CHAPTER 10 The Basics of Capital Budgeting. Should we build this plant?. What is capital budgeting?. Analysis of potential additions to fixed assets. Longterm decisions; involve large expenditures (see p. 392393). Very important to firm’s future (see p. 389 – GM story, and p. 390391).
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CHAPTER 10The Basics of Capital Budgeting
Should we
build this
plant?
BRIDGE vs. BOAT to get
products across a river.
Inflow (+) or Outflow () in Year
0
1
2
3
4
5
N
NN

+
+
+
+
+
N

+
+
+
+

NN



+
+
+
N
+
+
+



N

+
+

+

NN
2.4
3
0
1
2
Project L
80
CFt100 10 60 100
Cumulative 100 90 0 50
30
30
80
PaybackL = 2 + / = 2.375 years
=
1.6
3
0
1
2
Project S
CFt100 70 100 20
50
Cumulative 100 0 20 40
30
30
50
PaybackS = 1 + / = 1.6 years
=
2.7
3
0
1
2
10%
CFt 100 10 60 80
PV of CFt 100 9.09 49.59
60.11
Cumulative 100 90.91 18.79
41.32
Disc PaybackL = 2 + / = 2.7 years
=
41.32
60.11
NPV:Sum of the PVs of cash inflows (+CF) and cash outflows (CF).
Cost often is CF0 and is negative.
YearCFtPV of CFt
0100 $100
1 10 9.09
2 60 49.59
3 80 60.11
NPVL = $18.79
NPVS = $19.98 or ($119.98  $100)
NPV= PV of inflows – Cost
= Net gain in wealth

10?(1134.2) 901000
7.08%
k NPVLNPVS
0$50$40
5 33 29
10 19 20
15 7 12
20 (4) 5
NPV
($)
60
.
50
.
40
.
Crossover Point = 8.7%
.
30
.
.
IRRL = 18.1%
20
.
.
S
.
IRRS = 23.6%
10
L
.
.
Discount Rate (%)
0
5
15
20
23.6
10
10
0 1 2 3
10%
100.0 10.0 60.0 80.0
10%
66.0
12.1
10%
MIRR = 16.5%
158.1
$158.1
(1 + MIRRL)3
100.0
TV inflows
$100
=
PV outflows
MIRRL = 16.5%
(set CF0 = 0)
CFj = 0, 10, 60, 80
I = 10%, solve for NPV = $118.78
PV = 118.78, n = 3, solve for FV = 158.10
PV = 100, solve for I/YR = 16.50% = MIRR
0 1 2
k = 10%
800 5,000 5,000
NPV Profile
NPV
IRR2 = 400%
450
0
k
100
400
IRR1 = 25%
800
10 ■ ORANGE KEY / STO
■ IRR = 25% (the lower IRR)
200 ■ ORANGE KEY / STO
■ IRR = 400% (the higher IRR)
$4,932.2314.