Corporate Investments and Capital Budgeting

This week’s course of study focuses on expected outcomes associated with corporate investments and the capital budgeting process.  Expected outcomes include understanding how to use, calculate, and evaluate the traditional criteria used in examining corporate capital investments.

After completing the studies for the week, students should be able to explain the steps in the capital budgeting process and demonstrate proficiency with calculating the costs of asset acquisition and disposition.  They should be proficient with the estimation of cash flows for potential capital investment projects.  Similarly, it is expected that students are able to estimate the working capital investments required to support capital investments and understand how to incorporate those investments in the assessment of capital budgeting projects.

A principal expected outcome for this week is to be able to demonstrate proficiency with the calculation of the traditional capital budgeting criteria including NPV, IRR, MIRR, PI, and payback period.  It is also necessary to demonstrate proficiency with the interpretation of these criteria and understand how to use them properly in making capital investment decisions.

Another important outcome is the ability to evaluate and select the optimal capital investment project in situations of (1) mutually exclusive projects with unequal lives, using either the least common multiple of lives approach or the equivalent annual annuity approach, and (2) capital rationing.

Another expected outcome is the capability to accommodate risk into the capital budgeting process.  This includes knowing how to utilize a risk-adjusted discount rate, real options, and certainty equivalents to accommodate risk in capital budgeting project analysis.

It is expected that students will learn how to evaluate international investment opportunities, and to describe a multinational firm’s decision-making process for capital budgeting and cash-flow management.  They should also be able to compare leasing and borrowing as sources of financing for capital investments.

Explaining the procedure for determining the discount rate to be used in valuing a capital project is an expected outcome for the week.  This includes the capability to calculate the cost of financing including debt, equity and other financing and estimate the weighted average cost of capital. 

Another important outcome is the ability to explain the relationship between capital investment decisions and investment policies to company valuation.

Observation:

For a useful overview of the capital budgeting process and the traditional evaluation criteria (payback, discounted payback, net present value, profitability index, internal rate of return, and modified internal rate of return) see:

http://www.teachmefinance.com/capitalbudgeting.html