COMM 300: Capital budgeting
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capital budgeting
- capital in this term: fixed assets used in production
- therefore, capital budgeting is a plan of expected inflows and outflows associated with the fixed assets used in production
- Capital budgeting projects can be:
- Independent project
- Mutually exclusive projects
- Replacement projects
Risk & return
- Capital projects should be evaluated with risk & return
Replacement project
- Medium risk & return
Expansion projects
- High risk, high return
Safety & environmental projects
- Low risk, negative returns.
How you evaluate returns & risk
(YOU KNOW BOTH OF THESE METHODS)
Balance method
- Present value of benefts are compared to present value of the costs (at a specified discount rate - this incorporates the risk!)
- Know the equation!
Hurdle method
- Here you compute an internal rate of return, which the project must exceed.
- Know the equation for this!
Risk analysis
- You must decide
- Magnitude
- Timing
- Discount rate
- And your uncertainty
Four major considerations
- What are you trying to answer
- You must use a valid technique
- not sure about the other two...
