Capital budgeting
Finance 09/05/2014
A - Capital budgeting is an analysis of potential additions to fixed assets, it is part of the long term decisions taken by the top management and involve large expenditures. The capital budgeting is very important to firm’s future. The difference between capital budgeting and individual’s investment decisions are in the estimation of cash flows, risk, and determination of the appropriate discount.
B - The difference between interdependent and mutually exclusive projects is that the independent project’s cash flows are not affected by the acceptance of the other, although the mutually exclusive can be adversely impacted by the acceptance of the other. the difference between normal and no normal cash flow stream projects occurs in the signs since for the normal cash flows if the cost ( negative CF) followed by a series of positive cash flows will lead to one change of sign. On the other hand the non-normal project cash flows have two or more changes of sign
C – 1 NPV: is the sum of all cash inflows and outflows of a project
C - 2 - The rationale behind the NPV method is that it is equal to PV of inflows minus the cost which is the net gain in wealth. If the projects are mutually exclusive we will choose the project with the highest NPV and here in our case we will choose project S since it has a greater NPV compared to project S (19.98>18.79). If the projects are independent we will choose both.
C - 3 The NPV will change if the WACC change; if the WACC increases the NPV will decrease on the other hand if the WACC decreases the NPV will increase.
D – 1 Internal rate of return (IRR) is the discount rate that forces PV inflows equal to cost, and the NPV = 0.
IRR using excel for project L:
IRR
18.13% For project S:
IRR
23.6%
D – 2 A project IRR is the same as a bond’s YTM. The YTM on the bond would
A - Capital budgeting is an analysis of potential additions to fixed assets, it is part of the long term decisions taken by the top management and involve large expenditures. The capital budgeting is very important to firm’s future. The difference between capital budgeting and individual’s investment decisions are in the estimation of cash flows, risk, and determination of the appropriate discount.
B - The difference between interdependent and mutually exclusive projects is that the independent project’s cash flows are not affected by the acceptance of the other, although the mutually exclusive can be adversely impacted by the acceptance of the other. the difference between normal and no normal cash flow stream projects occurs in the signs since for the normal cash flows if the cost ( negative CF) followed by a series of positive cash flows will lead to one change of sign. On the other hand the non-normal project cash flows have two or more changes of sign
C – 1 NPV: is the sum of all cash inflows and outflows of a project
C - 2 - The rationale behind the NPV method is that it is equal to PV of inflows minus the cost which is the net gain in wealth. If the projects are mutually exclusive we will choose the project with the highest NPV and here in our case we will choose project S since it has a greater NPV compared to project S (19.98>18.79). If the projects are independent we will choose both.
C - 3 The NPV will change if the WACC change; if the WACC increases the NPV will decrease on the other hand if the WACC decreases the NPV will increase.
D – 1 Internal rate of return (IRR) is the discount rate that forces PV inflows equal to cost, and the NPV = 0.
IRR using excel for project L:
IRR
18.13% For project S:
IRR
23.6%
D – 2 A project IRR is the same as a bond’s YTM. The YTM on the bond would