Financial Management BUS 310 Jon Hunter

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Financial ManagementBUS 310Jon Hunter
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Third examReview session

• What is capital budgeting?
• What are tools to use?

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Capital budgeting

• Payback period
• Expressed in years
• Quick and easy
• Disregards time value of money
• Disregards cash flow after payback
• Compare to benchmark

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Capital budgeting

• Net present value
• Expressed in dollars
• Sum of discounted cash flows
• Including negative cash flow for initial
  investment
• Positive do
• Negative dont do

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Capital budgeting

• Internal rate of return
• Solve for the discount rate when NPV0
• Compare to required rate

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Capital budgeting

• Analyzing the results
• Prioritizing capital projects
• Making a decision

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Capital budgetingGuidelines

• Use cash flows, not profit
• Incremental changes
• Positive
• Negative
• Working capital
• Taxes

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Capital budgetingGuidelines

• IMPORTANT
• Dont consider financing costs when calculating
  cash flows
• They are considered in the discount rate

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Three sets of cash flows

• Initial outlay
• Sale of old equipment
• Installation
• Ongoing operations
• Terminal cash flows

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Capital budgeting

• Capital rationing IRR
• Mutually exclusive projects

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Cost of capital

• Required rate of return
• Discount rate
• Minimum rate to make an investment
• Weighted average cost of capital

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Cost of capital

• Cost of debt
• Interest paid / net proceeds
• Tax benefit

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Cost of capital

• Cost of preferred stock
• dividends / net proceeds
• no tax benefit

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Cost of capital

• Cost of common stock
• Method 1 Dividend growth model
• K dividend / price growth rate
• g ROE x retention rate

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Cost of capital

• Cost of common stock
• Method 2 Capital asset pricing model
• k krf B(km krf)