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The typical steps in the capital budge…

Projects susceptible to capital budget…

The average accounting rate of return…

The profitability index

1) generating ideas, 2) analyzing individual proposals, 3) pl…

1) replacement, 2) expansion, 3) new products and services, a…

The typical steps in the capital budge…

1) generating ideas, 2) analyzing individual proposals, 3) pl…

Projects susceptible to capital budget…

1) replacement, 2) expansion, 3) new products and services, a…

compute beta capital using debt to cap…

The unlevered beta is often referred t…

beta estimates are sensitive to

two methods to estimate the before-tax…

The unlevered beta is often referred to as the asset beta bec…

the method of estimation and data used.

the yield-to-maturity approach and debt-rating approach.

compute beta capital using debt to cap…

The unlevered beta is often referred t…

The unlevered beta is often referred to as the asset beta bec…

Capital Budgeting

Typical capital budgeting steps (4)

5 key principles of capital budgeting

Independent projects

the process that companies use for decision making on long-te…

1) Generate good investment ideas... 2) forecast CF for each pro…

1) Decisions are based on *incremental cash flows*... 2) Conside…

two projects do not depend on each other

Capital Budgeting

the process that companies use for decision making on long-te…

Typical capital budgeting steps (4)

1) Generate good investment ideas... 2) forecast CF for each pro…

What are the four administrative steps…

What are the five key principals of ca…

What is cannibalization?

What is a conventional and unconventio…

1. Idea generation... 2. Analyzing project proposals... 3. Create t…

1. Decisions are based on cash flows, not accounting income.…

Occurs when a new project takes sales from an existing product.

It is conventional if the sign on the cash flows changes only…

What are the four administrative steps…

1. Idea generation... 2. Analyzing project proposals... 3. Create t…

What are the five key principals of ca…

1. Decisions are based on cash flows, not accounting income.…

Capital Budgeting

Typical capital budgeting steps (4)

5 key principles of capital budgeting

Independent projects

the process that companies use for decision making on long-te…

1) Generate good investment ideas... 2) forecast CF for each pro…

1) Decisions are based on *incremental cash flows*... 2) Conside…

two projects do not depend on each other

Capital Budgeting

the process that companies use for decision making on long-te…

Typical capital budgeting steps (4)

1) Generate good investment ideas... 2) forecast CF for each pro…

Capital Budgeting

Typical capital budgeting steps (4)

5 key principles of capital budgeting

Independent projects

the process that companies use for decision making on long-te…

1) Generate good investment ideas... 2) forecast CF for each pro…

1) Decisions are based on *incremental cash flows*... 2) Conside…

two projects do not depend on each other

Capital Budgeting

the process that companies use for decision making on long-te…

Typical capital budgeting steps (4)

1) Generate good investment ideas... 2) forecast CF for each pro…

Agency costs (dividends and share repos)

Cash vs stock mergers... Takeaways:... • St…

Clientele effect (Dividend policies)…

Conglomerate mergers... Not so attractiv…

Investors are worried that management may take on new project…

*Cash offer: target shareholder's gains are capped at the amo…

*Different groups of investors prefer different dividend poli…

Least likely for mature growth and stabilised companies. In t…

Agency costs (dividends and share repos)

Investors are worried that management may take on new project…

Cash vs stock mergers... Takeaways:... • St…

*Cash offer: target shareholder's gains are capped at the amo…

Capital Budgeting

Incremental

Sunk Cost

externalities

4 steps of the ____ _____ process are 1. Idea Generation, 2.…

____ Cash Flows are the changes in CFs that will occur if the…

A ____ _____ is a cost that cannot be avoided even if the pro…

the effects the acceptance of a project may have on other fir…

Capital Budgeting

4 steps of the ____ _____ process are 1. Idea Generation, 2.…

Incremental

____ Cash Flows are the changes in CFs that will occur if the…

Capital budgeting steps

Capital budgeting assumptions

Externality

Cannibalization

1. Generating Ideas... 2. Analyzing individual proposals... 3. Plan…

1. Decisions are based on CF rather than accounting concepts,…

effect of an investment on other things beside investment its…

when an investment takes customers and sales from another par…

Capital budgeting steps

1. Generating Ideas... 2. Analyzing individual proposals... 3. Plan…

Capital budgeting assumptions

1. Decisions are based on CF rather than accounting concepts,…

Capital Budgeting:... calculate the yearl…

Capital Budgeting:... explain how inflati…

Capital Budgeting:... evaluate capital pr…

Capital Budgeting:... describe types of r…

The depreciation method and speed effects the book value- suc…

- Have to determine whether or not to use real or nominal cas…

Least Common multiple of Lives - the analyst extends the time…

Timing Options - ... Instead of investing now, the company can d…

Capital Budgeting:... calculate the yearl…

The depreciation method and speed effects the book value- suc…

Capital Budgeting:... explain how inflati…

- Have to determine whether or not to use real or nominal cas…

Capital Budgeting Expansion... (initial o…

Capital Budgeting Expansion... (Op. Cash…

Capital Budgeting Expansion... (TNOCF)

