...cash flow, incremental cash flow, sunk cost, opportunity cost, externalities, and cannibalization. • Identify the three categories to which incremental cash flows can be classified. • Analyze an expansion project and make a decision whether the project should be accepted on the basis of standard capital budgeting techniques. • Explain three reasons why corporate risk is important even if a firm’s stockholders are well diversified. • Identify two reasons why stand-alone risk is important. • Demonstrate sensitivity and scenario analyses and explain Monte Carlo simulation. • Discuss the two methods used to incorporate risk into capital budgeting decisions. • List four different types of embedded real options, explain what a decision tree is, and provide an example of one. • List the steps a firm goes through when establishing its optimal capital budget in practice. LECTURE SUGGESTIONS This chapter develops procedures for estimating and identifying relevant cash flows, discusses techniques used to measure and take account of project risk, introduces the concept of real options, and discusses general principles for determining the optimal capital budget. Assuming you are going to cover the entire chapter, the details of what we cover, and the way we cover it, can be seen by scanning Blueprints, Chapter 12. For other suggestions about the lecture, please see the “Lecture Suggestions” in Chapter 2, where we describe how we conduct our classes...
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...Management J. Volume 2 No. 1 (January 1989) ,' CAPITAL BUDGETING PRACTICES OF INDIAN COMPANIES I. M. PANDEY ' Objective " The objectives of this study are: (a) to document the capital bud geting policies and practices of companies in India, a developing country, and contrast them with those of USA and UK, the developed countries, and (b) to ascertain how business executives look upon the linkage between corporate strategy and investment decision-making. Capital expenditure planning and control is a process of facilitating decisions covering expenditures on long-term assets. Since a company's survival and profitability hinges on capital expenditures, specially the major ones, the importance of the capital budgeting process cannot be over-emphasized. Sample and Methodology We have followed an intensive interview-cum-questionnaire method. Two questionnaires—one dealing with investment evaluation practice and second with other phases—were sent to companies which had agreed to participate in the study. In all, 14 companies were studied. The responding companies belonged to different businesses. In terms of size (sales and number of employees), capital intensity (net tangible fixed assets), volume of spending (capital expenditure incurred), and level of technology, they represent a variety (Table 1). The study relates to 1984. •-, Capital Expenditure: How Defined Strictly speaking, capital expenditure includes all those expenditures which are expected to produce...
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...Capital Budgeting Techniques | | GLOSSARY Capital Budget: (1) The amount of money set aside for the purchase of fixed assets (e.g., equipment, buildings, etc.). Also, (2) a request for authorization to purchase new fixed assets. Mutually Exclusive Proposals: Consideration of two or more assets that perform the same function. If one is chosen for purchase, the others are automatically rejected. Profitability Index: A ratio of the present value of the benefits (PVB) to the present value of the costs (PVC). The index is used instead of Net Present Value (i.e., PVB - PVC) when evaluating mutually exclusive proposals that have different costs. As the picture above illustrates, the capital budgeting decision may be thought of as a cost-benefit analysis. We are asking a very simple question: "If I purchase this fixed asset, will the benefits to the company be greater than the cost of the asset?" In essence, we are placing the cash inflows and outflows on a scale (similar to the one above) to see which is greater. A complicating factor is that the inflows and outflows may not be comparable: cash outflows (costs) are typically concentrated at the time of the purchase, while cash inflows (benefits) may be spread over many years. The time value of money principle states that dollars today are not the same as dollars in the future (because we would all prefer possessing dollars today to receiving the same amount of dollars in the future). Therefore, before we can place...
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...Financial Management Case Presented to Ms. Shama Ahmed Presented by Sabeen Jamil Sana’a Imran Shah Zainab Dadabhoy Table of Contents Executive Summary 3 Section One 4 Introduction 4 Company Information: 4 Background: 4 Section Two 5 Problem Statement: 5 Existing Processes 6 Process of Approving Capital Expenditure Requests 6 Time Value of Money 7 Illustration 7 Proposed Methodology and Requirements: 7 Existing Process of approving capital expenditure requests 8 Strengths of Existing Processes 8 Limitations 8 Section Three 10 Solutions: 10 Present Value Techniques 10 Depreciation Accounts: 10 Taxable Transactions: 11 Assessment Of Suggested Technique 13 Strengths 13 Weaknesses 13 Recommendations: 13 Strategic Investments 14 Replacement Analysis 15 Executive Summary This case revolves around the financial analysis of a Company, Thermo Rubber. The essence of this report was to identify the weaknesses and problems listed in the case and to provide plausible solutions and recommendations to counter it. This involves detail study and extensive analysis to provide a pragmatic view of the company’s financial dealings and propose an implementable solution or alterations in the current financial set-up. Section One Introduction Company...
