what is our objective when deciding what projects we should pick
- accept all investments with return over the cost of capital
- invest only if the project yield if the return is higher than the opportunity cost
- opportunity cost of investment returns= returns available to sh in financial markets from investments with the same risk as the project
5 stages of capital budgeting
- identification of projects
- information acquisition
- predictions
- choosing among the alternatives
- implementation and control
methods to choose a project
discounted cf method
-npv, irr
payback
ARR
when thinking about accepting a project think about, not just the financial side
flexibility
quality
impact on customers
impact on competitors
IRR
RL + [NL/(NL-NH)] X (RH-RL)
Comparison of NPV and IRR
NPV
-expressed as money
-individual projects can be added to see the effect of accepting projects
-can be used where regular rate of return varies of the life of the project
-Assumes internal cashflows are reinvested at the cost of capital
IRR
-Expressed as a %
-can’t add projects together
-Assumes internal cashflows are reinvested at the IRR
Payback advan
simple
good when liquidity constraints exist and fast payback is needed
good for risky investments in uncertain markets
often used as intial screening
ARR
Shows the rate at which an £ of investment generates operating income
when answering a question look at
cost consideration
quality considerations
product considerations
human resources considerations
