
The process of planning and evaluating expenditures on assets whose cash flows are expected to extend beyond one year  analysis of potential additions to fixed assets  long term decisions involving large expenditures  very important to a firms future
Capital Budgeting

A firms growth and its ability to remain competitive depend on a constant flow of _____ for new products, ways to make existing products better, and ways to produce output at a lower cost.
ideas

Procedures must be established for evaluating the _____ of capital procedures
worth

Project Classification  Whether to purchase capital assets to take the place of existing assets to maintain or improve profitable operations using existing production levels.
Replacement Decisions

Project Classification  Whether to purchase capital projects and add them to existing assets to increase production levels.
Expansion Decisions

Project Classification  Projects whose cash flows are not affected by decisions made about other projects; acceptance of one project does not affect the acceptance of the other projects.
Independent Projects

Project Classification  A set of projects where the acceptance of one project means the others cannont be accepted.
Mutually Exclusive Projects

The length of time before the original cost of an investment is recovered from the expected cash flow or how long it takes to get our money back. Provides an indication of a project's risk and liquidity and it is easy to calculate and understand. But it ignores TVM and cash flows occuring after.
Payback Period

The length of time it takes for a project's discounted cash flows to repay the cost of the investment. Uses discounted cash flows at a specified time. If DPB < Projects Life, Accept the project
Discounted Payback Period

Sum of the PVs of Inflows and Outflows  shows by how much a firms value and thus stockholders' wealth will increase if a capital budgeting project is purchased
Net Present Value  for Capital Budgeting Decisions

the discount rate that forces PV_{inflows }to equal the cost. Same as forcing NPV to equal 0.
Internal Rate of Return (IRR)

How is a projects IRR related to a Bond's YTM?
they are the same

If IRR> the firm's requrired rate of return, r, then _____ _____ is left over to boost stockholders' returns
some return

A curve showing the relationship between a projects NPV and various discount rates (required rates of return)
NPV profile

Smaller project frees up funds at t = 0 for investment. The higher the opportunity cost, the more valuable these funds, so high r favors these projects.
Size (Scale) Differences

A project with faster payback provides more CF in early years for reinvestment. If r is high, early CFs are especially good.
Timing Differences

NVP assumes reinvestment at
r

IRR assumes reinvestment at
IRR

Reinvestment at the opportunity cost, r, is more realistic, so the ____ method is best. ___should be used to choose between mutually exclusive projects.
NVP

Firms use decision making methods that are based on ____ _____ concepts
fundamental valuation

Which capital budgeting methods do firms actually use
NPV and IRR

