BUA321 Chapter 10 Capital Budgeting Techniques. Capital Budgeting Terminology What kinds of projects are analyzed with capital budgeting? What is meant.

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Presentation transcript:

BUA321 Chapter 10 Capital Budgeting Techniques

Capital Budgeting Terminology What kinds of projects are analyzed with capital budgeting? What is meant by unlimited funds? Describe mutually exclusive projects.

Techniques What is the goal of the financial manager? What are the basic investment rules?

Techniques What does payback period tell us? Why is NPV the superior technique for analyzing projects? Describe the profitability index.

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Techniques Describe IRR. What can cause techniques to provide conflicting solutions? What methods are generally used by companies?

Example Calculate the capital budgeting solutions for the following techniques: NPV Profitability Index IRR Payback The company has decided to purchase a new asset. The expected cost of the project is $195,000. The cost of financing projects is 13%. The expected cash flows follow: 1 $40,000 2 $60,000 3 $85,000 4 $70,000 5 $50,000

Example The company is considering another project. This one costs $400,000. The cost of financing is the same. The forecasted cash flows are below. – 1 $70,000 – 2 $100,000 – 3 $120,000 – 4 $145,000 – 5 $100,000 – 6 $80,000 – 7 $70,000

Capital Budgeting Decisions Using the above projects, decide which projects you would do? First, assume both projects are independent. Next, assume they are mutually exclusive. Use the two projects and create the NPV profiles for the projects.

Chapter 10 Exercise Complete the following table using the data in this table. Project A 12%Project B 12%Project C 12%

Project AProject BProject C Payback rule3.75 Discounted payback rule4.0 Discount rate12% Payback Discounted Payback NPV IRR PI Accept if independent? Yes / No Payback Discounted Payback NPV IRR PI Best if mutually exclusive (mark yes / no) Payback Discounted Payback NPV IRR PI

Net Present Value Profile Copy and paste the net Present Value Profile with all three projects. (10) What does the profile illustrate?