Reading 32.Capital Budgeting
32a. Describe the capital budgeting process and distinguish among the various categories of capital projects.
capital budgeting process
-process of identifying and evaluating capital projects
-projects where cash flow to firm will receive over a period longer than a year.
capital budgeting對financial manager最重要
原因是：
1.decision involves the purchase of costly long-term assets with lives of many years, decisions made determine the future success of the firm
- principles underlying the capital budgeting process apply to other corporate decisions
- making good capital budgeting decisions is consistent with management's primary goal of maximizing shareholder value
4 administrative steps:
1)Idea generation
2)Analyzing project proposals
3)Create the firm-wide capital budget
4)Monitor decisions and conduct a post-audit
Categories of capital budgeting projects
資本預算的項目可分為：
a.replacement projects to maintain the business are normally made without detailed analysis.
用于更新換代，確保公司能夠繼續運行的項目
b.replace ment projects for cost reduction determine whether equipment that is obsolete but still usable,should be replaced.
降低成本的替代項目
c.expansion projects 擴張性項目
d.new product or market development
e.mandatory projects強制性項目
f.other projects其他項目
32b. Describe the basic principles of capital budgeting.
5 key principles:基本預算過程的五個基本原則
1)Decisions are based on cash flows, not accounting income.
決策是建立在現金流基礎上，不是會計收益上
incremental cash flows增量現金流，在評估項目時，僅考慮接受相應的項目財產生的現金流。
sunk costs
externalities-effects the acceptance of a project
cannibalization-negative externality
-occurs when a new project takes sales from an existing product
positive externality exists
when doing the project have positive effect on sales of a firm's other product lines.
conventional cash flow pattern
-if the sign on the cash flows changes only once, with one or more cash outflows followed by one or more cash inflows.
unconventional cash flow pattern
-more than one sign change.
2)Cash flows are based on opportunity costs.
opportunity costs-a firm will lose by undertaking the project under analysis.
3)The timing of cash flows is important.
4)Cash flows are analyzed on an after-tax basis.
5)Financing costs are reflected in the project's required rate of return.
32c.Explain how the evaluation and selection of capital projects is affected by mutually exclusive projects, project sequencing and capital rationing.
Independent vs mutually exclusive projects
independent projects
-unrelated to each other and allow for each project to be evaluated based on profitability.
mutually exclusive
-only one project in a set of possible projects can be accepted and projects compete with each other.
Project sequencing
Unlimited funds vs capital rationing
32d. Calculate and interpret NPV, IRR, payback period, discounted payback period, PI of a single capital project
NPV is the sum of the present values of all the expected incremental cash flows if a project is undertaken.
discount rate used is the firm's cost of capital, adjusted a series of expected after-tax cash inflows, the NPV is present value of the expected inflows-initial cost of project.
IRR is the discount rate that makes PV of expected incremental after-tax cash inflows just equal to the initial cost of project.
PV(inflow)=PV(outflow)
hurdle rate-the minimum IRR that a firm requires internally for a project to be accepted
Payback period(PBP)is the number of years it takes to recover the initial cost of an investment.
-a measure of liquidity
-project decisions should not made on the basis of payback periods
PBP缺點：
--沒考慮time value of money or cash flows beyond the payback period
--terminal or salvage value 不考慮
--無法作為 a measure of profitability
PBP優點：
--a good measure of project liquidity
--limited access to additional liquidity and measure of profitability
--evaluate projects that satisfy maximum payback period constraint.
Discounted payback period
--uses the PV of project's estimated cash flows.
--不考慮cash flows beyond the payback period--poor measure of profitabilty
--measure of liquidity
Profitability Index (PI)
-project's future cash flows divided by the initial cash outlay
PI=PV of future cash flows/CF0=1+NPV/CF0
NPV大于0時，PI大于1，accept the project
PI小于1,reject the project
32e. Explain the NPV profile, compare the NPV and IRR methods when evaluating independent and mutually exclusive projects and describe the problems with each evaluation methods.
NPV profile-a graph that shows a project's NPV for different discount rate.
NPV在y軸，discount rates在x軸
crossover rate
The relative advantages and disadvantages of NPV and IRR method
NPV優點：direct measure of expected increase in the value of firm
IRR優點: measure profitability as a percentage, show the return on each dollar invested
32f. Contrast the NPV decision rule to IRR decision rule and identify problems associated with IRR rules.
The "multiple IRR" and "no IRR"problems
32g. Describe expected relationships among an investment's NPV, company value, share price
