Capital Budgeting Issues Types of Projects Cost of Capital Capital Budgeting Process Cash flows considerations 9/17/2019 Capital Budgeting

Cost of Capital Types of Projects Replacement Efficiency/replacement Expand existing business New business projects Research and development 9/17/2019 Capital Budgeting

Cost of Capital Why determine cost of capital? WACC Weights Market versus book values Cost of debt LT debt versus ST&LT debt Cost of equity Estimating R(f) and R(m) 9/17/2019 Capital Budgeting

Capital Budgeting Process 1) Estimate marginal after-tax CF Initial invest outlays Annual operating CF over project life Terminal year cash flows 2) Assess risk (WACC) 3) Apply evaluation methods PB, NPV, IRR, MIRR 9/17/2019 Capital Budgeting

Capital Budgeting Process (continued) 4) Sensitivity analysis Vary key drivers to determine changes in NPV 5) Incorporate strategic/subjective issues Consider flexibilities & “real options” 6) Decision 9/17/2019 Capital Budgeting

Capital Budgeting Cash flow considerations New revenues Taxes Depreciation effect Sunk versus opportunity costs Changes in working capital 9/17/2019 Capital Budgeting

Capital Budgeting Cash flow considerations (continued) Salvage of old equipment Life of project Role of fixed versus variable costs operating leverage and breakeven 9/17/2019 Capital Budgeting