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...does not suit the company’s operational goals and objectives. Guillermo can determine the best course of action through capital budgeting techniques. Through calculating the net present value (NPV), the internal rate of return (IRR), and the weighted average cost of capital (WACC) Guillermo can determine the best course of action that will have the best profitability outcomes. Guillermo could decide to maintain doing business without making any changes to the structure of the company. If he chose to stay on his current path, furniture sales could decrease because of the competitions ability to sell quality furniture at discounted prices. Continuing with business as usual, Guillermo will miss opportunities for growth. Currently Guillermo has a net income before taxes of forty-four thousand dollars. If Guillermo continues to operate the same way he will be facing many challenges going forward. Some challenges he will be facing consists of; increased competition, residents of Sonora have better job opportunities with increased wages (University of Phoenix, n.d.). Guillermo’s profit margins have begun to decrease from the increased cost of labor. The competition offering quality product at a lesser price will force Guillermo decrease price which will also result in decreased profit margins. A new high-tech company has entered the marketplace with cost saving technology to create furniture on the same quality scale as Guillermo....
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...Capital Budgeting Practices MGMT 640 Section 9040 Professor J.Jain Executive Summary This essay discusses the importance of capital budgeting and analyzes the most common techniques. The most frequently used methods are the net present value (NPV) and internal rate of return (IRR). These are both tools that analyze the present value of the cost of a project as well as the present value of that projects future cash flows. An essential part of these methods is that they both account for discounted cash flow (DCF), meaning that they both reflect the time value of money. When analyzing independent projects with conventional cash flows, both the NPV and IRR will provide projections along the same lines. However when those two conditions are not met, the IRR method will become misleading. Therefore I argue that the NPV should take precedence over the IRR when only one method can be chosen. However, financial managers should be wary when using the NPV as it does not account for certain factors such as the value of waiting and cash flows that occur on a non-yearly basis. There are direct correlations between the size of a firm and the capital budgeting method most utilized. Small businesses frequently overlook the two most popular methods and opt to analyze projects with the “payback period”, which evaluates the time it will take in order to recuperate cash flows invested in a given project. The variation of this method is known as the discounted payback period, which also accounts...
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...Capital budgeting Making decisions having significant future benefits or costs for various entities and their stakeholders. Capital budgeting is the backbone of financial economics. Related topics in financial economics include: the time value of money, the meaning of net-present value, accounting concepts consistent with present-value calculations, discount rates, and option valuation techniques. In the public sector, the term is often exclusively associated with infrastructure investments -- plant and equipment. It is more properly associated with all policy choices that have significant, long-term consequences: especially decisions about missions, programs, products, processes, or procedures. There are standard solutions to several kinds of capital-budgeting problems: make or buy decisions, investment in working capital (especially inventories) decisions, maintenance-level decisions, project selection, the choice of mutually exclusive investments, and investments in plant with fluctuating rates of production. However, the same basic calculus of benefits and costs is supposed to guide all classes policy choices with long-term consequences. Financial Theory Financial theory teaches that, in the presence of a capital market where funds can be obtained at a price, welfare will be maximized by the implementation of all policy choices that generate positive net-present values. This means, in part, that the timing of benefits and costs is generally of no...
