Basic Steps of Capital Budgeting

1. Estimate the cash flows

2. Assess the riskiness of the cash flows.

3. Determine the appropriate discount rate.

4. Find the PV of the expected cash flows.

5. Accept the project if PV of inflows > costs. IRR > Hurdle Rate and/or

payback < policy

Definitions:

Independent versus mutually exclusive projects.

Normal versus nonnormal projects.

Evaluation Techniques

· Payback period

· Net present value (NPV)

· Internal rate of return (IRR)

· Modified internal rate of return (MIRR)

· Profitability index