Professional Documents
Culture Documents
Outline
Meaning of Capital Budgeting
Significance of Capital Budgeting Analysis
Traditional Capital Budgeting Techniques
Payback Period Approach
Discounted Payback Period Approach
Discounted Cash Flow Techniques
Capital Budgeting
Is to a company what buying
stocks or bonds is to individuals:
An investment decision where each
want a return > cost
CFs
generated by a project &
returned to company .
costs
INDIVIDUAL
CFs
generated by stocks or
bonds & returned to
individual > costs
Significance of Capital
Budgeting
10
operations
Replacement to reduce costs
Expansion of existing products or markets
Expansion into new products/markets
Contraction decisions
Safety and/or environmental projects
Mergers
Other
12
13
Independent Project
For this project, assume that it is
independent of any other potential projects
that Basket Wonders may undertake.
Independent A project whose
acceptance (or rejection) does not
prevent the acceptance of other
projects under consideration.
1
10 K
2
12 K
15 K
10 K
7K
40 K (-b) 10 K
10 K
Cumulative
Inflows
2
12 K
22 K
3
15 K
37 K
(a)
10 K
(c) 47 K
5
(d)
7K
54 K
PBP = a + ( b c ) / d
= 3 + (40 37) / 10 =
3 + (3) / 10 = 3.3
Years
40 K
40 K
10 K
30 K
12 K
18 K
Cumulative
Cash Flows
3
15 K
3 K
4
10 K
7K
5
7K
14 K
PBP Strengths
and Weaknesses
Strengths:
Weaknesses:
CFt
-100
PVCFt
-100
Cumulative-100
10
60
80
9.09
49.59
60.11
-90.91
-41.32
18.79
Discounted
= 2 + $41.32/$60.11 = 2.7 yrs
payback
CF2
+
(1+k)2
CFn
+...+
(1+k)n
- ICO
NPV Solution
Basket Wonders has determined that
the appropriate discount rate (k) for
this project is 13%.
NPV = $10,000 +$12,000 $15,000
+
+
(1.13)1 (1.13)2 (1.13)3
$10,000 $7,000
4 +
(1.13)
(1.13)5
- $40,000
NPV Solution
NPV Strengths
and Weaknesses
Strengths:
Weaknesses:
CF1
CF2
+...+
CFn
(1 + IRR)n
IRR Solution
$10,000
$12,000
$40,000 =
+
(1+IRR)1 (1+IRR)2
$15,000
$10,000
+
(1+IRR)3 (1+IRR)4
$7,000
+
(1+IRR)5
X
0.05
0.10 $41,444
$1,444
IRR $40,000
0.15 $36,841
$1,444
$4,603
$4,603
X
0.05
0.10 $41,444
$1,444
IRR $40,000
0.15 $36,841
$1,444
$4,603
$4,603
0.10 $41,444
$1,444
IRR $40,000
0.15 $36,841
($1,444)(0.05)
$4,603
X=
$4,603
X = 0.0157
10%
-100.0
10.0
60.0
80.0
10%
10%
100.0
PV outflows
66.0
12.1
158.1
TV inflows
44
MIRR = 16.5%
-100.0
PV outflows
3
158.1
TV inflows
$100
=
MIRRL =
$158.1
(1+MIRRL)3
45
47
49
CF1
PI =
(1+k)1
CF2
+
(1+k)2
CFn
+...+
(1+k)n
<< OR >>
Method #2:
PI = 1 + [ NPV / ICO ]
ICO
PI Acceptance Criterion
PI
= $38,572 / $40,000
= .9643 (Method #1, previous
slide)
PI Strengths
and Weaknesses
Strengths:
Weaknesses:
Capital Rationing
Capital Rationing occurs when a
constraint (or budget ceiling) is
placed on the total size of capital
expenditures during a particular
period.
ICO
IRR
NPV
PI
A
$
500
18%
$
50
1.10
B
5,000
25 6,500 2.30
C
5,000
37 5,500 2.10 D
7,500
20 5,000 1.67 E
12,500
26
500 1.04 F
15,000
28
21,000 2.40
G
17,500
19
7,500 1.43 H
25,000
15 6,000
1.24
ICO
IRR
NPV
PI
C
$ 5,000 37%
$ 5,500 2.10
F
15,000 28
21,000 2.40
E
12,500 26
500 1.04 B
5,000
25
6,500 2.30
Projects C, F, and E have the
three largest IRRs.
The resulting increase in shareholder wealth
is $27,000 with a $32,500 outlay.
ICO
IRR
NPV
F
$15,000 28%
$21,000
G 17,500
19
7,500 1.43 B
5,000
25
6,500 2.30
PI
2.40
two