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...Executive Summary Reckitt Benckiser Bangladesh Ltd is a leading player in the FMCG market of Bangladesh with a focus on Health, Hygiene & Home. Making differencing from conventional playing company in Bangladesh Reckitt Benckiser has strong intention for modern developed capital budgeting technique in evaluating their potential projects especially in large R&D projects. The company mainly uses IRR. It uses sophisticated methods to project future cash flows. The company also uses scenario analysis to incorporate risk and for some very complex projects, it uses simulation analysis with the help of parent company in UK. However, Reckitt Benckiser Bangladesh Ltd is a well established company and it does not take large projects very often. Those capital budgeting techniques are normally used in evaluating large projects and in case of acquisition of an existing company. Company Overview Company Profile Reckitt Benckiser is a world leader in FMCG household, health and personal care. In Bangladesh it has started its journey as Reckitt Benckiser (Bangladesh) Ltd. The Company was listed in DSE in 1986 and in CSE in 1995 as a pharmaceuticals and chemical company. Currently, Reckitt Benckiser (Bangladesh) Ltd is a leading player in the FMCG market of Bangladesh with a focus on Health, Hygiene & Home. RB is involved in the business of manufacturing and marketing Household, Toiletries and Pharmaceuticals items. The company’s product array includes brands like Disprin, Dettol...
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...ORGANIZATION & CULTURE FINANCE & ACCOUNTING HUMAN RESOURCES COMPETITIONCompetitive Edge Finance Function in a Global Corporation The H 108 Harvard Business Review | by Mihir A. Desai HISTORICALLY, the finance functions in large U.S. and European firms have focused on cost control, operating budgets, and internal auditing. But as corporations go global, a world of finance opens up within them, presenting new opportunities and challenges for CFOs. Rather than simply make aggregate capital-structure and dividend decisions, for example, they also have to wrestle with the capital structure and profit repatriation policies of their companies’ subsidiaries. Capital budgeting decisions and valuation must reflect not only divisional differences but also the complications introduced by currency, tax, and country risks. Incentive systems need to measure and reward managers operating in various economic and financial settings. The existence of what amounts to internal markets for capital gives global corporations a powerful mechanism for arbitrage across national financial markets. But in managing their July–August 2008 | hbr.org John Hersey Honing Your Competitive Edge FINANCE & ACCOUNTING internal markets to create a competitive advantage, finance executives must delicately balance the financial opportunities they offer with the strategic opportunities and challenges presented by operating in multiple...
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...effective Investment appraisal tool? Capital Budgeting: To understand the value of NPV, the identification of its purpose in capital budgeting should be addressed beforehand, with its alternatives. This process of Capital Budgeting refers to the evaluation of potential in large scale business expenses and investments over long-term ventures. Often this step in the investment appraisal assessment, identifies the cashflows over the projects life-span, determining its generated returns in comparison to the organisations benchmark targets. (Book) Flowton’s options of replacing its older systems (Project A) or upgrading them to a centrally controlled platform (Project B) are considered such a venture. Ideally, Flowton would...
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...HOW DO CFOS MAKE CAPITAL BUDGETING AND CAPITAL STRUCTURE DECISIONS? by John Graham and Campbell Harvey, Duke University* e recently conducted a comprehensive survey that analyzed the current practice of corporate finance, with particular focus on the areas of capital budgeting and capital structure. The survey results enabled us to identify aspects of corporate practice that are consistent with finance theory, as well as aspects that are hard to reconcile with what we teach in our business schools today. In presenting these results, we hope that some practitioners will find it worthwhile to observe how other companies operate and perhaps modify their own practices. It may also be useful for finance academics to consider differences between theory and practice as a reason to revisit the theory. We solicited responses from approximately 4,440 companies and received 392 completed surveys, representing a wide variety of firms and industries.1 The survey contained nearly 100 questions and explored both capital budgeting and capital structure decisions in depth. The responses to these questions enabled us to explore whether and how these corporate policies are interrelated. For example, we investigated whether companies that made more aggressive use of debt financing also tended to use more sophisticated capital budgeting techniques, perhaps because of their greater need for discipline and precision in the corporate investment process. More generally, the design of our survey...
