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CAPITAL EXPENDITURES
Analyzing capital expenditure proposals is
not costless-benefits can be gained.
Following are generally categorized projects
1. Replacement: needed to continue
current operations.
2. Replacement: cost reduction
3. Expansion of existing products or
markets
4. Expansion into new products or
markets
5. Safety and/or environmental projects
6. Mergers
CAPITAL BUDGETING METHODS
Decision criteria to accept or not
investment proposals
NET PRESENT VALUE
A method of ranking investment
proposals using the net present value
(NPV) , which is equal to the present
value of future net cash flows,
discounted at the cost of capital
Tells us how much a project
contributes to shareholder wealth
the larger the NPV, the more value the
project adds and added value means a
higher stock price.
CONCEPTUAL ISSUES IN
CASH FLOW ESTIMATION
1. Cash Flow versus Accounting
Income
Many things can lead to differences
between net cash flows and net
income:
Depreciation is not a cash
outlay but it is deducted when
net income is calculated
Net income is based on the
depreciation rate
An addition to working capital
directly affects cash flows but
not net income
FOR CAPITAL BUDGETING PURPOSES,
THE PROJECTS CASH FLOWS, NOT ITS
ACCOUNTING INCOME, IS THE KEY ITEM
CONCEPTUAL ISSUES
1. Timing of Cash Flows - We generally
assume that all cash flows at the end
of the year
3. Incremental Cash Flows A cash
flow that will occur , if and only if, the
firm takes a project
4. Replacement Projects A type of
project where the firm replaces
existing assets, generally to reduce
costs
5. Sunk Costs A cash outlay that has
already been incurred and that cannot
be recovered regardless of whether
the project is accepted or rejected
6. BEING SUCH, THEY ARE NOT
RELEVANT IN THE CAPITAL
BUDGETING ANALYSIS
7. Opportunity Costs Associated with
Assets the Firm owns The best
return that can be earned on assets
the firm already owns if those assets
are not used for the new project
DECISION CRITERIA USED IN PRACTICE
A summary of all surveys: what
method is given more weight, what
methods are actually calculated and
used
SUMMARY ON THE METHODS
NPV tells us how much value each
project contributes to share holders
wealth
Other methods provide useful
information and in this age of
computers, it is easy to calculate all of
them
Decision makers generally look at all
the criteria when deciding to accept or
3)
4)
5)
6)
TYPES OF MERGER
1. HORIZONTAL MERGER a
combination of two firms that produce
the same type of goods or services
2. VERTICAL MERGER A merger
between a firm and one of its suppliers
or customers
3. CONGENERIC MERGER A merger of
firms in the same general industry but
for which no costomer or supplier
relationship exists
4. CONGLOMERATE MERGER A
merger of companies in totally
different industries
EFFECTS OF MERGER
HOSTILE VS. FRIENDLY TURNOVERS
Acquiring Company a company
that seeks to purchase another firm
Target Company A firm that
another company seeks to acquire
Friendly Merger a merger whose
terms are approved by management
of both companies
Hostile Merger a merger in which
the target firms management resists
acquisition
Tender offer the offer of one firm to
buy the stock of another firm by going
directly to the stockholders, frequently
but not always over the opposition of
the target companys management
ONCE AN ACQUIRING COMPANY HAS
IDENTIFIED A POSSIBLE TARGET COMPANY
VALUATION METHODS
Discounted Cash Flow Analysis
this approach to valuing a business
involves the application of capital
budgeting procedures to an entire firm
rather than to a single project. To
apply this method, two key items are
needed:
1. Pro-forma statements
2. Discount rate, or cost of capital
Market Multiple Analysis a
method of valuing a target company
that applies a market determined
multiple to net income, earnings per
share, sales, book value and so forth
WHAT HAPPENS AFTER THE MERGER?
Merger bring together two
organizations with different histories
and corporate cultures
Change of management
Staff reductions
Economies of scale
Improved market reach and industry
visibility
Improved companys standing
FINANCE MANAGER ETHICS
Should be above approach
Includes more than just acting in an
honest, above-board manner
Means establishing boundaries that
prevent professional and personal
interests from appearing to conflict
with the interest of the employer
TOP ETHICAL RESPONSIBILITIES
Must provide accurate, competent and
timely information
Responsible for protecting the
confidentiality of the employer
Stays within the boundaries of law