1. Chapter 8 Capital Budgeting Cash Flows
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2. Learning Goals
Understand the motives for key capital budgeting expenditures and the steps in the capital budgeting process.
Define basic capital budgeting terminology.
Discuss relevant cash flows, expansion versus replacement decisions, sunk costs and opportunity costs, and international capital budgeting.
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3. Learning Goals (cont.)
Calculate the initial investment associated with a proposed capital expenditure.
Find the relevant operating cash inflows
associated with a proposed capital expenditure.
Determine the terminal cash flow associated
with a proposed capital expenditure.
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4. The Capital Budgeting Decision Process
Capital Budgeting is the process of identifying, evaluating, and implementing a firm’s investment opportunities.
It seeks to identify investments that will enhance a firm’s competitive advantage and increase shareholder wealth.
The typical capital budgeting decision involves a large up-front investment followed by a series of smaller cash inflows.
Poor capital budgeting decisions can ultimately result in company bankruptcy.
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5. Table 8.1 Key Motives for Making Capital Expenditures
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6. Steps in the Process Proposal Generation Review and Analysis
Our Focus is on Step 2 and 3
3. Decision Making
Implementation
Follow-up
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7. Basic Terminology: Independent versus Mutually Exclusive Projects
Independent Projects, on the other hand, do not compete with the firm’s resources. A company can select one, or the other, or both—so long as they meet minimum profitability thresholds.
Mutually Exclusive Projects are investments that compete in some way for a company’s resources—a firm can select one or another but not both.
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8. Basic Terminology: Unlimited Funds versus Capital Rationing
If the firm has unlimited funds for making investments, then all independent projects that provide returns greater than some specified level can be accepted and implemented.
However, in most cases firms face capital rationing restrictions since they only have a given amount of funds to invest in potential investment projects at any given time.
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9. Basic Terminology: Accept-Reject versus Ranking Approaches
The accept-reject approach involves the evaluation of capital expenditure proposals to determine whether they meet the firm’s minimum acceptance criteria.
The ranking approach involves the ranking of capital expenditures on the basis of some predetermined measure, such as the rate of return.
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10. Basic Terminology: Conventional versus Nonconventional Cash Flows
Figure 8.1 Conventional Cash Flow
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11. Figure 8.2 Nonconventional Cash Flow
Basic Terminology: Conventional versus Nonconventional Cash Flows (cont.)
Figure 8.2 Nonconventional
Cash Flow
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12. The Relevant Cash Flows
Incremental cash flows:
are cash flows specifically associated with the
investment, and
their effect on the firms other investments (both
positive and negative) must also be considered.
For example, if a day-care center decides to open another facility, the impact of customers who decide to move from one facility to the new facility must be considered.
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13. Figure 8.3 Cash Flow Components
Relevant Cash Flows:
Major Cash Flow Components
Figure 8.3 Cash Flow Components
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14. Relevant Cash Flows: Expansion Versus Replacement Decisions
Estimating incremental cash flows is relatively straightforward in the case of expansion projects, but not so in the case of replacement projects.
With replacement projects, incremental cash flows must be computed by subtracting existing project cash flows from those expected from the new project.
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15. Figure 8.4 Relevant Cash Flows for Replacement Decisions
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