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    Managerial Economics in A Global Economy: Long-Run Investment Decisions: Capital Budgeting

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    Arif Darmawan
    ch14[1]managerialeconomic

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    Managerial Economics in A Global Economy: Long-Run Investment Decisions: Capital Budgeting

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    Arif Darmawan
    102 views16 pages
    ch14[1]managerialeconomic

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    ch14[1]managerialeconomic

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    ch14[1]managerialeconomic

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    Download as ppt, pdf, or txt
    102 views16 pages

    Managerial Economics in A Global Economy: Long-Run Investment Decisions: Capital Budgeting

    Uploaded by

    Arif Darmawan
    ch14[1]managerialeconomic

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
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    Managerial Economics in a Global Economy

    Chapter 14 Long-Run Investment Decisions: Capital Budgeting

    PowerPoint Slides by Robert F. Brooker

    Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    Capital Budgeting Defined


    Process of planning expenditures that give rise to revenues or returns over a number of years

    PowerPoint Slides by Robert F. Brooker

    Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    Categories of Investment
    Replacement Cost Reduction Output Expansion to Accommodate Demand Increases Output Expansion for New Products Government Regulation

    PowerPoint Slides by Robert F. Brooker

    Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    Capital Budgeting Process


    Demand for Capital
    Schedule of investment projects Ordered from highest to lowest return

    Supply of Capital
    Marginal cost of capital Increasing marginal cost

    Optimal Capital Budget


    Undertake all projects where return is greater than marginal cost
    PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    Capital Budgeting Process


    Firm will undertake projects A, B, and C

    PowerPoint Slides by Robert F. Brooker

    Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    Capital Budgeting Process


    Projecting Net Cash Flows
    Incremental basis After-tax basis Depreciation is a non-cash expense that affects cash flows through its effect on taxes

    PowerPoint Slides by Robert F. Brooker

    Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    Capital Budgeting Process


    Example: Calculation of Net Cash Flow

    Sales $1,000,000 Less: Variable costs 500,000 Fixed costs 150,000 Depreciation 200,000 Profit before taxes $150,000 Less: Income tax 60,000 Profit after taxes $90,000 Plus: Depreciation 200,000 Net cash flow $290,000
    PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    Capital Budgeting Process


    Net Present Value (NPV)
    Rt NPV C0 t t 1 (1 k )
    n

    Rt = Return (net cash flow) k = Risk-adjusted discount rate C0 = Initial cost of project
    PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    Capital Budgeting Process


    Internal Rate of Return (IRR)
    Rt C0 t t 1 (1 k *)
    n

    Rt = Return (net cash flow) k* = IRR C0 = Initial cost of project


    PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    Capital Rationing
    Profitability Index (PI)
    Rt t (1 k ) PI t 1 C0
    n

    Rt = Return (net cash flow) k = Risk-adjusted discount rate C0 = Initial cost of project
    PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    The Cost of Capital


    Cost of Debt (kd) kd = r(1-t) r = Interest rate t = Marginal tax rate kd = After-tax cost of debt
    PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    The Cost of Capital


    Cost of Equity Capital (ke): Risk-Free Rate Plus Premium ke = rf + rp ke = rf + p1 + p2 rf = Risk free rate of return rp = Risk premium p1 = Additional risk of firms debt p2 = Additional risk of firms equities
    PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    The Cost of Capital


    Cost of Equity Capital (ke): Dividend Valuation Model D D D P ke t ke P t 1 (1 ke ) P = Price of a share of stock D = Constant dividend per share ke = Required rate of return
    PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    The Cost of Capital


    Cost of Equity Capital (ke): Dividend Valuation Model
    D P Ke g

    D ke g P

    P= D= ke = g=

    Price of a share of stock Dividend per share Required rate of return Growth rate of dividends
    Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    PowerPoint Slides by Robert F. Brooker

    The Cost of Capital


    Cost of Equity Capital (ke): Capital Asset Pricing Model (CAPM)
    ke rf b ( k m rf )

    rf = Risk-free rate of return b = Beta coefficient km = Average rate of return on all shares of common stock
    PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    The Cost of Capital


    Weighted Cost of Capital: Composite Cost of Capital (kc)
    kc wd kd we ke

    wd = kd = we = ke =

    Proportion of debt Cost of debt Proportion of equity Cost of equity


    Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

    PowerPoint Slides by Robert F. Brooker

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