Capital Budgeting Techniques Discussion

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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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?