The process of planning and evaluating expenditures on assets whose cash flows are expected to extend beyond one year - analysis of potential additions to fixed assets - long term decisions involving large expenditures - very important to a firms future
A firms growth and its ability to remain competitive depend on a constant flow of _____ for new products, ways to make existing products better, and ways to produce output at a lower cost.
Procedures must be established for evaluating the _____ of capital procedures
Project Classification - Whether to purchase capital assets to take the place of existing assets to maintain or improve profitable operations using existing production levels.
Project Classification - Whether to purchase capital projects and add them to existing assets to increase production levels.
Project Classification - Projects whose cash flows are not affected by decisions made about other projects; acceptance of one project does not affect the acceptance of the other projects.
Project Classification - A set of projects where the acceptance of one project means the others cannont be accepted.
Mutually Exclusive Projects
The length of time before the original cost of an investment is recovered from the expected cash flow or how long it takes to get our money back. Provides an indication of a project's risk and liquidity and it is easy to calculate and understand. But it ignores TVM and cash flows occuring after.
The length of time it takes for a project's discounted cash flows to repay the cost of the investment. Uses discounted cash flows at a specified time. If DPB < Projects Life, Accept the project
Discounted Payback Period
Sum of the PVs of Inflows and Outflows - shows by how much a firms value and thus stockholders' wealth will increase if a capital budgeting project is purchased
Net Present Value - for Capital Budgeting Decisions
the discount rate that forces PVinflows to equal the cost. Same as forcing NPV to equal 0.
Internal Rate of Return (IRR)
How is a projects IRR related to a Bond's YTM?
they are the same
If IRR> the firm's requrired rate of return, r, then _____ _____ is left over to boost stockholders' returns
A curve showing the relationship between a projects NPV and various discount rates (required rates of return)
Smaller project frees up funds at t = 0 for investment. The higher the opportunity cost, the more valuable these funds, so high r favors these projects.
Size (Scale) Differences
A project with faster payback provides more CF in early years for reinvestment. If r is high, early CFs are especially good.
NVP assumes reinvestment at
IRR assumes reinvestment at
Reinvestment at the opportunity cost, r, is more realistic, so the ____ method is best. ___should be used to choose between mutually exclusive projects.
Firms use decision making methods that are based on ____ _____ concepts
Which capital budgeting methods do firms actually use