MANAGERIAL ECONOMICS 11 th Edition By Mark Hirschey.

Slides:



Advertisements
Similar presentations
Principles of Managerial Finance 9th Edition
Advertisements

The Capital Budgeting Decision (Chapter 12)  Capital Budgeting: An Overview  Estimating Incremental Cash Flows  Payback Period  Net Present Value 
INVESTMENT ANALYSIS OR CAPITAL BUDGETING. What is Capital Budgeting? THE PROCESS OF PLANNING EXPENDITURES ON ASSETS WHOSE RETURN WILL EXTEND BEYOND ONE.
Chapter 10 Capital-Budgeting Techniques and Practice.
© Prentice Hall, Chapter 8 Evaluating Investment Projects Shapiro and Balbirer: Modern Corporate Finance: A Multidisciplinary Approach to Value.
1 PowerPointPresentation by PowerPoint Presentation by Gail B. Wright Professor Emeritus of Accounting Bryant University © Copyright 2007 Thomson South-Western,
1 The Basics of Capital Budgeting: Evaluating and Estimating Cash Flows Corporate Finance Dr. A. DeMaskey Should we build this plant?
B280F Introduction to Financial Management
CAPITAL BUDGETING TECHNIQUES
4-1 Business Finance (MGT 232) Lecture Capital Budgeting.
Capital Budgeting Net Present Value Rule Payback Period Rule
Chapter 10 - Capital Budgeting
Chapter 9. Investment In Long-Term Assets Chapter Objectives Difficulty in finding profitable projects Use capital budget techniques to evaluate new.
CHAPTER 12 THE CAPITAL BUDGETING DECISION Capital Expenditures Decision §CE usually require initial cash outflows in hope of future benefits or cash.
1 第四章 資本投資之評估 Evaluating Capital Investment (Capital Budgeting)
Principles of Corporate Finance Session 17 & 18 Unit III: Capital Budgeting And its Practices.
Capital Budgeting (I): Different Approaches (Ch 9) Net Present Value The Payback Rule The Discounted Payback The Average Accounting Return The Internal.
CAPITAL BUDGETING (A Short Review). CAPITAL BUDGETING Recall that one reason money has a time value is because of the opportunity to invest in productive.
CAPITAL BUDGETING. CAPITAL EXPENDITURES AND THEIR IMPORTANCE The basic characteristics of a capital expenditure (also referred to as a capital investment.
CAPITAL BUDGETING AND LEASING Chapter 4. Investment The addition of durable assets to a business Disinvestment is the withdrawal of durable assets from.
The Finance Function and Business Strategy. Accounting Accounting is the process of measuring, interpreting, and communicating financial information to.
Chapter 10 Capital Budgeting Techniques. 2 Bennett Company is a medium sized metal fabricator that is currently contemplating two projects: Project A.
Contemporary Engineering Economics, 4 th edition, © 2007 Choice of MARR Lecture No. 62 Chapter 15 Contemporary Engineering Economics Copyright © 2006.
Cost of Capital Minggu 10 Lecture Notes.
Capital Budgeting Decision Tools 05/17/06. Introduction Capital Budgeting is the process of identifying, evaluating, and implementing a firm’s longer.
Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2000 Chapter Three Opportunity Cost of Capital and of Capital and Capital Budgeting.
Chapter 10: The Basics Of Capital Budgeting. 2 The Basics Of Capital Budgeting :
Capital Budgeting Chapter 13. Capital Budgeting uThe process of planning investments in assets whose cash flows are expected to extend beyond one year.
Capital Expenditure Decisions Chapter 16 Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
Capital Budgeting - Measuring Investment Returns 6 th June 2014.
Chapter 13 Capital Budgeting Techniques. Learning Objectives After studying Chapter 13, you should be able to: Understand the payback period (PBP) method.
1 Cost of Capital Chapter Learning Objectives Learning Objectives  Explain the concept and purpose of determining a firm’s cost of capital.  Identify.
Ch.11 Capital Budgeting 1. Goals: 1) After tax cash flow 2) Capital budgeting decision techniques 3) “Solver” to determine the firm’s optimal capital budgeting.
Risk, Return, and Capital Budgeting (Chapter 12) Financial Policy and Planning (MB 29)
Ch 12: Capital Budgeting Decision Criteria
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Capital Budgeting Chapter 11.
Opportunity Cost of Capital and Capital Budgeting
Long-Run Investment Decisions: Capital Budgeting
Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Choice of MARR and Capital Budgeting.
Business Finance (MGT 232)
Capital Budgeting The Capital Budgeting Decision Time Value of Money Methods of Capital Project Evaluation Cash Flows Capital Rationing The Value of a.
1 Copyright © 2008 Cengage Learning South-Western Heitger/Mowen/Hansen Capital Investment Decisions Chapter Twelve Fundamental Cornerstones of Managerial.
Exam 3 Review.  The ideal evaluation method should: a) include all cash flows that occur during the life of the project, b) consider the time value of.
Chapter 8 The Cost of Capital Fin 320 Dr. B. Asiri © 2005 Thomson/South-Western.
1. 2 Learning Outcomes Chapter 11 Compute the component cost of capital for (a) debt, (b) preferred stock, (c) retained earnings, and (d) new common equity.
Opportunity Cost of Capital and Capital Budgeting Chapter Three Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights Reserved. 1-1 McGraw-Hill/Irwin © 2008 The McGraw-Hill Companies, Inc., All Rights.
Chapter 8 Capital Asset Selection and Capital Budgeting.
Summary of Previous Lecture We covered following topics in our previous lecture; capital budgeting” and the steps involved in the capital budgeting process.
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton ©2008 Prentice Hall Business Publishing,
Capital Budgeting: Decision Criteria
©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton Capital Budgeting Chapter 11.
Chapter 8 The Cost of Capital © 2005 Thomson/South-Western.
Capital Budgeting Techniques
13-1 Chapter 13 Capital Budgeting Techniques © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D.
U8-1 UNIT 8 Project Valuation Should we build this plant?
STRATEGIC FINANCIAL MANAGEMENT MEASURING RETURN ON INVESTMENTS KHURAM RAZA ACMA, MS FINANCE.
Chapter 11 The Cost of Capital 1. Learning Outcomes Chapter 11  Compute the component cost of capital for (a) debt, (b) preferred stock, (c) retained.
Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 1 Managerial Economics.
INSTRUCTORS: ANTHONY ESSEL-ANDERSON & EBENEZER SIMPSON INTRODUCTION TO FINANCE Jan. 11, Prepared by A. Essel-Anderson.
Capital Budgeting Techniques. Capital budgeting is the process of evaluating capital projects, projects with cash flows over more than one year. The four.
Cash Flows and Other Topics in Capital Budgeting
1 Capital Budgeting Techniques © 2007 Thomson/South-Western.
Net Present Value and Other Investment Criteria Chapter 9.
Planning Investments: Capital Budgeting
INVESTMENT ANALYSIS OR CAPITAL BUDGETING
Chapter 14 Long-Run Investment Decisions: Capital Budgeting
Managerial Economics in a Global Economy
Planning Investments: Capital Budgeting
CAPITAL BUDGETING.
Presentation transcript:

