FIN 614: Financial Management
Larry Schrenk, Instructor
1. What is Capital Budgeting?
2. Importance of Capital Budgeting
3. Overview of Capital Budgeting (Topics
7 and 8)
Decisions about where to Invest the
Capital Raised by the Firm
Valuation Techniques for Real Asset
Investment Decisions
Long-Term Decisions Involving Large
Expenditures
Firm Value Maximization
Most Important Financial Function
Decisions continue for many future years,
so firm loses some flexibility
Define firm’s strategic direction
Timing Key: Assets must be available when
needed
Parallel to Valuing Financial Assets
Estimate Cash Flows
Inflows & Outflows
Assess Risk of Cash Flows
Determine Discount Rate for Cash Flows
Find PV of Cash Flows
1. Replacement to Continue Profitable
2.
3.
4.
5.
6.
7.
8.
Operations
Replacement to Reduce Costs
Expansion of Existing Products or
Markets
Expansion into New Products/Markets
Contraction Decisions
Safety and/or Environmental Projects
Mergers
Other
Independent, if the cash flows of one
are unaffected by the acceptance of
the other.
Mutually exclusive, if the cash flows of
one can be adversely impacted by the
acceptance of the other.
Decision Criteria (Topic 7)
Cash Flow Analysis (Topic 8)
Determining Period Cash Flows for Project
Risk Analysis
Sensitivity Analysis
Scenario Analysis
Monte Carlo Simulation
Real Options
Techniques to Decide which Projects a
Firm Should Undertake
Goal: Select Only Projects that Increase
Firm Value
1. Recognize the Time Value of Money
2. Incorporate All Relevant Free Cash Flows
3. Avoid Arbitrary Assumptions
4. Avoid Need for Uncertain Data
5. Avoid Excessive Complexity in Calculation
6. Avoid Technical Problems
1. Net Present Value (NPV)
2. Internal Rate of Return (IRR)
3. Modified Internal Rate of Return (MIRR)
4. Profitability Index (PI)
5. Payback Period
1. Non-Discounted
2. Discounted
Determining Period Cash Flows for Project
Depreciation, Sunk Costs, Externalities
Risk Analysis
Sensitivity Analysis
Scenario Analysis
Monte Carlo Analysis
Real Options
Application of Techniques of Financial Options,
e.g., Puts and Calls, to Capital Budgeting
Abandonment Options, Flexibility Options
FIN 614: Financial Management
Larry Schrenk, Instructor