The Basics of Capital Budgeting: Evaluation Cash Flows
Write Up: Mini Case ofChapter 10: The Basics of Capital Budgeting: Evaluation Cash Flows
Oct 2, 2014
Executive Summary:
We heritage $1 million from our grandfather, and we just received our master degree in MBA, and because we love to be our own boss and, we don not have the skills to trade on the market, we decided to purchase an established franchise in the fast-food area to make some investments. We chose two franchises: L, Lisa’s Soups, Salads, & Stuff which serves breakfast and lunch; and S, Sam’s Fabulous Fried Chicken that serves dinner. We think these two franchises are perfect complement to each other, also we estimate that both projects has the same risk characteristics, and for that we required 10% for our return, but we do not have the ability to stay on the project for more than 3 years, for that reason we estimate the free cash flows for both projects for the next three years. The main problem here that we have to evaluate and determine whether one or both of the franchises should be accepted.
To solve this problem, we used 6 capital budgeting techniques: net present value (NPV), internal rate of return (IRR), modified IRR (MIRR), profitability index (PI), payback and discounted payback. Each approach provides a different piece of information, so it is better to look at all of them when evaluating projects. Each one of them has it’s own strengths and weaknesses, which may help us to understand each project return liquidity and risk.
Financial Theory:
Six capital budgeting decision criteria are used in this case: NPV, IRR, MIRR, PI, payback and discounted payback. Three other issues in capital budgeting are also discussed in the case: (1) how to choose mutual exclusive projects with unequal lives; (2) the potential advantage of terminating a project before the end of its physical life; (3) how to optimal capital budgeting.
NPV is the single best criterion because it provides a direct measure of the value a project adds to shareholder
Oct 2, 2014
Executive Summary:
We heritage $1 million from our grandfather, and we just received our master degree in MBA, and because we love to be our own boss and, we don not have the skills to trade on the market, we decided to purchase an established franchise in the fast-food area to make some investments. We chose two franchises: L, Lisa’s Soups, Salads, & Stuff which serves breakfast and lunch; and S, Sam’s Fabulous Fried Chicken that serves dinner. We think these two franchises are perfect complement to each other, also we estimate that both projects has the same risk characteristics, and for that we required 10% for our return, but we do not have the ability to stay on the project for more than 3 years, for that reason we estimate the free cash flows for both projects for the next three years. The main problem here that we have to evaluate and determine whether one or both of the franchises should be accepted.
To solve this problem, we used 6 capital budgeting techniques: net present value (NPV), internal rate of return (IRR), modified IRR (MIRR), profitability index (PI), payback and discounted payback. Each approach provides a different piece of information, so it is better to look at all of them when evaluating projects. Each one of them has it’s own strengths and weaknesses, which may help us to understand each project return liquidity and risk.
Financial Theory:
Six capital budgeting decision criteria are used in this case: NPV, IRR, MIRR, PI, payback and discounted payback. Three other issues in capital budgeting are also discussed in the case: (1) how to choose mutual exclusive projects with unequal lives; (2) the potential advantage of terminating a project before the end of its physical life; (3) how to optimal capital budgeting.
NPV is the single best criterion because it provides a direct measure of the value a project adds to shareholder