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CHAPTER 13



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13 1 CHAPTER 13 The Basics of Capital Budgeting Evaluating Cash Flows Should we build this plant Copyright 2002 Harcourt Inc All rights reserved 13 2 What is capital budgeting nAnalysis of potential additions to fixed assets nLong term decisions involve large expenditures nVery important to firm s future Copyright 2002 Harcourt Inc All rights reserved 13 3 Steps 1 Estimate CFs inflows outflows 2 Assess riskiness of CFs 3 Determine k WACC for project 4 Find NPV and or IRR 5 Accept if NPV 0 and or IRR WACC Copyright 2002 Harcourt Inc All rights reserved 13 4 What is the difference between independent and mutually exclusive projects Projects are independent if the cash flows of one are unaffected by the acceptance of the other mutually exclusive if the cash flows of one can be adversely impacted by the acceptance of the other Copyright 2002 Harcourt Inc All rights reserved 13 5 An Example of Mutually Exclusive Projects BRIDGE vs BOAT to get products across a river Copyright 2002 Harcourt Inc All rights reserved 13 6 Normal Cash Flow Project Cost negative CF followed by a series of positive cash inflows One change of signs Nonnormal Cash Flow Project Two or more changes of signs Most common Cost negative CF then string of positive CFs then cost to close project Nuclear power plant strip mine Copyright 2002 Harcourt Inc All rights reserved 13 7 Inflow or Outflow in Year 0 1 2 3 4 5 N N N N Copyright 2002 Harcourt Inc NN NN NN All rights reserved 13 8 What is the payback period The number of years required to recover a project s cost or how long does it take to get the business s money back Copyright 2002 Harcourt Inc All rights reserved 13 9 Payback for Project L Long Most CFs in out years 0 1 CFt 100 Cumulative 100 PaybackL 2 Copyright 2002 Harcourt Inc 10 90 30 80 2 2 4 3 60 100 30 0 80 50 2 375 years All rights reserved 13 10 Project S Short CFs come quickly 0 CFt 100 Cumulative 100 PaybackS 1 6 2 3 70 100 50 20 30 40 1 0 20 1 30 50 1 6 years Copyright 2002 Harcourt



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