1. Cost of Capital

The cost of capital–a capital budgeting project’s required return–is based on the concept of an opportunity cost and estimated from the expected return on comparable publicly traded securities.

Startup costs of a business can be expensive, for many times a business owner has an initial idea what is necessary for the business, but many times there are additional unexpected expenses, or as you indicated, miscellaneous costs needed. Managers need to create a budget (i.e. have an understanding of their cost of capital).

There are five steps within the process of a project transferring from an idea to reality:

  1. Generating ideas for capital budgeting projects
  2. Reviewing existing projects and facilities
  3. Preparing proposals
  4. Evaluating proposed projects and creating the capital budget, the firm’s set of planned capital expenditures
  5. Preparing appropriation requests

Your thoughts, Class?

  1. Boeing and Sunken Cost

If a firm has already paid an expense or is obligated to pay one in the future, regardless of whether a particular project is undertaken, that expense is a sunken cost.

Take for instance, Boeing continues to focus on value, but management must also monitor sunken costs. Delays for a scheduled product(s) can cause large sunken costs (which cannot be regained). In addition, Boeing’s losses could be the result of renegotiating contracts (meaning renegotiating new deadline dates to buyers). Think about it, if Boeing continues to delay production, airline companies lose money.

Class, do you see how this becomes a problem?

  1. Capital Budgeting Tools

Let us explain the process involved in identifying a profitable project using capital budgeting tools and techniques by sharing Fortune 500 businesses.

Chevron used capital budgeting tools in hopes to increase profits, but failed to meet their target. The company was required to make extensive cutbacks to maintain operations. However, analysts believe the company may see positive results this year due to their 2015 cutbacks.

  1. IRR and MIRR

What is the purpose of calculating the internal rate of return (IRR) and the modified internal rate of return (MIRR) methods when evaluating capital investment opportunities? What are the pros and cons of both methods?

Please offer some business examples or current events to share your point of view with the class.

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