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Week 10 Basics-Of-Capital-Budgeting
Week 10 Basics-Of-Capital-Budgeting
Should we
build this
plant?
What is capital budgeting?
0 1 2 3 4 5 N NN
- + + + + + N
- + + + + - NN
- - - + + + N
+ + + - - - N
- + + - + - NN
NPV: Sum of the PVs of inflows and
outflows.
n
CFt
NPV t .
t 0 1 k
What is Project L’s NPV?
Project L:
0 1 2 3
10%
-100.00 10 60 80
9.09
49.59
60.11
18.79 = NPVL
Calculator Solution
Enter in CFLO for L:
-100 CF0
10 CF1
60 CF2
80 CF3
Project S:
0 1 2 3
10%
-100.00 70 50 20
63.64
41.32
15.03
19.99 = NPVS
Calculator Solution
Enter in CFLO for S:
-100 CF0
70 CF1
50 CF2
20 CF3
0 1 2 3
-100.00 10 60 80
PV1
PV2
PV3
0 = NPV
Enter CFs in CFLO, then press IRR:
IRRL = 18.13%.
Finding IRR Without a Financial
Calculator
-100.00 70 50 20
PV1
PV2
PV3
0 = NPV
Enter CFs in CFLO, then press IRR:
IRRS = 23.56%.
Finding IRR Without a Financial
Calculator
Find the NPV first. If the NPV is positive, then try an IRR >
WACC.
Project S, Try 12%:
100 =(70*1/1.12)+(50*1/(1.12)2) +(20*1/(1.12)3)
100=116.60 Need lower PV, so higher IRR
Answer IRR>12%, accept (WACC = 10%)
Q. How is a project’s IRR related to a bond’s YTM?
A. They are the same thing. A bond’s YTM is the IRR
if you invest in the bond.
0 1 2 10
IRR = ? ...
-1134.2 90 90 1090