Capital Budgeting Rules: NPV‚ IRR‚ Payback‚ Discounted Payback‚ AAR Categories of Plans 1. Replacement Projects: decisions to replace old equipment – those are among the easier of capital budgeting techniques. It is important to decide whether to replace the equipment when it wears out or to invest in repairing the machine. 2. Expansion Projects: These are decisions whether to increase the size of business or not – they are more uncertain than replacement projects. 3. New products and services: These
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Capital budgeting is the process of evaluating a company’s potential investments and deciding which ones to accept. A company’s market value added (MVA) is the sum of all its projects’ net present values (NPVs). Basically‚ one can calculate the free cash flows (FCFs) for a project in much the same way as for a firm. When a project’s free cash flows are discounted at the appropriate risk-adjusted rate‚ the result is the project’s value. One difference between valuing a firm and a project is the
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( Answers to Mini-Case Questions BioCom Inc. This mini-case provides a review of the methodology and rationale associated with the various capital budgeting evaluation methods such as payback period‚ discounted payback period‚ NPV‚ IRR‚ MIRR‚ and PI. 1. Compute the payback period for each project. |Time of Cash Flow |Nano Test Tubes |Microsurgery Kit | |Investment |−$11‚000.00 |−$11‚000.00
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to evaluate a potential investment. There are discounted and non-discounted cash-flow capital budgeting criteria to evaluate proposed investments. They are 1) Net present value: NPV is a discounted cash flow technique‚ which is the difference between an investment’s market value and its cost. NPV = Present value of cash inflow- Present value of cash outflow The investment should be accepted if the net present value is positive and rejected if it is negative. 2) Profitability
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5 1‚500‚000 0.567 850‚500 3‚049‚700 NPV = CF1/(1+k)1 + CF2/(1+k)2 + CF3/(1+k)3 + CF4/(1+k)4 + CF5/(1+k)5 – CF0 Calculator solution = 349‚700 NPV = 3‚049‚700 - 2‚700‚000 NPV = 349‚700 IRRX = 16.22% Plan Y Year CF PVIF12%‚n PV 1 380‚000 0.893 339‚340 2 700‚000 0.797 557‚900 3 800‚000 0.712 569‚600 4 600‚000 0.636 381‚600 5 1‚200‚000 0.567 680‚400 2‚528‚840 NPV = CF1/(1+k)1 + CF2/(1+k)2 + CF3/(1+k)3 + CF4/(1+k)4
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is called Net Present Value (NPV). Assuming you will be maximizing the shareholders wealth‚ when calculating the NPV‚ the project with the positive outcome will be the project that should be pursued. In capital budgeting‚ the profitability index (PI) measures the dollar return for the amount invested. Hence‚ PI is useful for capital rationing (Ross‚ et al‚ 2005‚ p. 14). The investment in net working capital is an important part of any capital budgeting analysis. NPV calculates all cash flows rather
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capital budgeting tools that financial managers and analysts use to evaluate the merits of an investment. Some of these techniques are quite intuitive and simple to use‚ such as payback analysis. Other techniques are a little more complex‚ such as the NPV and IRR approaches. In general‚ the more complex techniques provide more comprehensive evaluations‚ however‚ the simpler approaches often lead to the same value-maximizing decisions. Chapter 11 illustrates how to develop the capital budgeting cash flows
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decision. Linn is facing two simple choices: to buy a new capsize vessel for leasing or not buying it so as to maintain the company’s previous operating status. The following is an analysis of the NPV of the investment‚ based on multiple scenarios. The scenario that garners the greatest favorable NPV is the optimal choice. * Scenarios under different tax rates and years Net present value are calculated based on given data including annual operating days‚ daily hire rates‚ daily operating costs
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of each period we have a NPV of 79‚246 ‚ which is greater than the NPV of our project which is 23‚720. So assuming equal life of the projects and no other side-effect we would prefer to rent the site. Time 0 1st Year 2nd Year 3rd Year 4th Year 25‚000 25‚000 25‚000 25‚000 22‚727 20‚661 18‚783 17‚075 NPV: 79‚247 PVIF(10%‚1)( 25‚000) = 22‚727 PVIF(10%‚2)( 25‚000) = 20‚661 PVIF(10%‚3)( 25‚000) = 18‚783 PVIF(10%‚4)( 25‚000) = 17‚075 NPV
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Thinking 4. Evaluate the strengths and weaknesses of the Cash Payback Period‚ Discounted Cash Payback Period‚ NPV‚ IRR and MIRR capital expenditure budgeting methods. Prepare a recommendation for Stewart regarding the capital budgeting method or methods to use in evaluating the expansion alternatives. Support your answer. Capital budgeting techniques such as payback period‚ net present value (NPV)‚ internal rate of return (IRR) and modified internal rate of return (MIRR) all offer particular strengths
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