Capital budgeting
Payback period
Quick and easy
Disregards time value of money
Disregards cash flow after payback
Discounted payback – not much better
Net present value
Sum of discounted cash flows
Including negative cash flow for initial investment
Positive – do
Negative – don’t do
Internal rate of return
Solve for the discount rate
when NPV=0
Compare to required rate
Capital budgeting Guidelines
IMPORTANT:
Don’t consider financing costs when calculating cash flows
They are considered in the discount rate
Three sets of cash flows
Initial outlay
Sale of old equipment
Installation
Ongoing operations
Terminal cash flows
Capital rationing – IRR
Mutually exclusive projects
Payback period
Quick and easy
Disregards time value of money
Disregards cash flow after payback
Discounted payback – not much better
Net present value
Sum of discounted cash flows
Including negative cash flow for initial investment
Positive – do
Negative – don’t do
Internal rate of return
Solve for the discount rate
when NPV=0
Compare to required rate
Capital budgeting Guidelines
IMPORTANT:
Don’t consider financing costs when calculating cash flows
They are considered in the discount rate
Three sets of cash flows
Initial outlay
Sale of old equipment
Installation
Ongoing operations
Terminal cash flows
Capital rationing – IRR
Mutually exclusive projects