Finance School of management Chapter 6. Capital Budgeting The basics Obiective Explain Capital Budgeting and Cost of Capital, Apply NPV Rule, and Develop Criteria of Evaluating Project STC
1 Finance School of Management Chapter 6. Capital Budgeting: The Basics Objective Explain Capital Budgeting and Cost of Capital, Apply NPV Rule, and Develop Criteria of Evaluating Project
Finance School of management Capital Budgeting Any capital budgeting process consists of three elements coming up with proposals for investment projects evaluating them deciding which ones to accept and which to reject uesTc
2 Finance School of Management Capital Budgeting u Any capital budgeting process consists of three elements: – coming up with proposals for investment projects – evaluating them – deciding which ones to accept and which to reject
Finance School of management The Nature of Project analysis Starting point: an idea for increasing shareholder wealth Procedures of project analysis Forecasting cash flows: decisions and events Flexibility of decisions in the projects uesTc
3 Finance School of Management The Nature of Project Analysis – Starting point: an idea for increasing shareholder wealth – Procedures of project analysis – Forecasting cash flows: decisions and events – Flexibility of decisions in the project’ s life
Finance School of management Objectives Investment projects fall into roughly three categories Whether to enter a new line of business Whether to invest in equipment to reduce costs Whether to replace an existing plant uesTc
4 Finance School of Management Objectives u Investment projects fall into roughly three categories: – Whether to enter a new line of business – Whether to invest in equipment to reduce costs – Whether to replace an existing plant
Finance School of management NPV Rule revisited Invest if the proposed project's NPv is positive Discount rate Opportunity cost: the rate of return on comparable Investment opportunities Cost of capital NPV: the fair market value in competitive and efficient market uesTc
5 Finance School of Management NPV Rule Revisited u Invest if the proposed project’s NPV is positive u Discount rate u Opportunity cost: the rate of return on comparable investment opportunities u Cost of capital u NPV: the fair market value in competitive and efficient market