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Unformatted text preview: tomer base. Another potential savings: lower paper costs, because more tickets will be issued electronically, even when last-minute changes are involved. The system is more cost-effective, thereby resulting in better resource utilization and a higher ROI. Improved productivity is another benefit to be derived from this wireless project. Delta hopes to add self-service features so that passengers can choose seats, check in, and handle other routine transactions online. This will free reservations agents to handle more calls placed to purchase tickets, thus generating more revenue. Building on its initial success, Delta is ready to expand its wireless applications. A joint project with American Airlines, United Airlines, and Boeing Corporation will equip planes with broadband Internet connections so that the airlines can sell in-flight wireless services. Delta’s innovative technology initiatives have made it one of five finalists for Computerworld’s 21st Century Achievement Award. Delta based its decision to accept the wireless-communication project on the project’s positive NPV, which indicated that the project would earn a return above its cost of capital. This chapter focuses on the capital budgeting techniques, including NPV, that companies use to accept or reject and to rank proposed projects. H 395 396 PART 3 Long-Term Investment Decisions LG1 9.1 Overview of Capital Budgeting Techniques When firms have developed relevant cash flows, as demonstrated in Chapter 8, they analyze them to assess whether a project is acceptable or to rank projects. A number of techniques are available for performing such analyses. The preferred approaches integrate time value procedures, risk and return considerations, and valuation concepts to select capital expenditures that are consistent with the firm’s goal of maximizing owners’ wealth. This chapter focuses on the use of these techniques in an environment of certainty. Chapter 10 covers risk and other refinements in capital budgeting. We will use one basic problem to illustrate all the techniques described in this chapter. The problem concerns Bennett Company, a medium-sized metal fabricator that is currently contemplating two projects: Project A requires an initial investment of $42,000, project B an initial investment of $45,000. The projected relevant operating cash inflows for the two projects are presented in Table 9.1 and depicted on the time lines in Figure 9.1.1 The projects exhibit conventional cash flow patterns, which are assumed throughout the text. In addition, we initially assume that all projects’ cash flows have the same level of risk, that projects being compared have equal usable lives, and that the firm has unlimited funds. (The risk assumption will be relaxed in Chapter 10.) We begin with a look at the three most popular capital budgeting techniques: payback period, net present value, and internal rate of return.2 Hint Remember that the initial investment is an outflow occurring at...
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