Capital Budgeting

BUS422E Capital Budgeting

Autumn 2020

  • Topics

    This course deals with company real investments in order to understand and make use of different approaches to calculate project values. They are in turn the basis for project decisions. The focus is on  problems and basic models with a simple structure, however, they are at the same time rich enough to give important general knowledge.

    The uncertainty dimension is important in this course. First, the classic consumption decision in Fisher diagrams is dealt with. Next, the problem of budget restrictions are analyzed within the framework of a simple LP model. Furthermore, a number of different approaches related to the individual's evaluation of uncertainty at the project level are introduced. Projects are analyzed in a portfolio perspective and further linked to capital market models. An interesting question here is what is relevant risk. The relationship between uncertainty and decision flexibility is primarily discussed by describing and analyzing real options, but also by the case of gradually revealing uncertainty. The importance of capital structure for projects are dealt with by focusing specifically on how investment decisions are made in case of financial distress, and the course finally discusses traditional approaches to take care of project financing, both separately and included in the required rate of return.

  • Learning outcome

    Knowledge - upon successful completion the student

    • has a solid foundation for understanding theories connected to evaluation and choice of real investment under uncertainty. This includes utility theory, capital asset pricing model, state preference model and option pricing theory/models.
    • understands the importance of relevant risk and how this is included in the calculation of project values and the associated project decision.
    • understands how capital rationing and risk-reducing information may affect investment decision making.
    • understands how capital structure may influence project values and create conflicts between debt and equity holders.

    Skill - upon successful completion the student can

    • make investment decisions when capital is limited.
    • analyze projects in order to assess and evaluate uncertainty at both project and portfolio level.
    • evaluate projects using models when total risk is relevant and when only part of the risk is relevant.
    • take flexibility into account by identifying, analyzing and calculating value of real options, as well as adjusting decisions when uncertainty is gradually revealed.
    • value financing effects for projects and explain how the financial situation of a company may create conflicts between various stakeholders as well as calculate the consequence of the related investment decisions.

    General competence - upon successful completion the student

    • is able to evaluate and deal with real investments in a number of different organizations in a sound manner.
    • is able to ask critical questions and contribute in a constructive way to organizations working with real investments.

  • Teaching

    Combination of physical meetings (for those who can attend) and streaming (for those who cannot attend). Theories, methods and examples will be presented. There will be exercises associated with each topic (lecture) and students are expected to work with these exercises between lectures. There will be time available during lectures to present solutions to them. There are two compulsory assignments. 

  • Recommended prerequisites

    Nothing more than the knowledge students have acquired in bachelor courses within capital budgeting and finance, microeconomics, linear programming and statistics.

  • Credit reduction due to overlap

    BUS422 / BUS422N Investeringsanalyse.

  • Requirements for course approval

    There will be two compulsory assignments with a set of problems in each assignment. It is allowed to work in groups of maximum three people to solve the problems (sole authored hand-ins are also accepted). Grading scale is Approved - Not approved. Approved is required on both assignments in order to be allowed to take the school exam.

    Note: There might be mandatory activities in the course before the deadline for course registration.

    Course approval from BUS422N is valid for BUS422E.

  • Assessment

    4 hours written home exam. The answers may be written in English or in a Scandinavian language.

  • Grading Scale

    A - F.

  • Computer tools

    No particular requirements.

  • Literature

    A compendium consisting of a collection of articles and excerpts from books and reports.

Overview

ECTS Credits
7.5
Teaching language
English.
Semester

Autumn. Offered Autumn 2020.

Note: This course description was formerly published with a disclaimer regarding potential changes to teaching methods, mandatory requirements and assessment. The course description has now been updated, and this is the final version.

Course responsible

Professor Øystein Gjerde, Department of Business and Management Science.