Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
11th Edition
ISBN: 9780077861759
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher: McGraw-Hill Education
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Chapter 18, Problem 4CQ
Summary Introduction
To determine: The Suitable Method that is to be used.
Introduction: A capital budgeting is the procedure by which an organization decides if the undertakings, are valuable seeking after. A venture that is valuable seeking after if it expands the worth of the organization. For example: Opening another branch putting resources into R&D, supplanting a machine.
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Which of the following statements is FALSE?
A. When evaluating a capital budgeting decision, we generally include interest expense.
B. Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of
the decision to take on the project.
C. Many projects use a resource that the company already owns.
O D. As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.
In the textbook's capital budgeting examples, the book assumes that the firm recovers all of its working capital invested into a project. In the real world, is this a reasonable assumption? Justify your position and discuss when it would
Why does capital budgeting rely on an analysis of cash flows rather than on net income?
Base your answer on the accounting principles of recognizing and reporting revenue and expenses.Describe two capital budgeting decisions based on the time value of money.
Which of the two methods would you select for a capital budgeting project and why?
Chapter 18 Solutions
Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 18 - APV How is the APV of a project calculated?Ch. 18 - WACC and APV What is the main difference between...Ch. 18 - FTE What is the main difference between the FTE...Ch. 18 - Prob. 4CQCh. 18 - Prob. 5CQCh. 18 - NPV and APV Zoso is a rental car company that is...Ch. 18 - APV Gemini, Inc., an all-equity firm, is...Ch. 18 - Prob. 3QPCh. 18 - Prob. 4QPCh. 18 - Prob. 5QP
Ch. 18 - Prob. 6QPCh. 18 - Prob. 7QPCh. 18 - WACC National Electric Company (NEC) is...Ch. 18 - WACC Bolero, Inc., has compiled the following...Ch. 18 - Prob. 10QPCh. 18 - Prob. 11QPCh. 18 - APV MVP, Inc., has produced rodeo supplies for...Ch. 18 - Prob. 13QPCh. 18 - Prob. 14QPCh. 18 - Prob. 15QPCh. 18 - Prob. 16QPCh. 18 - Prob. 17QPCh. 18 - Prob. 18QPCh. 18 - Prob. 1MC
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- Imagine that you have been tasked with evaluating the future investment of equipment for a company. To make an effective decision you will likely consider various capital budgeting techniques such as the cash payback technique, internal rate of return (IRR), annual rate of return (ARR), and the net present value (NPR) methods. Which method are you most likely to use to evaluate future investments and which are you least likely to use?arrow_forwardIf you as a business owner know that your bank will provide financing for a project and that the cash generated from the project must cover the loan payments, would you then have to include financing in your capital budgeting decision? Why or why not?arrow_forwardCompanies often use several methods to evaluate the project’s cash flows and each of them has its benefits and disadvantages. Based on your understanding of the capital budgeting evaluation methods, which of the following conclusions about capital budgeting are valid? Check all that apply. The discounted payback period improves on the regular payback period by accounting for the time value of money. For most firms, the reinvestment rate assumption in the NPV is more realistic than the assumption in the IRR. Because the MIRR and NPV use the same reinvestment rate assumption, they always lead to the same accept/reject decision for mutually exclusive projects. True or False: Sophisticated firms use only the NPV method in capital budgeting decisions.arrow_forward
- Imagine that you have been tasked with evaluating the future investment of equipment for a company. To make an effective decision you will likely consider various capital budgeting techniques such as the cash payback technique, internal rate of return (IRR), annual rate of return (ARR), and the net present value (NPR) methods. Discuss which method you are most likely to use to evaluate future investments and which you are least likely to use.arrow_forwardExplain what a discounted cash flow method of making capital budgeting decisions is. Why are discounted cash flow methods superior to other methods? What are the risks related to using discounted cash flow methods? What a project profitability index? What does it measure? Why is it used? What is the primary criticism of the payback and simple rate of return methods of making capital budget decisions? What are the benefits in using these methods? Should companies continue to use these methods? Why or why not? What role, if any, should qualitative factors play in capital budgeting decisions? Explain your reasoning for your answer Discuss some of the major benefits to be gained from budgeting.arrow_forwardWhy are interest charges not deducted when a project’s cash flows for use in a capital budgeting analysis are calculated? Most firms generate cash inflows every day, not just once at the end of the year. In capital budgeting, should we recognize this fact by estimating daily project cash flows and then using them in the analysis? If we do not, are our results biased? If so, would the NPV be biased up or down? Explain.arrow_forward
- Discuss the notions of conventional and nonconventional cash flows in capital budgeting. Which investment evaluation criteria would you use for unconventional cash flows and why? Provide a fictitious unconventional cash flow example and apply the payback period, NPV, IRR, MIRR, and PI methods to your example. Interpret the results.arrow_forwardWhen we use the term “capital budget,” we are referring to the list of projects that business might undertake during the next planning period. When analyzing whether a company should undertake a certain project, one of the most critical steps in analyzing a capital investment proposal is estimating the incremental cash flows for the project. This is important because there is financial risk involved when undertaking any new business venture. A variety of factors must be considered such as opportunity costs and sunk costs. Inflation must also be considered. The process of analyzing capital budget decisions requires a manager to consider many factors, as well as possibly even conducting a sensitivity analysis or a scenario analysis. By inputting different variables, the manager will be able to see the different outcomes which might occur. In the health care industry, these factors may include risk, profitability, the needs of both the medical staff and the patient population and how the…arrow_forwardDiscuss the payback period, NPV (net present value), and IRR (internal rate of return) methods for capital budgeting analysis. What result does each method provide the user? What are the limitations of each of these methods? Which method would you find most useful in making the best investment decisions for your business and why?arrow_forward
- Calculate the terminal cash flow of the project Taking into consideration all the information given, determine the Net Present Value of the project and advice the company on whether to invest in the new line of product. Why should the cost of capital used in capital budgeting be calculated as a weighted average of the capital component rather than the cost of the specific financing used to fund a particular project?arrow_forwardSuppose a company uses the NPV method, alongwith risk-adjusted WACCs, to calculate projectNPVs. However, it has not been considering realoptions in its capital budgeting decisions. Nowsuppose the company changes its capital budgeting process to take account of four types of realoptions investment timing, flexibility, growth,and abandonment. Would this decision be likelyto affect some of the calculated NPVs? Explainyour answerarrow_forwardWhich of the following best describes the process of capital budgeting? a Forecasting revenues and expenses hmiting funds for capital improvements without considering the profitability of proposed prot determining a companys short term goals d. determinung the amount to spend on fixed assets and which fixed assets to purchasearrow_forward
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