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UnitVI

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UNIT VI STUDY GUIDE
Capital Budgeting and
Value Creation
Course Learning Outcomes for Unit VI
Upon completion of this unit, students should be able to:
1. Synthesize traditional capital budgeting concepts with valuing capabilities theory.
1.1 Devise a strategy for dealing with sustainable capital costs.
1.2 Combine capital costs with sustainable capital costs.
1.3 Justify new techniques for dealing with creating value in an organization.
Reading Assignment
Chapter 7: Capital Budgeting Processes and Techniques
Chapter 8: Cash Flows and Capital Budgeting
Chapter 9: Cost of Capital and Project Risk
Unit Lesson
Benjamin Sharpe successfully built his commercial real estate business by investing in undervalued
properties. Sharpe relied on traditional capital budgeting measures like net present value (NPV), internal rate
of return (IRR), profitability index (PI), and payback to evaluate real estate investments. Especially when
Sharpe first started his business, he found sources of capital were limited and had to ration capital amongst
the best opportunities determined by traditional capital budgeting methods.
As Sharpe's business grew, he developed alternative sources of capital and could rely more on outside
capital sources to grow his business. For example, Sharpe established a credit line with his bank, built
relationships with other commercial real estate investors, and had a solid financial track record he could take
to the bond and stock markets to raise capital.
Besides building greater access to capital, Sharpe believed opportunities existed in the market he could only
take advantage of if he made an investment in them. Only with time would these opportunities come more
clearly into focus. Sharpe knew also if he did not invest in these opportunities early on he could lose the
opportunity to reap the rewards from them.
Because of the uncertain possibilities, Sharpe believed he could reshape the capital budgeting process in his
company to consider all potential opportunities instead of losing some of them. Sharpe asked Milton Muller,
his chief financial officer, to revisit the capital budgeting process to consider these uncertain projects.
Armed with this directive from Sharpe, Muller started to explore other ways to evaluate projects that would
consider those highly uncertain ones that could materialize down the road. Muller belonged to a financial
officers group and decided to see what some other chief financial officers used to evaluate uncertain projects
and include them in the mix.
Meanwhile, Sharpe observed the financial recovery saw more people starting to move to the city because of
the cost of commuting and the lack of jobs in suburban areas. Businesses also expressed a preference to
locate in urban areas for a more stable labor supply and a more central location. Urban areas had a higher
concentration of space and many existing buildings either needed renovation and rebuilding or major
remodeling. Sharpe clearly needed a new plan to take advantage of these trends.
Despite his reliance on traditional capital budgeting methods, Muller kept an open mind about exploring new
ways to evaluate projects and add value to the firm. Muller learned other companies used some other
DBA 8341, Corporate Finance
1
methods to evaluate projects and consider some of the more uncertain opportunities. For example, Muller
learned more about other techniques such as real options, decision trees, and Monte Carlo analysis from his
financial officer's group.
Suggested Reading
In order to access the resources below, you must first log into the myCSU Student Portal and access the
Business Source Complete database within the CSU Online Library.
Brealey, R. A., Myers, S. C., & Allen, F. (2008). Brealey, Myers, and Allen on real options. Journal of Applied
Corporate Finance, 20(4), 58-71. doi:10.1111/j.1745-6622.2008.00204.x
Cotter, J., Marcum, B., & Martin, D. (2003). A cure for outdated capital budgeting techniques. The Journal of
Corporate Accounting & Finance, 14(3), 71-80. Retrieved from
http://ezproxy.apollolibrary.com/login?url=http://search.proquest.com.ezproxy.apollolibrary.com/docvi
ew/201580620?accountid=35812
Chang, C., & Chen, M. (2012). Re-examining the investment-uncertainty relationship in a real options model.
Review of Quantitative Finance and Accounting, 38(2), 241-255.
Park, C. S., & Herath, H. S. B. (2000). Exploiting uncertainty--investment opportunities as real options: A new
way of thinking in engineering economics. Engineering Economist, 45(1), 1.
The resource below is not available in the CSU Online Library but may be available for purchase online.
Figge, F., & Hahn, T. (2005). The cost of sustainability capital and the creation of sustainable value by
companies. Journal of Industrial Ecology, 9(4), 47-58. doi:10.1162/108819805775247936
Learning Activities (Nongraded)
Nongraded Learning Activities are provided to aid students in their course of study. You do not have to
submit them. If you have questions, contact your instructor for further guidance and information.
Understanding terminology is not only vital to understanding a particular industry, profession, or field of study,
but is also necessary to communicate effectively. This learning activity will help you build your professional
vocabulary.
Click here to access Unit VI Learning Activity.
DBA 8341, Corporate Finance
2
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