Special Topics and Problems in Capital Budgeting

Special Topics

Capital rationing

• Borderline projects (positive NPV but no funds) might be rejected.

• PI (or IRR) as method to rank indivisible projects

 Mutual Exclusive Projects

• Use NPV to rank

 Ranking Problems

• Size disparity

• Time Disparity

• Unequal Lives

Ranking Problems

• Size disparity

• No capital rationing è highest NPV of project

• Capital rationing è highest NPV of set of projects

• Time Disparity (really reinvestment rate assumption problem)

• NPV v. IRR ?

• Unequal Lives

• Replacement chain

• Find the common life assuming a replacement chain

• assume repeated investment at required return

• compare NPV

• Equivalent Annual Annuity

• Compare two projects - Take PV of both and calculate annual PMT associated with annuity problems with n = life of project.  The result is the annual annuity payment (implied) for each of the two project.  These two numbers are now comparable.  Assuming infinite replacement chains, the PV of the discounted annual payment (i.e., perpetuity) can be calculated.

  Be sure to see the text book assignments for more information on this topic.