Capital Budgeting

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Capital Budgeting by Mind Map: Capital Budgeting

1. What is it?

1.1. the process of identifying, evaluating and implementing long-term investment strategies

2. what does the process look like?

2.1. Proposal generation

2.2. Review and analysis

2.3. Decision making

2.4. Implementation

2.5. Follow up

3. Basic terminology

3.1. Projects

3.1.1. independent projects

3.1.2. mutually exclusive projects

3.2. Capital and Funding

3.2.1. unlimited funds

3.2.2. capital rationing

3.3. Approach

3.3.1. accept/reject

3.3.2. ranking

4. Relevant CFs

4.1. evaluate capital investment alternatives by focusing on the incremental cash flows

4.2. incremental cashflows are the additional cashflows (initial outflow and subsequent inflows) associated with the investment

4.2.1. remember to compute incremental cashflows for replacement projects

4.3. major cashflow components

4.3.1. initial investment

4.3.1.1. Calculation

4.3.2. operating cashflows

4.3.2.1. Calculation

4.3.3. terminal cashflows

4.3.3.1. Calculation

5. Payback period

5.1. measures how long it will take to recover the initial investment

5.2. rejecting the project based on the payback period

5.3. PROS

5.3.1. considers cashflows rather than accounting profits

5.3.2. gives implicit consideration to the timing of cashflows

5.3.3. used to supplement other periods (NPV, IRR)

5.4. CONS

5.4.1. appropriate payback period number is subjectively determined

5.4.2. fails to fully consider the time value of money

5.4.3. not based on discounted cashflows

6. NPV and the Profitability Index

6.1. NPV

6.1.1. if NPV > 0

6.1.2. if NPV < 0

6.1.3. if NPV = 0

6.2. Profitability Index

6.2.1. if PI > 1

6.2.2. if PI < 1

6.2.3. if PI = 0

6.3. Economic Value Added (EVA)

6.3.1. calculates return in excess of the competitive return of a business

6.3.2. asks whether a project generates positive cashflows over and above what investors demand

7. Internal Rate of Return

7.1. this is the discount rate that will equate the PV of the outflows with the PV of the inflows

7.2. if IRR > cost of capital

7.3. if IRR < cost of capital

7.4. if IRR = cost of capital