Chapter 10 study guide

CAPITAL BUDGETING TECHNIQUES

Topical review

• Describe the importance of capital budgeting in a firm
• Distinguish independent and mutually exclusive projects as well as normal and non-normal cash flows
• Calculate, explain the advantages and disadvantages, and state the decision rules for the following capital budgeting decision rules:
  
  • Payback period
  • Discounted payback period
  • Net present value (NPV) - use your financial calculators
  • Internal rate of return (IRR) - use your financial calculators
  • Modified internal rate of return (MIRR)
  • (Don't worry about profitability index (PI))
• Describe the information provided in a NPV profile - Compare IRR and NPV decisions
• Resolve conflicting decisions between IRR and NPV for mutually exclusive projects
  
  • Size disparity - capital rationing
  • Unequal lives - equivalent annual annuity (EAA) or replacement chain
  • Timing of cash flows - reinvestment assumptions

Definitions

• General: Capital budgeting, capital rationing, independent vs. mutually exclusive projects, normal vs. non-normal cash flows
• Techniques: net present value (NPV), internal rate of return (IRR), payback period, discounted payback period, modified internal rate of return (MIRR), replacement chain, equivalent annual annuity (EAA), NPV profile

Basic numerical problems from textbook

ST-1 parts a-c (no profitability index), #16 (there are lots of other problems you can practice too)