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what is Capital Expenditures

a firm's investments in long-lived or fixed assets


what are the types of capital expenditures

1. tangible - such as property, plant and equipment 2. Intangible - such as research and development knowledge, patents, copyrights, trademarks, brand names and franchise agreements


Capital expenditures decisions determine what

the future direction of a company and are among the most important that a firm can make


why is capital expenditure among the most important decision a firm can make

1. involves a very significant outlay of money and managerial time 2. takes many years to demonstrate their return 3. are irrevocable 4. significantly alter the risk of the entire firm because of their size and long-term nature


what is capital budgeting

the process through which a firm makes capital expenditure decisions


what does capital budgeting involve

identifying and evaluating investment alternatives, implementing the chosen proposals, and monitoring implemented decisions


what are Michael Porter's Five Forces

1. entry barriers 2. threat of substitute products 3. Bargaining power of buyers 4. bargaining power of suppliers 5. rivalry among existing competitors


what is Michael Porter's five forces (describe what it is)

identifies 5 critical factors that determine the attractiveness of an industry


Companies do exert control over how they strive to create a competivitve advantage within their industry. they can strive for what

1. Cost leadership 2. Product differentiation


what is an example cost leadership

ie. be the lowest cost producer


what is an example of product differentiation

have products considered unique


is it easy or hard to sustain a competitive advantage

difficult and requires on-going planning and investment


how should capital expenditure decision be made

with a strategic focus and be subject to rigorous financial analysis


what is bottom up analysis

an investment strategy in which capital expenditure decisions are considered in isolation without regard for whether the firm should continue in its particular business or for general industry and economic trends


what is top-down analysis

is an investment strategy that focuses or strategic decisions, such as which industries or products the firm should be involved in, looking at the overall economic picture


Capital expenditure decisions, like security valuation, must take into account

timing, magnitude, and riskiness of net incremental after-tax cash flow benefits that an initial investment is forecast to produce


Unlike security valuation, however, analysts can change what

the underlying cash flows by changing the structure of the project to impact its feasibility and profitability


All discounted cash flow (DCF) methods require what

an estimate of the initial investment, the net incremental after-tax cash flows, and the required rate of return on the project for the discount rate


We will consider four DCF methods for evaluating investment alternatives what are they

net present value (NPV), internal rate of return (IRR), payback period and discounted payback period, and profitability index (PI).


The firm’s cost of capital determines what

the minimum rate of return that would be acceptable for a capital project


The weighted average cost of capital (WACC) is what

the discount rate (k) used in NPV analysis, assuming the risk of the project being evaluated is similar to the risk of the overall firm, and the hurdle rate for IRR analysis


If the risk of the project differs from what

the risk of the overall firm, however, a risk-adjusted discount rate (RADR) should be used.


RADRs can be estimated using two techniques what are they

1. CAPM after determining the projects beta 2. Pure-play approach


what does the CAPM approach used for RADRs involve

This approach involves forecast ROA that must be regressed against the ROA of the market index, and estimation errors can be significant.


what does the Pure-Play approach used for RADRs invole

where you find the cost of capital of another firm operating in the industry associated with the project. The key to this approach is that the firm must not be diversified across industries but truly represent an investment solely in that industry.


what is the net present value analysis formula



Essentially, the net present value (NPV) is

the present value of all benefits (net cash inflows) minus the present value of costs (net cash outflows)


If PV(benefits) > PV(costs), then

•NPV > 0 and the project is acceptable because it will add value


If PV(benefits) < PV(costs), then

•NPV < 0 and the project should not be accepted because it will destroy value


What type of measure is NPV

absolute measure