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Chapter 11

The Basics of Capital Budgeting

LEARNING OBJECTIVES

After reading this chapter, students should be able to:

• Define capital budgeting, explain why it is important, and state how project proposals are generally classified.

• List the steps involved in evaluating a capital budgeting project.

• Calculate payback period, discounted payback period, Net Present Value (NPV), and Internal Rate of Return (IRR) for a given project and evaluate each method.

• Define NPV profiles, and explain the rationale behind the NPV and IRR methods, their reinvestment rate assumptions, and which method is better when evaluating independent versus mutually exclusive projects.

• Briefly explain the problem of multiple IRRs and when this situation could occur.

• Calculate the Modified Internal Rate of Return (MIRR) for a given project and evaluate this method.

• Identify at least one relevant piece of information provided to decision makers for each capital budgeting decision method discussed in the chapter.

• Identify and explain the purposes of the post-audit in the capital budgeting process.

• Identify a number of different types of decisions that use the capital budgeting techniques developed in this chapter.
LECTURE SUGGESTIONS

This is a relatively straight-forward chapter, and, for the most part, it is a direct application of the time value concepts first discussed in Chapter 7. We point out that capital budgeting is to a company what buying stocks or bonds is to an individual--an investment decision, when the company wants to know if the expected value of the cash flows is greater than the cost of the project, and whether or not the expected rate of return on the project exceeds the cost of the funds required to take on the project. We cover the standard capital budgeting procedures--payback, discounted payback, NPV, IRR, and MIRR.
At this point, students who have not yet mastered time...