Session 10 - Basics of Capital Budgeting (NPV and Other Investment Criteria), Chapter 10 All page numbers are references to Corporate Finance: A Focused Approach 7th edition by Ehrhardt and Brigham (Cengage Learning, 2020) Chapter 10 Capital Budgeting Basics - Capital Budgeting Decisions are the most important decisions that are made within a company. This chapter covers the basic methods of evaluating capital budgeting projects. Things to Absorb How to calculate and interpret Payback method, Net Present Value, Internal Rate of Return, and Profitability Index. Know the difference between Independent and Mutually Exclusive projects. Pay particular attention to NPV and IRR, and know why they sometimes produce different choices. Know the Reinvestment Rate assumptions for all methods. Know the strengths and weaknesses of Payback method, Net Present Value, Internal Rate of Return, Modified Internal Rate of Return, and Profitability Index. You need to understand there are issues related to evaluating projects with Unequal Lives. Be able to define Capital Rationing. While unlikely to be on the exam, you should know how to compute the Optimal Capital Budget. Things You Do not Need to Absorb How to calculate Modified Internal Rate of Return or how to calculate and interpret Discounted Payback or Equivalent Annual Annuities. Things to Read Read the Chapter. Things to Do Make 100 on the quiz. Questions and Problems that you should answer- Self Test 1, Questions - All, and all end of chapter Problems related to NPV, IRR, Payback, and Profitability Index. I consider Self-Test 1, and Problems 9-13, 15, 19 and 21 to be exam level problems. If using the Excel Toolkit, pay particular attention to NPV and IRR calculations. Calculator links - Most Calculator Types. Watch the Chapter Introduction and Overview video. The PowerPoints for all of this chapter's videos are located here. Read pages 411-417. Watch the Introduction and Net Present Value video. After this video, you should be able to solve problems 1 and 7a. Read pages 417-424. Watch the video on Internal Rate of Return and Conflicts between NPV and IRR. After this video, you should be able to answer all of the suggested self-tests, questions, and problems. Read pages 424-430. Watch the video on Modified Internal Rate of Return, Profitability Index, Payback, and Discounted Payback. After this video, you should be able to solve problems 2 and 7b. Read the remainder of the chapter. Except for Non-Normal Projects, topics on the last video, Non-Normal Projects, Projects with Unequal Lives, the Optimal Economic Life of Projects. Below are audio solutions to problems of the type you will see from this chapter. Determine the Net Present Value (NPV) for a project that costs $104,000 and would yield after-tax cash flows of $16,000 the first year, $18,000 the second year, $21,000 the third year, $23,000 the fourth year, $27,000 the fifth year, and $33,000 the sixth year. Your firm's cost of capital is 12.00%. | Audio Solution Determine the NPV for a project that costs $253,494.00 and is expected to yield after-tax cash flows of $29,000 per year for the first ten years, $37,000 per year for the next ten years, and $50,000 per year for the following ten years. Your firm's cost of capital is 12.00%. | Audio Solution Determine the Internal Rate of Return (IRR) for a project that costs $78,000 and would yield after-tax cash flows of $12,000 the first year, $14,000 the second year, $17,000 the third year, $19,000 the fourth year, $23,000 the fifth year, and $29,000 the sixth year. | Audio Solution Determine the IRR for a project that costs $180,532.00 and is expected to yield after-tax cash flows of $25,000 per year for the first five years, $33,000 per year for the next five years, and $46,000 per year for the following five years. | Audio Solution Your company has an opportunity to invest in a project that is expected to result in after-tax cash flows of $18,000 the first year, $20,000 the second year, $23,000 the third year, -$8,000 the fourth year, $30,000 the fifth year, $36,000 the sixth year, $39,000 the seventh year, and -$6,000 the eighth year. The project would cost the firm $142,000. If the firm's cost of capital is 12%, what is the Modified Internal Rate of Return (MIRR) for the project? | Audio Solution Your company has an opportunity to invest in a project that is expected to result in after-tax cash flows of $8,000 the first year, $10,000 the second year, $13,000 the third year, -$8,000 the fourth year, $20,000 the fifth year, and $26,000 the sixth year. The project would cost the firm $59,000. If the firm's cost of capital is 13%, what is the MIRR for the project? | Audio Solution Determine the Payback period (in years) for a project that costs $120,000 and would yield after-tax cash flows of $20,000 the first year, $22,000 the second year, $25,000 the third year, $27,000 the fourth year, $31,000 the fifth year, and $37,000 the sixth year. | Audio Solution Your company has an opportunity to invest in a project that is expected to result in after-tax cash flows of $8,000 the first year, $10,000 the second year, $13,000 the third year, -$8,000 the fourth year, $20,000 the fifth year, and $26,000 the sixth year. The project would cost the firm $59,000. If the firm's cost of capital is 13%, what is the Profitability Index for the project? | Audio Solution Be prepared for a 60 minute quiz, with about 13 questions, over chapter 10. updated September 18, 2020