3.5 Capital Budgeting, part 1

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3.5 Capital Budgeting, part 1


Pages:
19
School:
University of Texas at Austin
Course:
Fin 320f - Foundations of Finance
Foundations of Finance Documents

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We can have facts without thinking but we cannot have thinking without facts John Dewey US educator, philosopher, & psychologist (1859 – 1952) Foundations of Finance 3.5 Capital Budgeting Part 1  An operating forecast is a plan to earn revenue and incur expenses; its timeline is one year or less  A capital budget is a plan to add and/or replace assets; its timeline is more than one year  Both operating and capital budgets focus on maximizing shareholder value 2011 - 2023© H Toprac 3 Operating vs capital planning  Independent projects do not compete with one another for the firm’s resources—all can be completed simultaneously  Mutually exclusive projects compete for the firm’s resources—the firm can complete one or the other, but not both 2011 - 2023© H Toprac 4 Independent projects versus mutually exclusive projects  A replacement project involves removing an old asset and installing a new one in its place  An expansion project involves adding a new asset where none previously existed 2011 - 2023© H Toprac 5 Replacement projects versus expansion projects  Only incremental cash flows are relevant for purposes of capital budgeting  Incremental cash flows are those that change because of the project under consideration  Sunk costs are not incremental and should be ignored for capital budgeting purposes 2011 - 2023© H Toprac 6 Which cash flows are relevant?



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