Capital Budgeting Alternatives to NPV and IRR Analysis
The discounting cash flow methods of net present value and internal rate of return analysis are common for capital project analysis, but other methods exist.
- Economic Income: applies the same after tax cash flow analysis as NPV modeling, but adds an adjustment to account for the change in the market value of the asset.
- Accounting Income: this method represents the income that would be reported under local accounting regulations. Deprecation will reflect historic asset values (unlike economic income) and interest expense will be deducted rather than captured as part of the discounting of future cash flows.
- Economic Profit (EP) or Economic Value Added (EVA): this method takes net operating profit after tax (NOPAT) and makes a reduction based on the weighted average cost of capital (WACC). The following formula represent the EP/EVA method:
EP = EBIT (1 – tax rate) – WACC (capital invested)
- Residual Income (RI): similar to EP, RI starts with net income and deducts an equity charge to the prior accounting period’s book value of equity.
RI = Net Income t – (return required on common equity * BV Equity t-1)
The NPV of a project is equal to the sum of its residuals incomes discounted by the required return on common equity.
- Claims Valuation: this method is a similar to standard NPV modeling. Under the claims valuation method, the analyst discounts cash flows to the different claimants (debt holders versus equity holders) at their respective costs of capital.
- CFA Level 2: Corporate Finance Part 1 – Introduction
- Introduction to Capital Structure and Leverage
- Introductory Capital Budgeting Remarks
- Expansion Projects vs. Replacement Projects and Cash Flows
- Impacts of Depreciation Method Choice on Capital Budget Analysis
- Inflation and Capital Budgeting
- Mutually Exclusive Capital Projects with Unequal Lives
- Equivalent Annual Annuity (EAA) Approach
- Least Common Multiple of Lives Approach
- Stand Alone Risk and Capital Projects
- CAPM and a Capital Project’s Discount Rate
- Capital Projects and Real Options
- Common Pitfalls in Capital Budgeting
- Capital Budgeting Alternatives to NPV and IRR Analysis
- Modigliani-Miller and Capital Structure Theory
- Evaluating Capital Structure Policy
- International Differences in Financial Leverage
- Dividend and Share Repurchase Policies
- Factors Affecting Corporate Dividend Policy Decisions
- Signals from Dividend Policies