Study Unit 10 Investment Decisions

SU – The Capital Budgeting Process Definition – Planning and controlling investment for long-term projects. Capital budgeting unlike other considerations will affect the company for many periods going forward. Predicting the need for future capital assets is one of the more challenging task, which can be affected by: Inflation Interst rates Cash availability Market demands What are the applications for capital budgeting? Buying equipment Building facilities Acquiring a business Developing a product of product line Expanding into new markets Continue

SU – The Capital Budgeting Process Consider the tax consequences All decisions should be done on an after tax basis Considered costs Avoidable cost Common cost Deferrable cost Fixed cost Imputed cost Incremental cost Opportunity cost Relevant cost Sunk Weighted-average Continued

SU – The Capital Budgeting Process Stages in Capital Budgeting Identification Search Information-acquisition Selection Financing Implementation and monitoring Continued

SU – The Capital Budgeting Process Investment Ranking Steps Det. Net Investment Costs Calculating est. cash flows Comparing cash-flows to Net Investment Costs Ranking investments Other considerations Book vs. cash accounting Relevant cash flows Net initial investment Annual net cash flows Project termination cash flows Inflation Post-audits Questions 5 – 7 on page 414

SU – 10.2 Discounted Cash flow Analysis Time Value of Money Concepts Present Value (PV) Future Value (FV) Annuities – equal payments at equal intervals Ordinary annuity (in arrears) Annuity due (in advance) – PV & FV is always greater than ordinary annuity Hurdle rate Net Present Value (NPV) Internal Rate of Return (IRR) Continued

SU – 10.2 Discounted Cash flow Analysis Cash flows and discounting NPV = Cash flow 0 Cash flow 1 Cash flow 2 (1 + r) 0 (1 + r) 1 (1 + r) 2 IRR shortcomings - Directional changes of cash flows Mutually exclusive projects Varying rates of return Multiple investments NPV vs IRR comparison

SU – 10.3 Payback and discounted payback Definition of Payback Payback and constant cash flows vs variable cash flows Discounted payback method and other payback methods

SU 10.4 Ranking investment projects Why should we rank investment projects Methods Profitability index Internal capital markets Linear programming

SU 10.5 Comprehensive Example Page 405

SU 10.6 Risk Analysis and real options in Capital Investments Risk analysis Real (managerial or strategic) options