Capital Budgeting (replacement)

Initial outlay = FCInv + WCInv

CF = (S-C)(1-T) + DT

TNOCF = Sal + NWCInv - T(Sal - BV)

- Same as expansion, except current after-tax salvage of old…

Capital Budgeting Expansion... (initial o…

Initial outlay = FCInv + WCInv

Capital Budgeting Expansion... (Op. Cash…

CF = (S-C)(1-T) + DT

Capital Budgeting

Typical capital budgeting steps (4)

5 key principles of capital budgeting

Independent projects

the process that companies use for decision making on long-te…

1) Generate good investment ideas... 2) forecast CF for each pro…

1) Decisions are based on *incremental cash flows*... 2) Conside…

two projects do not depend on each other

Capital Budgeting

the process that companies use for decision making on long-te…

Typical capital budgeting steps (4)

1) Generate good investment ideas... 2) forecast CF for each pro…

Capital Budgeting process

Capital Budgeting Steps

Cap Budgeting Principals

Externalities

identifying and evaluating capital projects....projects where…

1) idea generation... 2) analyzing project proposals... 3) create t…

1) decisions based on cash flows, not accounting income... 2) Ca…

effects the acceptance of a project may have on other firm ca…

Capital Budgeting process

identifying and evaluating capital projects....projects where…

Capital Budgeting Steps

1) idea generation... 2) analyzing project proposals... 3) create t…

Capital budgeting

Categories of capital projects

NPV

payback (discounted payback) period

Process of evaluating capital projects (projects with cash fl…

1. Replacement projects for maintaining the business or for c…

sum of the present values of a project's expected cash flows…

the number of years required to recover the original cost of…

Capital budgeting

Process of evaluating capital projects (projects with cash fl…

Categories of capital projects

1. Replacement projects for maintaining the business or for c…

Capital Budgeting

Categories of capital budgeting projects

5 Key Principles of Capital Budgeting

Capital Budgeting Methods

Identifying and evaluating projects for which the cash flows…

- Replacement projects to maintain the business... - Replacement…

1. Decisions are based on incremental cash flows. Sunk costs…

Payback period - the number of years taken to recover the ini…

Capital Budgeting

Identifying and evaluating projects for which the cash flows…

Categories of capital budgeting projects

- Replacement projects to maintain the business... - Replacement…

Capital Budgeting

Typical capital budgeting steps (4)

5 key principles of capital budgeting

Independent projects

the process that companies use for decision making on long-te…

1) Generate good investment ideas... 2) forecast CF for each pro…

1) Decisions are based on *incremental cash flows*... 2) Conside…

two projects do not depend on each other

Capital Budgeting

the process that companies use for decision making on long-te…

Typical capital budgeting steps (4)

1) Generate good investment ideas... 2) forecast CF for each pro…

Operating Break even Quantity

Breakpoint

Business Risk

NPV

Fixed Operating Cost / (Price Per Unit/VC Per Unit)

amount of capital where component cost changes / weight of co…

demand variability, sales price variability, input price vari…

preferred criterion when ranking projects because it measures…

Operating Break even Quantity

Fixed Operating Cost / (Price Per Unit/VC Per Unit)

Breakpoint

amount of capital where component cost changes / weight of co…

Capital Budgeting

Typical capital budgeting steps (4)

5 key principles of capital budgeting

Independent projects

the process that companies use for decision making on long-te…

1) Generate good investment ideas... 2) forecast CF for each pro…

1) Decisions are based on *incremental cash flows*... 2) Conside…

two projects do not depend on each other

Capital Budgeting

the process that companies use for decision making on long-te…

Typical capital budgeting steps (4)

1) Generate good investment ideas... 2) forecast CF for each pro…

Capital Budgeting Process (4 Steps)

Categories of Capital Budgeting Proces…

Unconventional Cash Flows

5 Principles of Capital Budgeting

1. Generate Idea... 2. Analyze Projects... 3. Create Firm Budget... 4.…

1. Replacement to Maintain or Reduce Costs... 2. Expansion of cu…

More than one sign change

1. Cash Flow based, not accounting Income... 2. Opportunity cost…

Capital Budgeting Process (4 Steps)