MANAGERIAL ECONOMICS 11 th Edition By Mark Hirschey

Capital Budgeting Chapter 18

Chapter 18 OVERVIEW Capital Budgeting Process Steps in Capital Budgeting Cash Flow Estimation Example Capital Budgeting Decision Rules Project Selection Cost of Capital Optimal Capital Budget

Chapter 18 KEY CONCEPTS capital budgeting replacement projects cost reduction projects safety and environmental projects expansion projects incremental cash flows net present-value (NPV) cost of capital profitability index (PI) internal rate of return (IRR) payback period net present-value profile crossover discount rate component cost of debt component cost of equity risk-free rate of return (RF) risk premium (RP) beta coefficient weighted average cost of capital optimal capital structure optimal capital budget investment opportunity schedule (IOS) marginal cost of capital post-audit

Capital Budgeting Process What Is Capital Budgeting? Planning expenditures that generate cash flows expected to stretch beyond one year. Project Classification Types Replacement projects are expenditures necessary to replace worn-out or damaged equipment. Cost reduction projects include expenditures to replace serviceable but obsolete plant and equipment. Safety and environmental projects are mandatory investments that may not produce revenues. Expansion projects increase the availability of existing products and services

Steps in Capital Budgeting Sequence of Project Valuation Project cost must be determined. Management must estimate the expected cash flows. Risk of projected cash flows must be estimated. Given the risk of projected cash flows, the firm must determine an appropriate discount rate. Expected cash flows must be converted to present- values. Compare present-value of expected cash inflows with the required outlay. Cash Flow Estimation Expected cash inflows and outflows must be estimated within a consistent and unbiased framework.

Capital Budgeting Decision Rules Net Present-value Analysis If NPV > 0, the project should be accepted. If NPV < 0, the project should be rejected. Profitability Index or Benefit/cost Ratio Analysis PI > 1 indicates a desirable investment. PI < 1 indicates an undesirable investment. Internal Rate of Return Analysis Accept when IRR > k; reject when IRR < k. Payback Period Analysis

Project Selection Reasons for Decision Rule Conflict NPV analysis has large project bias. With scarce capital, PI method can lead a better project mix. IRR can overstate attractiveness if you can’t reinvest excess cash flows at the IRR. Ranking Reversal Problem Ranking reversal occurs when a switch in project standing follows an increase in the relevant discount rate. Crossover discount rate is an interest factor that equates NPV for two or more projects

Making the Correct Investment Decision NPV ranking results in a value-maximizing selection of projects. With limited resources, PI approach allocates scarce resources to projects with the greatest relative effect on value.

Cost of Capital Component Cost of Debt Financing After-tax cost of debt, k d = (Interest Rate) × (1.0 - Tax Rate). Component Cost of Equity Financing Cost of equity is a risk-free rate, R F, plus a risk premium, R P : k e = R F + R P. Weighted Average Cost of Capital Marginal cost of a composite dollar of debt and equity financing.

Optimal Capital Budget Investment Opportunity Schedule IOS shows the pattern of returns for all potential investment projects Marginal Cost of Capital MCC is the extra financing cost necessary to fund an additional investment project. Post-audit Careful examination of actual and predicted results. Detailed reconciliation of any differences.