Hi, my name is Sae Yeul Park, and I'm an assistant professor of finance at Yonsei University. In this course, we'll discuss probably the most important decision making process in corporate finance capital budgeting. So what is capital budgeting? Capital budgeting is the process of deciding whether to undertake an investment project. In other words, in this process we evaluate the feasibility of a project, to accept it if it's a good and to reject it if it turns out to be a bad one. In this course, we will study the three most popular capital budgeting techniques in practice. Net present value, payback period, and internal rate of return. First of all, let's think about why it's important to study capital budgeting. First, we know that it is assets that define your company's business. For example, a soda company's a soda company because it owns and operates soda manufacturing equipment. That is, what investment we take on is a more important issue than some other corporate finance decisions. Such as where we get the loan from financing for investment, or how we'll manage working capital. Second, making the right capital budgeting decision is the key to not only survival, but also success of the company. A firm's growth and its ability to remain competitive, depend on a constant flow of ideas for new products, ways to make existing products better, and even ways to produce output at a lower cost. The first capital budgeting technique we are going to learn is called a net present value, or simply NPV. In fact, NPV is not only the most popular technique of all, but also is known to be the best technique, too. As we'll see later in this module. Suppose we have a project with the following cash flows. The project requires the initial investment of $8,000 now. In return, it will generate a net cash inflow of $2,000 per year over each of the next 6 years. Perhaps a manager would want to know the value of the project, and we can answer his question by calculating the project’s Net Present Value, or NPV. In fact, NPV calculation is the series finale of the DCF Valuation throughout the courses. So far we have estimated the value of an asset, by calculating present values of future cash flows that the asset can generate. Earlier, for example, we estimated the bond price by considering present values of future cash flows of the bond, which are coupon payment and principle payment. When we evaluate a business project from the company's perspective in this course, the same approach will be used. The value of a business project is the sum of present values of cash flows that the project can generate. This is the basic idea of the net present value, the main topic of the next lecture. In the next lecture, we will define NPV in a more formal manner, and learn how to calculate it using Excel. But before we conclude this lecture, let me show you the criteria for good capital budgeting decision rules. Many finance textbooks suggest that a good capital budgeting decision rule should meet the following criteria. First, a good rule should adjust for the time value of money. That is in the decision process, cash flows in the future should be discounted for it to be compared with cash flow in the present. Second, a good rule should adjust for risk as well. Third, a good decision rule should be able to indicate whether the project creates value for the firm. Is the net present value a good capital budgeting decision rule according to the criteria? Well, we'll find it out in the next lecture.
