1. Capital Budgeting Issues
Types of Projects
Cost of Capital
Capital Budgeting
Process
Cash flows considerations
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Capital Budgeting

2. Cost of Capital Types of Projects Replacement Efficiency/replacement
Expand existing business
New business projects
Research and development
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Capital Budgeting

3. Cost of Capital Why determine cost of capital? WACC Weights
Market versus book values
Cost of debt
LT debt versus ST&LT debt
Cost of equity
Estimating R(f) and R(m)
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Capital Budgeting

4. Capital Budgeting Process 1) Estimate marginal after-tax CF
Initial invest outlays
Annual operating CF over project life
Terminal year cash flows
2) Assess risk (WACC)
3) Apply evaluation methods
PB, NPV, IRR, MIRR
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Capital Budgeting

5. Capital Budgeting Process (continued) 4) Sensitivity analysis
Vary key drivers to determine changes in NPV
5) Incorporate strategic/subjective issues
Consider flexibilities & “real options”
6) Decision
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Capital Budgeting

6. Capital Budgeting Cash flow considerations New revenues Taxes
Depreciation effect
Sunk versus opportunity costs
Changes in working capital
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Capital Budgeting

7. Capital Budgeting Cash flow considerations (continued)
Salvage of old equipment
Life of project
Role of fixed versus variable costs
operating leverage and breakeven
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Capital Budgeting