1. Generate Idea... 2. Analyze Projects... 3. Create Firm Budget... 4.…

Categories of Capital Budgeting Proces…

1. Replacement to Maintain or Reduce Costs... 2. Expansion of cu…

Shareholders wealth includes two eleme…

Principles of capital budgeting... 五大原则

Profit index

MACRS-half year convention... Modified ac…

Capital gain=P1-P0... Dividend income=D1... Holding period yield=…

1. NPV based on cash flow, not profit... 2. Based on incremental…

1.Assume the asset is placed in service in the middle of the…

Shareholders wealth includes two eleme…

Capital gain=P1-P0... Dividend income=D1... Holding period yield=…

Principles of capital budgeting... 五大原则

1. NPV based on cash flow, not profit... 2. Based on incremental…

Capital Budgeting Process (4 Steps)

Categories of Capital Budgeting Proces…

Unconventional Cash Flows

5 Principles of Capital Budgeting

1. Generate Idea... 2. Analyze Projects... 3. Create Firm Budget... 4.…

1. Replacement to Maintain or Reduce Costs... 2. Expansion of cu…

More than one sign change

1. Cash Flow based, not accounting Income... 2. Opportunity cost…

Capital Budgeting Process (4 Steps)

1. Generate Idea... 2. Analyze Projects... 3. Create Firm Budget... 4.…

Categories of Capital Budgeting Proces…

1. Replacement to Maintain or Reduce Costs... 2. Expansion of cu…

Capital Budgeting process

Capital Budgeting Steps

Cap Budgeting Principals

Externalities

identifying and evaluating capital projects....projects where…

1) idea generation... 2) analyzing project proposals... 3) create t…

1) decisions based on cash flows, not accounting income... 2) Ca…

effects the acceptance of a project may have on other firm ca…

Capital Budgeting process

identifying and evaluating capital projects....projects where…

Capital Budgeting Steps

1) idea generation... 2) analyzing project proposals... 3) create t…

Capital Budgeting process

Capital Budgeting Steps

Cap Budgeting Principals

Externalities

identifying and evaluating capital projects....projects where…

1) idea generation... 2) analyzing project proposals... 3) create t…

1) decisions based on cash flows, not accounting income... 2) Ca…

effects the acceptance of a project may have on other firm ca…

Capital Budgeting process

identifying and evaluating capital projects....projects where…

Capital Budgeting Steps

1) idea generation... 2) analyzing project proposals... 3) create t…

Investment Outlay

NWCInv

After-tax Cash Flow (CF)

Terminal Year After-tax non operating…

=FCinv+NWCInv

=∆non-cash current assets - ∆non-debt current liabilities... li…

=(S-C-D)(1-t)+D... =(S-C)(1-t)+(D*t)... S=Sales... C=cash operating c…

=Sal(t)+NWCInv-(Sal(t)-B(t))*t... Sal(t)=pre-tax cash proceeds…

Investment Outlay

=FCinv+NWCInv

NWCInv

=∆non-cash current assets - ∆non-debt current liabilities... li…

Externality

Cash flows

Modified Accelerated Cost Recovery Sys…

half year convention

the analyst should subtract the lost sales of the existing pr…

need to be considered on an after-tax basis

A "depreciation" approach common to the tac code; generally p…

assumes that the asset is placed in service in the middle of…

Externality

the analyst should subtract the lost sales of the existing pr…

Cash flows

need to be considered on an after-tax basis

TNOCF

NWCinv

Impact of Higher Depreciation on cash…

Initial Outlay

Terminal non-operating cash flows represent the salvage value…

change in non cash current assets - change in non debt curren…

Higher depreciation leads to lower tax expenses and thus high…

FCinv + NWCinv

TNOCF

Terminal non-operating cash flows represent the salvage value…

NWCinv

change in non cash current assets - change in non debt curren…

MM Proposition I Without Taxes (5 assu…

MM Proposition II without taxes: Highe…

Agency Costs

Financial Distress

1. Investors have homogenous expectations regarding the cash…

i.e., the cost of equity is a linear function of the company'…

Costs associated with the conflict of interest present when a…

heightened uncertainty regarding a company's ability to meet…

MM Proposition I Without Taxes (5 assu…

1. Investors have homogenous expectations regarding the cash…

MM Proposition II without taxes: Highe…

i.e., the cost of equity is a linear function of the company'…

Capital Budgeting process

Capital Budgeting Steps

Cap Budgeting Principals

Externalities

identifying and evaluating capital projects....projects where…

1) idea generation... 2) analyzing project proposals... 3) create t…

1) decisions based on cash flows, not accounting income... 2) Ca…

effects the acceptance of a project may have on other firm ca…

Capital Budgeting process

identifying and evaluating capital projects....projects where…

Capital Budgeting Steps

1) idea generation... 2) analyzing project proposals... 3) create t…

WACC

Cost of Preferred Stock (Kps)

