Planning ahead for long-term, expensive projects Capital Budgeting Planning ahead for long-term, expensive projects

Reasons for taking on a project Quantitative Qualitative Financially more favorable than other projects Improves profits and/or net cash inflow in the future Increases cash revenues or accrual revenues decreases cash expenses or accrual expenses More sophisticated techniques take into account the time value of money concerning cash flows over the entire length of the project To maintain/improve a high quality product or service How does this project impact the following: customers community employees others Current and future qualitative impacts often affect future quantitative impacts

Techniques that look at cash flows and use time value of money (TVM) Net Present Value (NPV) Internal Rate of Return (IRR) Considers a hurdle rate, such as the cost of capital Takes into account the timing of future cash flows (cash benefits from revenues and cash savings on expenses) Considers the full length of the project Considers any projected future cash inflow from salvage when asset is sold If NPV is zero, it is an acceptable project If NPV is positive, it returns more than the hurdle rate If NPV is negative, it returns less than the hurdle rate Determines the exact percentage return on a project Takes into account time value of money Uses estimates of projected cash inflows/outflows for the project Considers the full length of the project Considers any future flow for salvage when asset is sold If NPV equals zero, then the hurdle rate equals IRR

Present value index – limited benefit but involves cash flows and present value Present value of cash inflows divided by present value of cash outflows for a project Determines which project has the higher return without giving the exact amount of percentage return Limited benefit –may as well do IRR to get exact return!

Methods that do not use the time value of money Cash Payback Unadjusted rate of return Easy to understand Uses net cash inflows/outflows How long does it take on an annual basis for cash in to equal the initial cash out? Does not consider the cash flows from total length of the project Does not consider the cash flow from the salvage value at the end of the project Does not use TVM Expressed as a percentage return (though not as useful as IRR) Uses net income instead of cash flow Does not consider the impact of the total length of the project Does not consider the impact from the sale of the asset Does not use TVM