Ch 4 Capita Budgeting under Certainty(公司理财(哈工大深圳研究生院,王苏生).pptVIP

HIT SGS CORPORATION FINANCECHAPTER 4 CAPITAL BUDGETING UNDER CERTAINTY: Competing Capital Budgeting Criteria This manuscript was prepared by the faculty. Dont distribute or reproduce any part of it without a written consent of the author. FOUNDATIONS OF CAPITAL BUDGETING The NPV or Net Present Value of a project is defined as where Io (=-C0 in Brealey and Myers) is the investment cost of the project and Ci is the cash flow in period I As such, NPV represents the addition to the market value of the firm from undertaking the project Moreover, it corresponds with the objective of the firm to maximize its value  FOUNDATIONS OF CAPITAL BUDGETING Because the objective of the firm is to maximize shareholders wealth, the following two rules come out of this definition of NPV. These rules are the foundation of capital budgeting 1. In evaluating a single project, accept the project if and only if NPV 0 2. In choosing between mutually exclusive projects, accept the project with the highest NPV if that NPV 0 COMPETING CAPITAL BUDGETING CRITERIA We will discuss another four popular capital budgeting criteria and evaluate their effectiveness by contrasting them against the NPV criterion They are 1. Payback 2. Average Return on Book Value 3. Internal rate of Return (IRR) 4. Profitability Index PAYBACK Payback looks at how long it takes for the cash flows of a project to pay back its investment The payback rule sets a time limit of T years. If a project does not pay back in T years, it is rejected In choosing between two projects, the project with the shortest payback is taken, as long as its payback is less than T years Example: Payback Consider a project with the following cash flows Year Cash Flow 0 -$1000 1 $600