1. Business Investment Analysis
Chapter 9

2. Business Investment Analysis
Capital Budgeting or
Capital Expenditure Analysis
Application of our Theory of Value (DCF):
Forecast future “incremental” FCF (operating definition)
The operating cost is called the cost of capital.

3. Business Investment Analysis
A typical business investment has a “no growth” pattern.
Company grow because they make individual investment, but individual investment does not grow.

4. Business Investment Analysis
if NPV ≥ 0 (measure of wealth creation) - objective #1.
This investment creates wealth for financial asset holders and shareholders in particular and
should be undertaken (regardless of the source of financing:
Borrowing
Share issue
Combination)

5. Business Investment Analysis
4 types of depreciation (presumed equal):
Financial reporting (depreciation)
Depreciation for tax purposes (CCA)
Economic depreciation – reduced ability of the real asset (or business investment) to produce cash flow, if company does nothing.
Maintenance capital expenditure (MCAPX vs. CAPX)

6. Business Investment Analysis
If:
or NPV ≥ 0
or IRR ≥ Cost of Capital
or Payback period ≤ Benchmark
Payback period is the # of years to recover an investment with incremental FCF or
Then, this is a “good investment” .

7. Business Investment Analysis
There are 3 cases where you must use IRR with care :
The IRR rule must be reverted for “disinvestment”
There may exist multiple IRR. Rare, generally, but common for natural resources & energy investment.
Rule of thumb:
The # of IRRs is equal to the # of sign in cash flows changes.
The IRR can have difficulty in identifying better or worse investment from a mutually exclusive set.