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...HOW DO CFOS MAKE CAPITAL BUDGETING AND CAPITAL STRUCTURE DECISIONS? by John Graham and Campbell Harvey, Duke University* e recently conducted a comprehensive survey that analyzed the current practice of corporate finance, with particular focus on the areas of capital budgeting and capital structure. The survey results enabled us to identify aspects of corporate practice that are consistent with finance theory, as well as aspects that are hard to reconcile with what we teach in our business schools today. In presenting these results, we hope that some practitioners will find it worthwhile to observe how other companies operate and perhaps modify their own practices. It may also be useful for finance academics to consider differences between theory and practice as a reason to revisit the theory. We solicited responses from approximately 4,440 companies and received 392 completed surveys, representing a wide variety of firms and industries.1 The survey contained nearly 100 questions and explored both capital budgeting and capital structure decisions in depth. The responses to these questions enabled us to explore whether and how these corporate policies are interrelated. For example, we investigated whether companies that made more aggressive use of debt financing also tended to use more sophisticated capital budgeting techniques, perhaps because of their greater need for discipline and precision in the corporate investment process. More generally, the design of our survey...
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...Operational Management Table of Contents 1 INTRODUCTION 3 2 THE SCOPE OF OPERATIONS MANAGMETNT 3 3 LOCATIONAL PLANNING 5 4 QUALITY 7 5 FORECASTS 8 6 INVESTMENT 10 7 CONCLUSION 12 * 1 INTRODUCTION EXPLANATION OF OPERATIONS MANAGEMENT The field of what has been known as production management has expanded in scope to cover management of non-manufacturing or service activities. Because of this broad scope, the field has taken a new name, production and operations management or simply operations management. Operations management is the process by which goods and services are created. We find productive process in all kinds of organized activities. Operations management deals with decision making related to production processes to ensure that the resulting goods or services comply with the specifications, in the amounts and by the schedule required, and at the minimum cost PURPOSE OF THIS PAPER The purpose of this paper is to understand the operations management for the company I work for and to ensure that I can apply the tools that I have learned to the real situation. Issues for the further study are identified. I find the following subjects interest me as part of the company’s operations management and I concentrate on these subjects for this paper. * Locational planning * Quality * Forecasting * Investment * 2 THE SCOPE OF OPERATIONS MANAGMETNT Operations management is the process by which goods and services are created. MAJOR...
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...CMA Exam Support Package Examination Essay Questions For Practice © Copyright 2010 By Institute of Certified Management Accountants Introduction The Institute of Certified Management Accountants (ICMA) is publishing this book of practice questions with answers to help you prepare for the CMA examination. Each question is referenced to the Content Specification Outline (CSO) and the Learning Outcome Statements (LOS). These questions are actual “retired” questions from the CMA exams and are intended to supplement other study materials. These practice questions will help you test your understanding of the concepts and rules included in your CMA study materials by requiring you to apply those concepts and rules to unique and varying situations. You will encounter different scenarios and applications on your actual examination so it is essential that you understand the underlying concepts. In general, it will not be helpful to you to memorize particular questions. Essay questions appear in both Part 1 and Part 2 of the CMA exam and combine topics from the part in which they appear. No inference should be made from the lack of practice questions in any topic areas. All topic areas listed in the Content Specification for each exam part can be tested in the essay questions for that part at the difficulty levels shown. The CMA Program is a rigorous test of your skills and capabilities and requires dedication to be successful. We hope that these practice questions...
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...Campbell R. Harveya,b,* aFuqua School of Business, Duke University, Durham, NC 27708, USA bNational Bureau of Economic Research, Cambridge, MA 02912, USA (Received 2 August 1999; final version received 10 December 1999) Abstract We survey 392 CFOs about the cost of capital, capital budgeting, and capital structure. Large firms rely heavily on present value techniques and the capital asset pricing model, while small firms are relatively likely to use the payback criterion. A surprising number of firms use firm risk rather than project risk in evaluating new investments. Firms are concerned about financial flexibility and credit ratings when issuing debt, and earnings per share dilution and recent stock price appreciation when issuing equity. We find some support for the pecking-order and trade-off capital structure hypotheses but little evidence that executives are concerned about asset substitution, asymmetric information, transactions costs, free cash flows, or personal taxes. JEL classification: G31, G32, G12 Key words: Capital structure; Cost of capital; Cost of equity; Capital budgeting; Discount rates; Project valuation; Survey *Corresponding author, Tel: 919 660 7768, Fax: 919 660 7971 E-mail address: cam.harvey@duke.edu We thank Franklin Allen for his detailed comments on the survey instrument and the overall project. We appreciate the input of Chris Allen, J.B. Heaton, Craig...
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