Chapter 13 Capital Budgeting, Risk Considerations, and Other Special Issues Notes 13.1 Capital Expenditures The Importance of the Capital Expenditure Decision capital expenditures a firms investments in long-lived assets, which may be tangible or intangible long-term investment decisions determine a companys future direct and could be viewed as most important decisions a firm can make, because a firms capital expenditures (capex) usually involve large amounts of money, and decisions are often irrevocable the importance of capex decisions lies in their ability to affect the risk of the firm capital budgeting process through which firm makes capital expenditure decisions by (1) identifying investment alternatives, (2) evaluating alternatives, (3) implementing chosen investment decisions, and (4) monitoring and evaluating chosen decisions five forces the five critical factors that determine the attractiveness of an industry: entry barriers, the threat of substitutes, the bargaining power of buyers, the bargaining power of suppliers, and rivalry among existing competitors Michael Porter argues that firms can create competitive advantages for themselves by adopting one of the following strategies: cost leadership (strive to be a low-cost producer); and differentiation (offer differentiated products) cost leadership usually follows from replacement decisions, when firms are constantly striving to use the latest technology to lower the costs of production, while product differentiation usually follows from new product development decisions bottom-up analysis an investment strategy in which capex decisions are considered in isolation, without regard for whether the firm should continue in this business or for general industry and economic trends top-down analysis an investment strategy that focuses on strategic decisions, such as which industries or products the firm should be involved in, looking at the overall economic picture discounted cash flow (DCF) methodologies techniques for making capex decisions that are consistent with the overriding objective of maximizing shareholder wealth; they involve estimating future cash flows and comparing their discounted values with investment outlays required today 13.2 Evaluating Investment Alternatives Net Present Value (NPV) Analysis net present value (NPV) sum of present value of all future after-tax incremental cash flows generated by an initial cash outlay, minus present value of investment outlays; present value of expected cash flows net of costs needed to generate them incremen
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