From the course: Managerial Finance Foundations
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Capital budgeting decisions
From the course: Managerial Finance Foundations
Capital budgeting decisions
- Capital budgeting is the process of making long-term asset purchase decisions. Because the cash flows from a long-term project are spread over many years, a proper capital budgeting analysis requires consideration of the time value of money in the form of an interest rate used as the hurdle rate. Let's work through an example of the capital budgeting decision process. Now, Les Vardy farms is considering the purchase of a new tractor to increase production. The tractor costs $20,000. At the end of 10 years, Les Vardy will be finished using the tractor and estimates that the tractor can then be sold in the used tractor market for $5,000. This new tractor will increase production and result in increased profits of $4,500 per year. The risk adjusted interest rate that Les Vardy is using to evaluate this tractor purchase is 18%. We've called this the hurdle rate. Now we are going to compute the net present value, or NPV,…
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