The Investment Detective

Topics: Net present value, Free cash flow, Investment Pages: 3 (644 words) Published: December 27, 2010
Bruner: Case Studies in Finance: Managing for Corporate Value Creation, 4/e

IV. Capital Budgeting and Resource Allocation

17. The Investment Detective

© The McGraw−Hill Companies, 2003

CASE 17

The Investment Detective

The essence of capital budgeting and resource allocation is a search for good investments in which to place the firm’s capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital-budgeting analyst is necessarily, therefore, a detective who must winnow good evidence from bad. Much of the challenge is knowing what quantitative analysis to generate in the first place. Suppose you are a new capital-budgeting analyst for a company considering investments in the eight projects listed in Exhibit 1. The chief financial officer of your company has asked you to rank the projects and recommend the “four best” that the company should accept. In this assignment, only the quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive. All the projects require the same initial investment, $2 million. Moreover, all are believed to be of the same risk class. The weighted-average cost of capital of the firm has never been estimated. In the past, analysts have simply assumed that 10 percent was an appropriate discount rate (although certain officers of the company have recently asserted that the discount rate should be much higher).

This case was prepared by Professor Robert F. Bruner with the permission of Professor Gordon Donaldson, the author of an antecedent case. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright© 1988 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To...
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