COMMERCE 2FA3 Chapter Notes - Chapter 6: Decision Rule, Net Present Value, Cash Flow
6 Apr 2017
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Document Summary
Capital budgeting: is the process of analyzing projects and deciding which ones should be undertaken. Relevant discount rates are not the risk-free rate, but rather embody a risk premium. Weighted average cost of capital (wacc): for this class use the assumption that all firms being discussed are all-equity firms, meaning that the cost of capital and the required return on equity are the same. Adding new projects does not change the risk condition of the firm. The greater the risk, the greater the cost of capital used to reflect this. All projects have both costs and benefits, thus capital budgeting is cost-benefit analysis, the costs are the outflows and benefits are inflows of cash. There are a variety of decision making criteria used to decide on which projects to ahead with, they include payback (pb), net present value (npv), the internal rate of return (irr), and profitability index (pi).
