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Corporate Finance Workbook: A Practical Approach, Second Edition by George H. Troughton, CFA, Martin S. Fridson, CFA, Michelle R. Clayman, CFA

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CHAPTER 2

CAPITAL BUDGETING

LEARNING OUTCOMES

After completing this chapter, you will be able to do the following:

  • Describe the capital budgeting process, including the typical steps of the process, and distinguish among the various categories of capital projects.
  • Describe the basic principles of capital budgeting, including cash flow estimation.
  • Explain how the evaluation and selection of capital projects is affected by mutually exclusive projects, project sequencing, and capital rationing.
  • Calculate and interpret the results using each of the following methods to evaluate a single capital project: net present value (NPV), internal rate of return (IRR), payback period, discounted payback period, average accounting rate of return (AAR), and profitability index (PI).
  • Explain the NPV profile, compare NPV and IRR methods when evaluating independent and mutually exclusive projects, and describe the problems associated with each of the evaluation methods.
  • Describe the relative popularity of the various capital budgeting methods and explain the relation between NPV and company value and stock price.
  • Describe the expected relations among an investment’s NPV, company value, and stock price.
  • Calculate the yearly cash flows of an expansion capital project and a replacement capital project, and evaluate how the choice of depreciation method affects those cash flows.
  • Explain the effects of inflation on capital budgeting analysis.
  • Evaluate and select the optimal capital project in situations ...

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