UNIVERSITY OF WISCONSIN-WHITEWATER
On-Line MBA Program
FNBSLW-770 -- Capital
Budgeting
Summer Term I 2003
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Instructor: Michael A. S. Guth, Ph.D., J.D.
phone: (H) 865-483-8309; (O)
865-483-8309
email: mike @ @michaelguth.com
Office Hours: M-W-F 10 AM - 12 PM Eastern time, or by
appointment.
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Required Text (specially
made for this course): Capital Budgeting,
Primis Books, 2003, ISBN 0-390-34305-6, derived from six chapters in Block and
Hirt, Foundations of Financial Management,
10th Edition, McGraw-Hill, 2002.
Prerequisites: One or more courses in basic corporate
financial and/or accounting, or equivalent experience. Strong quantitative
skills, proficiency with spreadsheet software, and a good working knowledge of
a financial calculator are all highly desirable.
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Course Description: Welcome to Capital Budgeting
taught with a quantitative,
problem-solving approach. This
fast-pace course covers a variety of financial topics related to the capital
budgeting process. We will review the time value of money; valuation models for
bonds, preferred stock, and common stock; the cost of capital and optimal
capital structure; the capital budgeting decision: methods of ranking
investments, capital rationing, net present value; risk in capital budgeting;
and external growth through mergers and acquisitions. The course is
quantitative and will combine
theoretical and practical applications for capital (long-term)
investment. The course will
analyze numerous investment criteria, especially net present
value, payback, and internal rate of return. Students will learn about the
advantages and disadvantages of each of these criteria. Each of the investment criteria depends on
accurate forecasts or calculations of generally uncertain future cash flows. Thus, the capital budgeting process
necessarily entails a study of risk and techniques to limit exposures to
risk. We will also examine capital budgets and performance evaluation, and
some distinctions between accounting and financial criteria. Two other important issues discussed are the
notion of the appropriate goal of project choice and the necessity of sustainable competitive advantage to
ensure long-term profitability. The final part of the course applies capital
budgeting concepts and techniques to such issues as leasing, mergers, and
acquisitions.
Educational Goals Supported by this Course: This course will expand
your analytical reasoning skills. You
will need to apply the algebraic, statistical, accounting, finance, and
economics skills that you have acquired in prior courses to the capital
budgeting process. Capital Budgeting could be taught as a high-level strategic
planning course or as a tools course.
Because employers seek people who can work with complicated models and
solve problems, this course will emphasize the techniques and formulas for
allocating long-term capital. This
course will introduce you to some new theoretical concepts, such as payback of
modified internal rate of return. Homework assignments will require you to
replicate algebraic valuation, and accounting problems similar to those you
have seen in your financial management course.
This course will certainly provide you with valuable change skills, as capital budgeting
decisions are some of the most profound strategic choices that firms must
make. Capital budgeting necessarily
impacts the long term strategic plan for the firm, and most students are
fascinated with the strategic aspects of investment decisions. Finally, students will be taught the
critical importance of thinking outside the box. You should question why
financial professionals use the formulas we will study in this course and
whether better models could be constructed.
Course Objectives:
After completing this course
on long-term investments, the student should be able to:
$ describe capital budgeting decisions and use the net present
value (NPV) method to make such investment decisions.
$ evaluate projects using sensitivity analysis.
$ calculate the NPV difference between two projects using both
the total project and differential approaches.
$ identify reasonable techniques to estimate or forecast
relevant cash flows for NPV analyses.
$ compute the after-tax net present values of projects.
$ explain the after-tax effect of cash on disposing of assets.
$ compute the impact of inflation on a capital-budgeting
project.
$ use the payback model and the internal rate-of-return model
and compare them with the NPV model.
$ reconcile the conflict between using an NPV model for making a
decision and using internal rate of return for evaluating the related
performance.
$ understand how companies make long-term capital investment
decisions and how such decisions can affect the companies’ financial results
for years to come.
Course Requirements:
Students will be assigned
approximately 35 pages of reading material from the textbook each week. These reading assignments form the basis for
the six units in this course. Student
comprehension of each unit’s material will be tested weekly through detailed,
open book quizzes that will be submitted on-line for a grade. In addition, there will be 3 case study
assignments. The weights toward your
final grade for these assignments are:
weekly problem sets 60%,
case study assignments 20%,
discussion board participation 20%.
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Policy Statement: The
University of Wisconsin-Whitewater is dedicated to a safe, supportive and
non-discriminatory learning environment. It is the responsibility of all
undergraduate and graduate students to familiarize themselves with University
policies regarding Special Accommodations, Misconduct, Religious Beliefs
Accommodation, Discrimination and Absence for University Sponsored Events. (For
details please refer to the Undergraduate and Graduate Timetables; the “Rights
and Responsibilities” section of the Undergraduate Bulletin; the Academic
Requirements and Policies and the Facilities and Services sections of the
Graduate Bulletin; and the ““Student Academic Disciplinary Procedures”” [UWS
Chapter 14]; and the ““Student Nonacademic Disciplinary Procedures”” [UWS
Chapter 17].
