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8: Introduction to Capital Budgeting

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Learning Objectives

After completing this chapter, students should be able to

  • Identify what a capital budgeting project is, provide an example, and discuss why the capital budgeting process is essential to maximizing shareholder wealth
  • Explain the difference between independent and mutually exclusive projects
  • Identify and explain the relevance of the four key capital budgeting criteria
  • Identify whether or not each of the criteria is met by each of the three decision techniques introduced in class (Payback Period, Internal Rate of Return, and Net Present Value)
  • Calculate and conceptually explain the concepts of Payback Period (PP), Internal Rate of Return (IRR), and Net Present Value (NPV)
  • Adjust for risk differences under PP, IRR, and NPV
  • Evaluate independent and/or mutually exclusive projects using each of the three decision techniques in isolation and as a whole
  • Explain the flaws and relevance of the PP
  • Explain the flaws and relevance of the IRR
  • Explain why NPV is the best model
  • Explain the concepts of the size problem, reinvestment rate problem, and crossover problem as well as identifying when these problems might be present
  • Explain the concept of the NPV profile
  • Discuss the survey results of how these methods are applied in practice.


8: Introduction to Capital Budgeting is shared under a CC BY-NC 4.0 license and was authored, remixed, and/or curated by LibreTexts.

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