Week 16 Capital Budgeting Techniques

After studying this Chapter, you should be able to:

l Understand the payback period (PBP) method of project evaluation and selection, including its: (a) calculation; (b) acceptance criterion; (c) advantages and disadvantages; and (d) focus on liquidity rather than profitability. l Understand the three major discounted cash flow (DCF) methods of project evaluation and selection – internal rate of return (IRR), net present value (NPV), and profitability index (PI).

l Explain the calculation, acceptance criterion, and advantages (over the PBP method) for each of the three major DCF methods.

l Define, construct, and interpret a graph called an “NPV profile.”

l Understand why ranking project proposals on the basis of the IRR, NPV, and PI methods “may” lead to conflicts in rankings.

l Describe the situations where ranking projects may be necessary and justify when to use either IRR, NPV, or PI rankings.

l Understand how “sensitivity analysis” allows us to challenge the single-point input estimates used in traditional capital budgeting analysis.

l Explain the role and process of project monitoring, including “progress reviews” and “postcompletion audits.”

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