Attendance: Missed quizzes can only be rescheduled
before the due date on Sunday.
Honesty: Cheating on any assigned
material in or out of class will not be tolerated.
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Course Schedule:
Week 1: Time Value of Money
Review the open-book quiz
for Chapter 9, then read Chapter 9.
Post an average of three
substantive comments to the course discussion board.
Calculate answers for the
quiz problems and submit them through the course web page by Sunday at 11:50 PM
your time.
Week 1: Time Value of Money
Review the open-book quiz
for Chapter 9, then read Chapter 9.
Post an average of three
substantive comments to the course discussion board.
Calculate answers for the
quiz problems and submit them through the course web page by Sunday at 11:50 PM
your time.
Week 1: Unit 1 --Time Value of Money
Review the open-book quiz
for Chapter 9, then read Chapter 9.
Post an average of three
substantive comments to the course discussion board.
Calculate answers for the
quiz problems and submit them through the course web page by Sunday at 11:50 PM
your time.
Unit 1 Concepts
* Money has a time value associated with it and therefore a
dollar received today is worth more than a dollar received in the future.
* The future value and present value of a dollar is based on
the number of periods involved and the going interest rate.
* Tables for future value and present value can be applied to
any problem to ease the analysis.
* Not only can future value and present value be computed, but
other factors such as yield (rate of return) can be determined as well.
Week 2: Unit 2 – Valuation and Rates of Return
Review the open-book quiz
for Chapter 10, then read Chapter 10.
Post an average of three
substantive comments to the course discussion board.
Calculate answers for the
quiz problems and submit them through the course web page by Sunday at 11:50 PM
your time.
Unit 2 Concepts
* The valuation of a financial asset is based on the present
value of future cash flows
* The required rate of return in valuing an asset is based on
the risk involved
* Bond valuation is based on the process of determining the
present value of interest payments plus the principal payment at maturity
* Stock valuation is based on determining the present value of
the future benefits of equity ownership
* A price-earnings ratio may also be applied to a firm's
earnings to determine value
Week 3: Unit 3 – Cost of Capital
Review the open-book quiz
for Chapter 11, then read Chapter 11.
Post an average of three
substantive comments to the course discussion board.
Calculate answers for the
quiz problems and submit them through the course web page by Sunday at 11:50 PM
your time.
Unit 3 Concepts
* The cost of capital represents the overall cost of financing
to the firm.
* The cost of capital is normally the discount rate to use in
analyzing an investment.
* The cost of capital is based on the valuation techniques from
the previous chapter and is applied to bonds, preferred stock and common stock.
* A firm attempts to find a minimum cost of capital through
varying the mix of its sources of financing.
* The cost of capital may eventually increase as larger amounts
of financing are utilized.
Week 4: Unit 4 – The Capital Budgeting Decision
Review the open-book quiz
for Chapter 12, then read Chapter 12.
Post an average of three
substantive comments to the course discussion board.
Calculate answers for the
quiz problems and submit them through the course web page by Sunday at 11:50 PM
your time.
Unit 4 Concepts
* A capital budgeting decision represents a long-term
investment decision.
* Cash flow rather than earnings is used in the capital
budgeting decision.
* The three methods of ranking investments are the payback
method, the internal rate of return, and the net present value.
* The discount or cut-off rate is normally the cost of capital.
* The two primary cash inflows analyzed in a capital budgeting
decision are the aftertax operating benefits and the tax shield benefits of
depreciation.
Week 5: Unit 5 --Risk and Capital
Budgeting
Review the open-book quiz
for Chapter 13, then read Chapter 13.
Post an average of three
substantive comments to the course discussion board.
Calculate answers for the
quiz problems and submit them through the course web page by Sunday at 11:50 PM
your time.
Unit 5 Concepts
* The concept of risk is based on uncertainty about future
outcomes.
* Most investors are risk averse, which means they dislike
uncertainty.
* Because investors dislike uncertainty, they will require higher
rates of return from risky projects.
* Simulation models and
decision trees can be used to help assess the risk of an investment.
* Not only the risk of an individual project must be
considered, but also how the project affects the total risk of the firm.
Week 6: Unit 6 – External Growth Through
Mergers
Review the open-book quiz
for Chapter 20, then read Chapter 20.
Post an average of three
substantive comments to the course discussion board.
Calculate answers for the
quiz problems and submit them through the course web page by Sunday at 11:50 PM
your time.
Unit 6 Concepts
* Firms engage in mergers for financial motives and to increase
operating efficiency.
* Companies may be acquired through cash purchases or by one
company exchanging its shares for another company's shares.
* The potential impact of the merger on earnings per share and
stock value must be carefully assessed.
* The diversification benefits of a merger should be evaluated.
* Some buyouts are of an unfriendly nature and are strongly
opposed by the potential candidate.
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MICHAEL A. S. GUTH, Ph.D., J.D.
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Financial Economics Homepage ||
Attorney at Law
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