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Capital budgeting techniques - Coggle Diagram
Capital budgeting techniques
Net Present Value
Approach calculates the present value of a project´s cash flows
The NPV uses a discount rate that reflects the project´s risk
A positive NPV means that the investment provides returns that exceed shareholders expectations and that the firm should invest in the project.
Internal Rate of Return
Calculates the discount rate at which a project´s NPV equals 0
If the IRR exceeds the project's hurdle rate, a rate chosen to reflect the project's risk then the firm should invest
Both make adjustments for a project's risk and for the timing of the cash flows.
The discount rate used in NPV calculation, should be the same as the hurdle rate to which the project's IRR is compared
Problems with the IRR
Can be difficult to interpret when a project's cash flows patterns are unusual
IRR and NPV sometimes disagree on how to rank competing projects
when firms have many desirable investment projects but can only undertake a few of them, firm needs to rank their investment opportunities for most to least desirable and the NPV and IRR methods creates different rankings
Co-management
Unusual Cash flows patterns
Outflows and inflows
Scale problem
Discount rate
Hurdle rate
Ranking competing projects
Timing problems
Capital expenditures
Inventory
Pretax income
After Tax contribution margin
Depreciation
Price