BUA321 CH10 Capital Budgeting Techniques
BUA321 Chapter 10 Class Notes Capital Budgeting Techniques
1. What kinds of projects are analyzed with capital budgeting?
Expansion (easiest to forecast)
Replacement (more complicated)
We must forecast cashflows with and without a project
Others (non-revenue)
2. What is meant by unlimited funds?
We assume unlimited funds.
For most companies this is a fact, but not assumed by management
For small companies, funds are scarce .
3. Describe mutually exclusive projects.
Accept one; reject others
Most projects start as mutually exclusive
They end up as independent
4. What is the goal of the financial manager?
Wealth maximization
5. What are the basic investment rules?
If value >= price buy
If expected return >= required return, buy
Techniques
6. What does payback period tell us?
Time to recover investment
Very simple technique (sometimes referred to as unsophisticated)
Who uses this type of technique ?
7. Why is NPV the superior technique for analyzing projects?
It directly measures t5he change in wealth.
Not a correct thing, but can think that if you divided NPV by the number of shares, that would approximate the increase in wealth
Show how NPV is really Investment Rule #1
Content Coordinator: Dr. Lawrence Byerly

BUA321 CH10 Capital Budgeting Techniques
8. Describe the profitability index.
Show how PI is really Investment rule #1
Shows a “bang for the buck” picture
Useful in breaking ties. It can show the best way to “manage” resources.
9. Economic Value added a. http://www.youtube.com/watch?feature=player_detailpage&v=ZCaeMTSTWYs
10. Describe IRR.
This is the expected return. If you buy the project and the cash flows occur, this is the average return per period.
Investment Rule #2.
11. What can cause techniques to provide conflicting solutions?
Time
Cash flow magnitude
Cash flow timing
Reinvestment assumption
12. What methods are generally used by companies?
It does not cost more to do them all.
Just formulas.
NPV is the best (theoretically)
IRR is preferred (easier to understand)
Content Coordinator: Dr. Lawrence Byerly

BUA321 CH10 Capital Budgeting Techniques
13. Calculate the capital budgeting solutions for the following techniques:
1. Payback
2. NPV
3. Profitability Index
4. IRR b. The company has decided to purchase a new asset. The expected cost of the project is $195,000. The cost of financing projects is 13%. The expected cash flows follow:
1. 1 $40,000
2. 2 $60,000
3. 3 $85,000
4. 4 $70,000
5. 5 $50,000
Investment (CF0)
CF1
CF2
CF3
CF4
CF5
CF6
CF7
CF8
-$195,000 negative
$40,000
$60,000
$85,000
$70,000
$50,000
Payback Period
Discounted Payback
Net Present Value
IRR
Modified IRR
Profitability Index
3.143
4.397
$16,366.60
16.207%
9.359%
1.084
Content Coordinator: Dr. Lawrence Byerly

BUA321 CH10 Capital Budgeting Techniques
14. The company in problem 13 is considering another project. This one costs $400,000.
The cost of financing is the same. The forecasted cash flows are below.
1. 1 $70,000
2. 2 $100,000
3. 3 $120,000
4. 4 $145,000
5. 5 $100,000
6. 6 $80,000
7. 7 $70,000
15. Using the projects in problems 13 and 14 with the techniques, decide which projects you would do? First, assume both projects are independent. Next, assume they are mutually exclusive.
Independent – do them both
Mutually exclusive – project in 14
16) Use the two projects and create the NPV profiles for the projects.
Content Coordinator: Dr. Lawrence Byerly

BUA321 CH10 Capital Budgeting Techniques
Also look at CB: Project Analysis worksheet
Content Coordinator: Dr. Lawrence Byerly

BUA321 CH10 Capital Budgeting Techniques
Complete the following table using the data in this table.
75 points
0
1
2
3
4
5
Project A 12%
40000
13000
13000
13000
13000
13000
Project B 12%
60000
27000
25000
24000
26000
20000
Project C 12%
40000
19000
16000
13000
10000
7000
Content Coordinator: Dr. Lawrence Byerly

BUA321 CH10 Capital Budgeting Techniques
Project A
Payback rule
Payback
Discounted
Payback
3.75
Project B
3.75
Discounted payback rule
Discount rate
Payback
Discounted
Payback
NPV
IRR
PI
4.0
12%
3.077
4.070
6,862
18.72
4.0
12%
2.33
2.93
28,991
30.87
1.17 1.48
Accept if independent? Yes / no
Yes no
Yes yes
NPV
IRR
PI yes yes yes yes yes yes
Best if mutually exclusive (mark yes)
Payback
Discounted
Payback
NPV
IRR yes yes yes yes
PI yes
Project C
3.75
4.0
12%
2.385
3.162
9,299
22.81
1.23
Yes
Yes
Yes
Yes
Yes
Content Coordinator: Dr. Lawrence Byerly

BUA321 CH10 Capital Budgeting Techniques
Insert the data into the spreadsheet “CB:NPV Profile”
Copy and paste the net Present Value Profile with all three projects. (10)
What does the profile illustrate?
Content Coordinator: Dr. Lawrence Byerly

BUA321 CH10 Capital Budgeting Techniques
Insert projects A and C into the worksheet CB Project Analysis (10 points)
Which project is preferable?
Insert projects B and C into the worksheet CB Project Analysis (10 points)
Which project is preferable?
Content Coordinator: Dr. Lawrence Byerly