Problems and Some Solutions Capital Budgeting is usually a cooperative effort, which leads
to some problems:
Ensuring That Forecasts Are Consistent To ensure consistency, begin the capital
budgeting process by establishing forecasts of economic indicato
Calculating Cash Flow A projects cash flow is composed of three elements:
1. Cash Flows from capital investments.
2. Operating Cash Flows.
3. Cash Flows from changes in Working Capital.
Capital Investment In order to start a project, a company needs to ma
Bubbles and Market Efficiency These Bubbles are when prices as a whole can no longer be
justified. The stock prices rose to levels hard to reconcile with reasonable outlooks for dividends
and earnings. (Ex. The Dot-Com Bubble, the technology heavy NASDAQ
When calculating to find the Internal Rate of Return (IRR) first try a zero discount rate. If
the NPV is positive then the IRR must be greater then zero. Next, try a discount rate of
50%. If negative then the IRR must lie between 0% and 50%.
When we c
Method 2: Fundamental Analysis This is when investors who attempt to find mispriced
securities by analyzing fundamental information, such as accounting performance and earnings
prospects. This analysis contrasts the technical analysis who focus on past st
Break Infinite Comparative Visuals
This line graph compares our Unit Labor Cost to other organizations within our
industry. It is good to keep this as low a number as possible. Although we are not the
leading firm in this category, we are close to it. B
Break-Even Analysis Analysis of the level of sales at which the project breaks even.
Accounting Break-Even Analysis The level of sales at which profits are zero or, equivalently,
at which total revenues equal total costs.
*Break-Even Level of Revenues = F
Capital Rationing Refers to a shortage of funds available for investment. Some big firms can
obtain large amounts of money at short notice, so why does top management sometimes tell
subordinates that capital is limited and that they may not exceed a speci
Remember Terminal Cash Flows The end of a project almost always brings
additional cash flows. Like the salvage value of selling a plant or equipment.
There are also sometimes expenses in shutting down a project.
Beware of Allocated Overhead Costs A pr
2 rules for deciding whether to go ahead with an investment project are:
1. The NPV Rule Invest in any project that has a positive NPV when its cash flows are
discounted at the Opportunity Cost of Capital.
2. The Rate of Return Rule Invest in any project