Capital Budgeting
Capital Budgeting
Read Chaptes 7,8 & 9
Problems from Chapter 7 : 1 to 28 Chapter 8 : 1 to 23 Chapter 9 : 1 to 24
1. NET PRESENT VALUE
A. The Basic Idea Net present value—the difference between the market value of an investment and its cost. While estimating cost is usually straightforward, finding the market value of assets can be tricky. The principle is to find the market price of comparables or substitutes. Perspectives:
Using the text example (page 257), the basic idea behind capital budgeting is to ‘add value’. After including all of the costs (cash outflows) and revenues (cash inflows), value is added if the present value of inflows is greater than the present value of outflows. Although this point may seem rather obvious, it is often helpful to stress the word "Net" in Net Present Value. It is not uncommon for some students to carelessly calculate the PV of a project's inflows and fail to subtract out its cost. The PV of inflows is not NPV; rather NPV is the amount remaining after offsetting the PV of the inflows with the PV of the outflows. Thus, the NPV amount determines the incremental value created by undertaking the investment.
B. Estimating Net Present Value Discounted cash flow (DCF) valuation—finding the market value of assets or their benefits by taking the present value of future cash flows, i.e., by estimating what the future cash flows would trade for in today's dollars.
Net present value rule—an investment should be accepted if the NPV is positive and rejected if it is negative. In other words, if the market value of the benefits is larger than the cost, an investment will increase value.
Perspectives: Here's another perspective on the meaning of NPV. In terms of the present, if we accept a project with a negative NPV of -$2,422, this is financially equivalent to investing $2,422 today and receiving nothing in return. Therefore, the total value of the firm would decrease by $2,422. This, of course,
Read Chaptes 7,8 & 9
Problems from Chapter 7 : 1 to 28 Chapter 8 : 1 to 23 Chapter 9 : 1 to 24
1. NET PRESENT VALUE
A. The Basic Idea Net present value—the difference between the market value of an investment and its cost. While estimating cost is usually straightforward, finding the market value of assets can be tricky. The principle is to find the market price of comparables or substitutes. Perspectives:
Using the text example (page 257), the basic idea behind capital budgeting is to ‘add value’. After including all of the costs (cash outflows) and revenues (cash inflows), value is added if the present value of inflows is greater than the present value of outflows. Although this point may seem rather obvious, it is often helpful to stress the word "Net" in Net Present Value. It is not uncommon for some students to carelessly calculate the PV of a project's inflows and fail to subtract out its cost. The PV of inflows is not NPV; rather NPV is the amount remaining after offsetting the PV of the inflows with the PV of the outflows. Thus, the NPV amount determines the incremental value created by undertaking the investment.
B. Estimating Net Present Value Discounted cash flow (DCF) valuation—finding the market value of assets or their benefits by taking the present value of future cash flows, i.e., by estimating what the future cash flows would trade for in today's dollars.
Net present value rule—an investment should be accepted if the NPV is positive and rejected if it is negative. In other words, if the market value of the benefits is larger than the cost, an investment will increase value.
Perspectives: Here's another perspective on the meaning of NPV. In terms of the present, if we accept a project with a negative NPV of -$2,422, this is financially equivalent to investing $2,422 today and receiving nothing in return. Therefore, the total value of the firm would decrease by $2,422. This, of course,