Cost of Equity Capital (Ke) not using…

Cost of Equity (Ke) using CAPM

(Wd)(Kd(1-t))+(Wps)(Kps)+(We)(Ke)

Dps/P

(D1/Po)+g ... dividend at time 1 over price at time 0 plus growth

Rf+b*(Rmarket-Rf)

WACC

(Wd)(Kd(1-t))+(Wps)(Kps)+(We)(Ke)

Cost of Preferred Stock (Kps)

Dps/P

Capital Budgeting process

Capital Budgeting Steps

Cap Budgeting Principals

Externalities

identifying and evaluating capital projects....projects where…

1) idea generation... 2) analyzing project proposals... 3) create t…

1) decisions based on cash flows, not accounting income... 2) Ca…

effects the acceptance of a project may have on other firm ca…

Capital Budgeting process

identifying and evaluating capital projects....projects where…

Capital Budgeting Steps

1) idea generation... 2) analyzing project proposals... 3) create t…

Capital Budgeting process

Capital Budgeting Steps

Cap Budgeting Principals

Externalities

identifying and evaluating capital projects....projects where…

1) idea generation... 2) analyzing project proposals... 3) create t…

1) decisions based on cash flows, not accounting income... 2) Ca…

effects the acceptance of a project may have on other firm ca…

Capital Budgeting process

identifying and evaluating capital projects....projects where…

Capital Budgeting Steps

1) idea generation... 2) analyzing project proposals... 3) create t…

Internal rate of return

IRR decision rule

Payback period

Profitability Index (PI)

discount rate that makes the PV of the expected incremental a…

determine required rate of return for given project.... IRR > re…

full years until recover + (unrecovered cost at beginning of…

PV of a projects future cash flows divided by the initial cas…

Internal rate of return

discount rate that makes the PV of the expected incremental a…

IRR decision rule

determine required rate of return for given project.... IRR > re…

FCInv+WCInv

(S-C)(1-T)+DT

SalT+NWCInv-T(SalT-BT)

delta non-cash current assets-delta no…

initial outlay formula for an expansion project

Cash flow formula for and expansion project... where ... S=sales... C…

TNOCF=?... Terminal year after tax non operating cash flows for…

NWCInv formula

FCInv+WCInv

initial outlay formula for an expansion project

(S-C)(1-T)+DT

Cash flow formula for and expansion project... where ... S=sales... C…

Capital Budgeting process

Capital Budgeting Steps

Cap Budgeting Principals

Externalities

identifying and evaluating capital projects....projects where…

1) idea generation... 2) analyzing project proposals... 3) create t…

1) decisions based on cash flows, not accounting income... 2) Ca…

effects the acceptance of a project may have on other firm ca…

Capital Budgeting process

identifying and evaluating capital projects....projects where…

Capital Budgeting Steps

1) idea generation... 2) analyzing project proposals... 3) create t…

What are the 5 principles of capital b…

Explain the 3 stages of evaluating cas…

What is the formula for a initial inve…

What is the formula for after-tax oper…

1. Decisions are based on incremental cash flows, not account…

1. Initial investment outlay ... 2. After-tax operating cash flo…

outlay = (FC)Inv + (NWC)Inv... NWC(Inv) = WC(Inv) - Salvage + T…

CF = (S - C)(1 - T) + (TD)... S = sales... C = cash operating cost…

What are the 5 principles of capital b…

1. Decisions are based on incremental cash flows, not account…

Explain the 3 stages of evaluating cas…

1. Initial investment outlay ... 2. After-tax operating cash flo…

Cost of Debt

Sunk Cost

Opportunity Cost

Incremental Cash Flow

The cost of debt financing to a company, such as when it issu…

A cost that has already been incurred.

The value that investors forgo by choosing a particular cours…

The cash flow that is realized because of a decision; the cha…

Cost of Debt

The cost of debt financing to a company, such as when it issu…

Sunk Cost

A cost that has already been incurred.

