Capital Budgeting Techniques Discussion1. The ______________ of capital is what the firm must

______________ for the funds needed to ______________

an investment. The ______________ of capital may be

a(n) ______________ cost, such as the ______________

paid on debt, or a(n) ______________ cost, such as the

expected ______________ appreciation of shares of the

firm’s ______________ stock, or the ______________

required by the ______________ of ______________ to

compensate them for the time ______________ of money

and the ______________ associated with the investment.

The more ______________ the future cash flows, the

______________ the cost of capital.

2. The ______________ period for a project is the ______________

of time it takes to get your ______________ back. It is the

period from the ______________ cash ______________ to the

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118 QUESTIONS AND PROBLEMS

time when the project’s cash ______________ add up to the

______________ cash ______________. The ______________

period is also referred to as the ______________ period or the

capital ______________ period.

3. The ______________ period is the time needed to

______________ back the ______________ investment in

terms of ______________ future cash flows, therefore the

______________ period is ______________ for

______________ cash flows than for ______________

flows that are not ______________.

4. The ______________ value (______________) is the

present value of all ______________ cash flows. The

term ______________ is used because we want to determine the ______________ between the ______________

in the operating cash flows and the investment cash

flows. Often ______________ in operating cash flows are

______________ and the ______________ cash flows are

______________, hence the reference to the

______________ as the ______________ between the

present value of the cash ______________ and the

present value of the cash ______________.

5. The ______________ technique considers all expected

______________ cash flows, the ______________ of

money and the ______________ of the ______________

cash flows. Evaluating projects using ______________ will

lead us to select the ones that ______________ owners’

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Capital Budgeting Techniques 119

wealth. The ______________ technique also allows you to

______________ the effect of ______________ in cost of

capital on a project’s ______________.

6. A project’s ______________ profile, also referred to as the

______________ profile, shows how ______________ changes

as the ______________ rate changes. The ______________

profile is a(n) ______________ depiction of the relation

between the ______________ of a project and the

______________ rate. It shows the ______________ of a

project for a(n) ______________ of ______________ rates.

7. The ______________ (______________) is the ratio of the

present value of change in ______________ cash

______________ to the present value of ______________

cash ______________. The ______________ is often

referred to as the ______________ ratio, as it is the ratio of

the ______________ from an investment to its

______________. The ______________ tells us how much

value we get for each dollar invested.

8. An investment’s ______________ of return

(______________) is the ______________ rate that makes

the present value of all expected ______________ cash

flows equal to ______________; or, in other words, the

______________ is the ______________ rate that causes

______________ to equal ______________. The

______________ is a(n) ______________—what is earned,

on average, per year. When evaluating ______________

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120 QUESTIONS AND PROBLEMS

projects, the one with the highest ______________ may

______________ be the one with the best NPV.

SHORT ANSWER QUESTIONS

Refer to Chapter 13, pages 399–444 in Financial Management and Analysis.

1. What are the six capital budgeting techniques? What

should be taken into consideration when applying each

technique?

2. What are the decision criteria for each capital budgeting

technique?

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Capital Budgeting Techniques 121

3. When should PI be used? When should it not be used?

4. What is the difference between the IRR and MIRR? Why

is using IRR or MIRR sometimes not appropriate?

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122 QUESTIONS AND PROBLEMS

5. Of all the capital budgeting techniques, which one is the

best evaluation technique? Which techniques do managers

most prefer in practice?

PROBLEMS

Refer to Chapter 13, pages 399–444 in Financial Management and Analysis.

1. You are the manager and are considering the following

two projects for investment:

Year 0 Year 1 Year 2 Year 3

Project A ($10,000) $3,000 $7,000 $9,000

Project B ($5,000) $3,000 $4,000 $5,000

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Capital Budgeting Techniques 123

a. Calculate the payback period assuming end-of-the-year

cash flows.

b. Calculate the discounted payback period assuming a

required rate of return of 10% and end-of-the-year cash

flows.

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124 QUESTIONS AND PROBLEMS

c. Calculate the NPV of each project.

d. Calculate the PI of each project.

e. Calculate the IRR of each project.

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Capital Budgeting Techniques 125

f. Calculate the MIRR of each project assuming a reinvestment rate of 10%.

g. If the projects are independent, which should be undertaken?

h. If the projects are mutually exclusive, which one should

be undertaken?

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