311 ch10 - Capital Budgeting Decision Criteria and Real...

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Capital Budgeting Decision Criteria and Real Option Considerations Chapter 10
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Capital Budgeting Criteria Net present value ( NPV ) Internal rate of return ( IRR ) Profitability index ( PI ) Payback period ( PB )
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Net Present Value PV of the stream of future CFs from a project minus the project’s net investment ( 29 ) ( ) ( Out PV In PV NPV NINV k NCF NPV NINV PVNCF NPV n t t t - = - + = - = = 1 1
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NPV Characteristics NPV > 0 acceptable above-normal profits Considers the time value of money Absolute measure of wealth Positive NPVs increase owner’s wealth Negative NPVs decrease owner’s wealth Difficulty: NPV is measured in $. This makes it hard to compare projects with different sizes Key assumption: Cash Flows over the projects life reinvested at k
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Sources of Positive NPV Projects Buyers preferences for established brand names Control of distribution systems Patent control Exclusive ownership of superior natural resources Inability of new firms to acquire factors of production Access to lower cost financial resources Economies of scale Access to superior labor or management talents
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IRR Rate of discount that equates the PV of net cash flows of a project with the PV of the NINV ( 29 r IRR NINV r NCF n t t t = + = 1 1
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This note was uploaded on 04/08/2008 for the course FINANCE fin taught by Professor Bradley during the Spring '08 term at Clemson.

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311 ch10 - Capital Budgeting Decision Criteria and Real...

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