Capital Budget Process

Capital Budgeting Projects

Capital Budgeting Assumptions

Sunk Cost vs. Opportunity Cost

Generating Ideas... Analyzing Individual Proposals... Planning the…

Replacement... Expansion... New Products and Services... Regulatory, S…

Decisions based on CF... Timing is crucial ... CF are based on op…

cost already been incurred... vs.... resource's worth in its nex…

Capital Budget Process

Generating Ideas... Analyzing Individual Proposals... Planning the…

Capital Budgeting Projects

Replacement... Expansion... New Products and Services... Regulatory, S…

Capital Budgeting process

Capital Budgeting Steps

Capital budgeting projects can be clas…

Capital budgeting concepts

The process that companies use for making long-term investmen…

1) idea generation - most important... 2) analyzing individual p…

-replacement projects - maintain normal business... -expansion p…

Sunk costs - costs that cannot be recovered once they have be…

Capital Budgeting process

The process that companies use for making long-term investmen…

Capital Budgeting Steps

1) idea generation - most important... 2) analyzing individual p…

Capital Budgeting Principal

Incremental Cash Flows

Initial Investment Outlay

After-Tax Operating CF

1. Decisions are based on incremental AFTER TAX cash flow.... -…

Cash flows are evaluated in 3 stages... - Initial investment out…

FCInv = cost of investment, getting it there... NWCInv = Change…

Add back depreciation tax shield because it is a non cash exp…

Capital Budgeting Principal

1. Decisions are based on incremental AFTER TAX cash flow.... -…

Incremental Cash Flows

Cash flows are evaluated in 3 stages... - Initial investment out…

Internal rate of return

IRR decision rule

Payback period

Profitability Index (PI)

discount rate that makes the PV of the expected incremental a…

determine required rate of return for given project.... IRR > re…

full years until recover + (unrecovered cost at beginning of…

PV of a projects future cash flows divided by the initial cas…

Internal rate of return

discount rate that makes the PV of the expected incremental a…

IRR decision rule

determine required rate of return for given project.... IRR > re…

MACRS

MACRS Half-year convention

Depreciable basis

Calculating investment in net working…

Modified accelerated cost recovery system. An alternate metho…

Assumes that the asset is placed in service at the middle of…

Purchase price plus any shipping, handling or installation co…

change in non cash current assets - change in non debt curren…

MACRS

Modified accelerated cost recovery system. An alternate metho…

MACRS Half-year convention

Assumes that the asset is placed in service at the middle of…

When will borrowing fund to pay divide…

traditional view in financing

MM dividend irrelevance

Bird-in-hand arguments

when after tax debt cost < earning yield (=EPS/P)

shareholders are indifferent to the addition of a SMALL amoun…

assume no tax/transaction cost... => investor can make homemade…

Re will increase when dividend payout is low, because more risk

When will borrowing fund to pay divide…

when after tax debt cost < earning yield (=EPS/P)

traditional view in financing

shareholders are indifferent to the addition of a SMALL amoun…

Sunk costs

Externalities

cannibalization

5 principles of corp finance

costs that cannot be avoided, even if the project is not unde…

the effects the acceptance of a project may have on other fir…

occurs when a new project takes sales from an existing produc…

1) Decisions are based on cash flows, not accounting income.…

Sunk costs

costs that cannot be avoided, even if the project is not unde…

Externalities

the effects the acceptance of a project may have on other fir…

Capital Budgeting Process

Steps in the Capital Budgeting Process

Types of Capital Projects

Principles of Capital Budgeting

Used to determine and select the most profitable long-term gr…

1. Idea generation... 2. analyze the project proposal ... 3. Create…

1 Replacement projects to maintain the business... 2 Replacement…

1 Decisions are made based on the changes in after-tax cash f…

Capital Budgeting Process

Used to determine and select the most profitable long-term gr…

Steps in the Capital Budgeting Process

1. Idea generation... 2. analyze the project proposal ... 3. Create…

How does ... SENSITIVITY ANALYSIS ... look…

How does ... SCENARIO ANALYSIS ... look at r…

How does ... MONTE CARLO ANALYSIS ... look…

What is the static trade off theory?

One variable at a time

Multiple variables at a time; considers bull/base/bear case

Creates a simulation of several random variables at a time... L…

A firm should continue to add leverage until the ... cost of fi…

How does ... SENSITIVITY ANALYSIS ... look…

One variable at a time

How does ... SCENARIO ANALYSIS ... look at r…

Multiple variables at a time; considers bull/base/bear case

Internal stakeholders

External stakeholders

Unethical behavior arises from

Friedman doctrine

• Shareholders... • Managers... • Employees... • BOD

• Customers... • Suppliers... • Creditors... • Unions... • Government... • L…

• Agents whose personal ethics are flawed are more likely to…

narrowly addresses the social responsibility of business and…

Internal stakeholders

• Shareholders... • Managers... • Employees... • BOD

External stakeholders

• Customers... • Suppliers... • Creditors... • Unions... • Government... • L…