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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 Net Present Value Internal Rate of Return Profitability Index Net Present Value versus Internal Rate of Return
corporate treasurer has to make. So much is the significance of capital budgeting that many business schools offer a separate course on capital budgeting
resources Are not easily reversible Have long-term implications for the firm Involve uncertainty and risk for the firm
become critical and must be evaluated very carefully. Any firm that does not follow the capital budgeting process will not be maximizing shareholder wealth and management will not be acting in the best interests of shareholders. RJR Nabiscos smokeless cigarette project example Similarly, Euro-Disney, Concorde Plane, Saturn of GM all faced problems due to bad capital budgeting, while Intel became global leader due to sound capital budgeting decisions in 1990s.
investment The number of years it takes including a fraction of the year to recover initial investment is called payback period To compute payback period, keep adding the cash flows till the sum equals initial investment Simplicity is the main benefit, but suffers from drawbacks Technique is not consistent with wealth maximizationWhy?
minus initial investment Technique is consistent with the principle of wealth maximizationWhy? Accept a project if NPV 0
flows of a project is zero, I.e., the rate at which the present value of cash inflows equals initial investment Projects promised rate of return given initial investment and cash flows Consistent with wealth maximization Accept a project if IRR Cost of Capital