The requirement for flexibility in capital budgeting

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dc.contributor Aalto University en
dc.contributor Aalto-yliopisto fi
dc.contributor.advisor Derichs, David Aadeli, Ada 2017-08-17T08:48:17Z 2017-08-17T08:48:17Z 2016
dc.description.abstract Capital investments are always long-term commitments of capital. When considering the undertaking of these projects, managers are faced with a high level of uncertainty. To better equip firms to respond to fluctuations in influencing factors, such as changes in demand and interest rate levels, capital budgeting needs to account for the value of flexibility options. Flexibility entails the alterations that can be conducted to the investment plan or when the initial capital outlay has already been done. It can contain altering the level of operations, choice of timing or even shutting down the project. In order to make the optimal capital budgeting decision, the value of a project needs to include flexibility into calculations. This paper examines the various forms and valuation of flexibility. The importance of flexibility has been widely recognised, as the review of previous literature proves. Bringing external factors into the analysis is crucial, as they have a direct effect on the principle elements of traditional capital budgeting. One of these factors is the interest rate level, which is directly linked to the set hurdle rate, weighted average cost of capital (WACC). The WACC is used in capital budgeting as a discount rate. To further highlight the effect of interest rate fluctuations in capital budgeting, a sensitivity analysis has been conducted by altering the used hurdle rate. The chosen focus on this specific external influencer stems from the current environment of low rates. If the current situation induces prolonged assumptions of low interest rate levels, the eventual shift may expose projects to be unprofitable ex post. The methods of valuing flexibility have been researched vastly, though rarely been put to practise. The main reason behind this is the complex nature of the methods. Also, flexibility is often viewed as an added expense or a burden to capital budgeting. The motivation behind this paper is to further demonstrate the true importance of flexibility options and to critically evaluate the applicability and precision of the presented valuation methods. en
dc.format.extent 33
dc.format.mimetype application/pdf en
dc.language.iso en en
dc.title The requirement for flexibility in capital budgeting en
dc.type G1 Kandidaatintyö fi Kauppakorkeakoulu fi School of Business en
dc.contributor.department Laskentatoimen laitos fi
dc.subject.keyword capital budgeting en
dc.subject.keyword flexibility en
dc.subject.keyword real options en
dc.subject.keyword interest rates en
dc.subject.keyword uncertainty en
dc.identifier.urn URN:NBN:fi:aalto-201708176607
dc.type.ontasot Bachelor's thesis en
dc.type.ontasot Kandidaatintyö fi
dc.programme Laskentatoimi fi

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