Capital Budgeting, Risk Considerations, and Other Special Issues
Autor: Sharon • November 13, 2018 • 6,221 Words (25 Pages) • 590 Views
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Ease: Payback is quick and easy to calculate.
16. Section: 13.2 Evaluating Investment Alternatives
Learning Objective: 13.2
Difficulty: Basic
Solution: The payback period does not take into account the time value of money. In addition, it does not account for the cash flows beyond the cut-off date. The choice of the cut-off date is arbitrary.
The discounted payback period has all the drawbacks that the payback period has except that it accounts for the time value of money.
17. Section: 13.2 Evaluating Investment Alternatives
Learning Objective: 13.2
Difficulty: Basic
Solution: Since the discount rate is zero, the discounted payback period should equal the payback period. Discounted payback = 2 + ($5,000-$2,500-$2,000)/$1,500 = 2.33 years.
18. Section: 13.4 Capital Rationing
Learning Objective: 13.4
Difficulty: Basic
Solution:
The pure play approach involves finding the beta of a company that operates almost exclusively (i.e., pure play) in the industry associated with the project under consideration and adjusting this company’s beta for the leverage associated with that company.
19. Section: 13.4 Capital Rationing
Learning Objective: 13.4
Difficulty: Basic
Solution:
a. With no capital constraint, the firm should invest in all positive NPV projects; therefore, it should invest in all the projects (A to F)
b. The firm has a total of $100 million to invest; it should maximize the NPV earned. Alternatives:
B + A → NPV = $20 million
A +C+ D +E → NPV = 5+8+7+3=$23 million
Recommendation: invest in projects: A, C, D, and E (maximizes the NPV).
c. The firm needs to have more funds available to invest. Possible ways to increase available capital are: cut costs elsewhere (i.e., sell unproductive assets); issue equity or debt to raise money; or cut dividends.
Intermediate
20. Section: 13.1 Capital Expenditures
Learning Objective: 13.1
Difficulty: Intermediate
Solution:
a. Bottom up
b. Top down
c. Bottom up (unless this reflects a change in the strategic direction of the firm)
d. Top down
e. Bottom up
f. Top down
21. Section: 13.2 Evaluating Investment Alternatives
Learning Objective: 13.2
Difficulty: Intermediate
Solution:
Discounted cash flows
Year
Project A
Project B
Project C
Project D
Project E
Project F
Project G
0
–1,200.00
–2,400.00
–8,500.00
–5,100.00
–5,300.00
–11,000.00
–3,200.00
1
454.55
1,363.64
1,818.18
4,363.64
2,272.73
2,727.27
1,363.64
2
826.45
991.74
1,652.89
826.45
2,479.34
1,652.89
991.74
3
901.58
225.39
6,010.52
4,507.89
3,756.57
751.31
375.66
4
1,707.53
341.51
1,366.03
–2,049.04
683.01
1,366.03
0.00
5
1,862.76
124.18
1,552.30
–2,483.69
1,862.76
1,862.76
0.00
Project A
Project B
Project C
Project
...