Table of Contents

Chapter 1 – Overview of Capital Budgeting. 4

Overview of Capital Budgeting. 4

The Capital Budgeting Application Form.. 5

Capital Expenditure Proposal Analysis. 9

Capital Budgeting Problems. 10

Opportunity Costs. 10

Sunk Costs. 11

Excessive Optimism.. 12

Capital Rationing. 12

Capital Budgeting in a Budget Format 13

Capital Budgeting in the Absence of a Budget Model 14

Capital Budgeting with Minimal Cash. 15

The Post Installation Review.. 16

Chapter 2 - Capital Budgeting Strategy. 19

Capacity Expansion Strategy. 19

Capacity Reduction Strategy. 20

Growth Strategy. 20

Risk Levels. 21

Additional Risk Factors for International Investments. 22

Factors Impacting Future Asset Usage. 23

Perceived Certainty of Future Demand. 24

Duration. 24

Impact of Financing Alternatives. 24

Chapter 3 - Discounted Cash Flow Analysis. 27

Cash Flows. 27

Time Value of Money. 27

Present and Future Value Tables. 29

Net Present Value. 30

Scenario and Sensitivity Analysis. 33

Internal Rate of Return. 33

Incremental Internal Rate of Return. 34

Terminal Value. 35

Profitability Index. 36

The Tax Rate. 36

Cash Flow Analysis Issues. 36

Chapter 4 - The Cost of Capital 39

Cost of Capital Derivation. 39

Cost of Debt 39

Cost of Preferred Stock. 40

Cost of Common Stock. 40

Weighted Average Cost of Capital 41

Variations in the Cost of Capital 41

Adjustments to the Cost of Capital 43

Cost of Capital as a Threshold Value. 44

Chapter 5 – Constraint Analysis. 47

The Bottleneck Operation. 47

Constraint Analysis. 48

The Inventory Buffer. 49

Buffer Sizing. 49

Sprint Capacity. 51

Local Optimization. 51

Investment Decision Priorities. 52

Priority 1 – Increases Throughput 52

Priority 2 – Reduces Invested Funds. 52

Priority 3 – Reduces Expenses. 53

Additional Investment Considerations. 53

The Constraint Analysis Model 54

Production Analysis. 57

Increase Downstream Capacity. 57

Increase Upstream Capacity. 59

Increase Upstream Processing. 60

Outsource to a Supplier 61

Chapter 6 – Other Capital Budgeting Analyses. 65

Breakeven Analysis. 65

The Payback Method. 66

Discounted Payback. 67

Accounting Rate of Return. 68

Real Options. 69

The Outsourcing Decision. 71

Research and Development Funding Analysis. 72

Complex Systems Analysis. 73

Chapter 7 – The Lease or Buy Decision. 76

The Lease Arrangement 76

The Lease or Buy Decision. 76

Leasing Concerns. 77

Leasing Advantages. 78

Chapter 8 - Capital Budgeting Controls. 81

Capital Budgeting Controls. 81

Answers to Chapter Questions. 84

Glossary. 93

Index. 95

Final Examination…………………………………………………………………………………………………...97