Chapter 11 The Basics of Capital Budgeting 357SELF^ TEST What trends in capital budgeting methodology can be seen from Table 11-2?In this chapter, we described! ve techniques—NPV, IRR, MIRR, payback, and dis-
counted payback—that are used to evaluate proposed capital budgeting projects.
NPV is the best single measure as it tells us how much value each project contributes
to shareholder wealth. Therefore, NPV is the method that should be given the great-
est weight in decisions. However, the other approaches provide useful information;
and in this age of computers, it is easy to calculate all of them. Therefore, managers
generally look at all! ve criteria when deciding to accept or reject projects and when
choosing among mutually exclusive projects.
In this chapter, we took the cash " ows given and used them to illustrate the
di$ erent capital budgeting methods. As you will see in the next chapter, estimating
cash " ows is a major task. Still, the framework established in this chapter is critically
important for sound capital budgeting analyses; and at this point, you should:
- Understand capital budgeting.
- Know how to calculate and use the major capital budgeting decision criteria,
which are NPV, IRR, MIRR, and payback. - Understand why NPV is the best criterion and how it overcomes problems inher-
ent in the other methods. - Recognize that while NPV is the best method, the other methods do provide infor-
mation that decision makers! nd useful.
T Y I N G I T A L L T O G E T H E R
KEY TERMS Define the following terms:
a. Capital budgeting; strategic business plan
b. Net present value (NPV)
c. Internal rate of return (IRR)
d. NPV profile; crossover rate
e. Mutually exclusive projects; independent projects
f. Nonnormal cash flows; normal cash flows; multiple IRRs
g. Modified internal rate of return (MIRR)
h. Payback period; discounted payback