IEN255 Chapter 13 - Capital
Budgeting Decisions
 Capital Budgeting - involves decisions related to
fixed assets
 Capital Budgeting - the whole process
Budgeting!!!!

Choice of financing, schedule of investment opportunities, and
estimate of MARR
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Methods of Financing
 Investment not independent of source of financing
 Equity financing
 use of retained earnings otherwise paid to
stockholders
 issuance of stock
 cost associated with issue (flotation cost)
 raise capital to finance projects!
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Example 13.1
 Solution only
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f
Debt Financing
 Short term borrowing from banks (term loans)
 sale of long-term bonds (bond financing, includes
floatation costs)
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Example 13.2
 Solution only
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Capital structure
•Debt Ratio (Capital structure)- percentage of total capital
provided by borrowed funds
•Target Debt Ratio - firm’s desired ratio (if actual debt ratio is
below target level, any new capital will probably raised by issuing new debt)
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Cost of Capital
 Cost of equity - opportunity cost, rate of return for stockholders
 eqn bottom of 686
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Cost of Retained Earnings
all blue eqns on 687
with flotation costs
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D0
ke 
g
P0 (1  f c )
(13.2)
Cost of Preferred Stock/Equity
 Preferred Stock
D*
ke  *
P (1  f c )
(13.3)
 equity
ie  ak r  bke  ck p
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(13.4)
Example 13.4
 Solution only
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Cost of Debt
 Specific cost of debt component
id  dks (1  tm )  (1  d )kb (1  tm )
Blue part of 691
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(13.5)
Calculating the Cost of Capital
 Weighted Average
id Cd ieCe
k 

V
V
 example 13.6
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(13.6)
Choice of MARR
 One value is NOT always right
 If Project Financing Known
 page 694
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MARR when financing unknown
 Depreciation Expenses under Inflation
 page 695 and 696
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MARR under Capital Rationing
 Page 699 - comments
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Capital Budgeting
 Terms (independent and dependent projects)
 Formulation
 Independent
 table at top of 702
 contingent
Mutually Exclusive
table middle of 702
table at bottom of 702
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Capital Budgeting w/ limited budgets
 Solution a) on pg 704 and 705
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Capital Budgeting w/ limited budgets
 figure 13.5 and table 13.5
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IEN255 Summer’99 Chapter 10,11,13
HW#4
 Homework Assignment:
Chapter 10
#’s 10.4; 10.6; 10.24
Chapter 11
#’s 11.1; 11.6; 11.13
Chapter 13
#’s 13.9
 Due together (Tues July 27)
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