment opportunities. Of course, very few capital expenditure choices are as...
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