MBA Course in Capital Budgeting

Home
About
Contact
Papers
Courses
Weird
Oddprose
Opinions

Jamal Munshi PhD, All rights reserved

The course
Managers who do not invest in new projects cannot offer growth to shareholders. They may become acquisition targets. Those that make bad investments reduce shareholder value. Only those managers that can identify new capital investment opportunities and make the right capital budgeting decisions can consisently add shareholder value. The value of a project is the present value of future net cash flow forecasts computed using a discount rate that is adjusted for risk. Students learn to make capital budgeting decisions under various real-world conditions using this basic principle of value. Students are expected to have completed courses in the fundamentals of finance, accounting, and statistics. The course is quantitative in nature and it requires proficiency in mathematics and in Microsoft Excel. Proficiency in written English is also important.
Textbook
Neil Seitz and Mitch Ellison, Capital budgeting and long term financing decisions
Harcourt Brace College Publishers, ISBN 0030237890
Classroom activities
There are 8 class meetings on 8 consecutive weeks, one day per week, and one scheduled final examination period.
There may be up to three activities per meeting
Activity #1: Quiz on previous topic: 1 hour
Activity #2: Lecture on new topic: 1.5 hours
Activity #3: Workshop on new topic: 1.5 hours
Meeting #1
Workshop #1: Introduction to NPV analysis
To prepare for workshop #1 please read chapter 5
Meeting #2
Quiz #1: NPV analysis
Workshop #2: IRR and other measures of value
To prepare for workshop #2 please read chapter 6
Meeting #3
Quiz #2: IRR analysis
Workshop #3: The analysis of mutually exclusive projects
To prepare for workshop #3 please read chapter 7
Meeting #4
Quiz #3: Mutually exclusive projects with unequal lives
Workshop #4: The estimation of net cash flows (NCF)
To prepare for workshop #4 please read chapter 8
Meeting #5
Quiz #4: NCF computation
Workshop #5: Standard deviation risk: risk analysis at the project level
To prepare for workshop #5 please read chapter 12
Meeting #6
Quiz #5: Project level risk
Workshop #6: Covariance risk: risk analysis at the firm level
To prepare for workshop #6 please read chapter 13
Meeting #7
Quiz #6: Firm level risk
Workshop #7: Beta risk: risk analysis at the market level
To prepare for workshop #7 please read chapter 14
Meeting #8
Quiz #7: Beta risk
Workshop #8: Estimation of the firm's cost of capital (WACC)
To prepare for workshop #8 please read chapter 16
Scheduled final examination period
Quiz #8: WACC
Semester project (select one)
Selected integrative case studies from the text
Excel model, report, and presentation.
Assignment types
The class is divided into groups. Workshops and semester projects are group assignments. They are carried out cooperatively by group members working as a team. The instructor serves as an ex-officio member of each group. Quizzes and examinations are individual assignements. Please do these on your own. You are expected to complete your quiz without using your book or notes. Please turn in your workshop before you take the quiz. For group assignments submit one paper per group. For individual assignments submit one paper per student.
Missed workshops and quizzes
Once per term, the student may carry the weight of a missed workshop forward to the next workshop. Once per term, the student may carry the weight of a missed quiz forward to the next quiz. There is no provision for make-up workshops or quizzes.
Evaluation of learning
8 Workshops x 4 points each = 32 points
8 In-class short quizzes x 8 points each = 64 points
Semester project = 4 points
Total = 100 points
Letter grade: 90-100 = A, 80-90 = B, 75-80 = B-, 60-75 = D, else F
Outcomes
After completing this course you should be able to answer all of these questions:
  • Compute, explain, and apply the NPV and IRR measures in making investment decisions under various risk and market conditions.
  • Explain the supremacy of the NPV/IRR method over alternative measures of investment value.
  • Use the equivalent annuity method to compare projects of unequal lives.
  • Use NPV/IRR criteria to make repair vs replace decisions for old machines.
  • Apply the real options concept in the valuation of abandonment options.
  • Identify the initial capital and net cash flows of a project that are relevant to the investment decision.
  • Compute and rationalize the net cash flows of a project given a sales forecast.
  • Describe the uncertainty of all forecast information in terms of the probability distribution.
  • Compute, explain, and make use of the standard deviation as a measure of risk.
  • Use utility theory to describe how risk averse investors make choices among risky investment alternatives.
  • Use breakeven NPV analysis, sensitivity analysis, and scenario analysis to compare riskiness of projects.
  • Use Monte Carlo simulation to infer the probability distribution of NPV and IRR.
  • Compute and explain the concept of covariance between two stochastic variables.
  • Apply and rationalize covariance as the measure of risk when risky assets are combined.
  • Estimate the covariance risk of the portfolio consisting of the existing firm and the new project.
  • Estimate the covariance risk of the portfolio consisting of the project and the market portfolio.
  • Use the relevant measure of risk in making capital budgeting decisions.
  • Apply the capital asset pricing model to capital budgeting decisions.
  • Estimate the cost of capital of the firm and explain its importance to managers and shareholders.
  • Describe how policy decisions affect the firm's cost of capital.
  • Apply the optimal capital budget in making investment decisions.
  • Explaim why the OCB is better than capital rationing in terms of shareholder value.

[Home] [Papers] [Courses] [Contact]