Fiance Mini-Case
MINI-CASE
A)
Answer: Capital budgeting is the process of analyzing additions to fixed assets. Capital budgeting is important because, more than anything else, fixed asset investment decisions chart a company's course for the future. Conceptually, the capital budgeting process is identical to the decision process used by individuals making investment decisions. These steps are involved:
1. Estimate, evaluate, & assess the riskiness of the cash flows
2. Determine the appropriate discount rate
B)
Answer: Projects are independent if the cash flows of one are not affected by the acceptance of the other. On the other hand, two projects are mutually exclusive if acceptance of one impacts adversely the cash flows of the other; that is, at most one of two or more such projects may be accepted.
C)
Answer 1: The net present value is the sum of the present values of a project's cash flows:
NPVs are easy to determine using a calculator with an NPV function. NPVL = $18.78 and NPVS = $19.98.
Answer 2: The rationale behind the NPV method is straightforward: if a project has NPV = $0, then the project generates exactly enough cash flows to recover the cost of the investment and to enable investors to earn their required rates of return (the opportunity cost of capital). If NPV = $0, then in a financial (but not an accounting) sense, the project breaks even. If the NPV is positive, then more than enough cash flow is generated, and conversely if NPV is negative.
Franchise L's cash inflows, which total $150. They are sufficient to return the $100 initial investment, to be able to provide investors with their 10 percent aggregate opportunity cost of capital, and to still have $18.79 left over on a present value basis. This $18.79 excess PV belongs to the shareholders--the debt holders' claims are fixed, so the shareholders' wealth will be increased by $18.79 if franchise L is accepted. Similarly, Axis's
A)
Answer: Capital budgeting is the process of analyzing additions to fixed assets. Capital budgeting is important because, more than anything else, fixed asset investment decisions chart a company's course for the future. Conceptually, the capital budgeting process is identical to the decision process used by individuals making investment decisions. These steps are involved:
1. Estimate, evaluate, & assess the riskiness of the cash flows
2. Determine the appropriate discount rate
B)
Answer: Projects are independent if the cash flows of one are not affected by the acceptance of the other. On the other hand, two projects are mutually exclusive if acceptance of one impacts adversely the cash flows of the other; that is, at most one of two or more such projects may be accepted.
C)
Answer 1: The net present value is the sum of the present values of a project's cash flows:
NPVs are easy to determine using a calculator with an NPV function. NPVL = $18.78 and NPVS = $19.98.
Answer 2: The rationale behind the NPV method is straightforward: if a project has NPV = $0, then the project generates exactly enough cash flows to recover the cost of the investment and to enable investors to earn their required rates of return (the opportunity cost of capital). If NPV = $0, then in a financial (but not an accounting) sense, the project breaks even. If the NPV is positive, then more than enough cash flow is generated, and conversely if NPV is negative.
Franchise L's cash inflows, which total $150. They are sufficient to return the $100 initial investment, to be able to provide investors with their 10 percent aggregate opportunity cost of capital, and to still have $18.79 left over on a present value basis. This $18.79 excess PV belongs to the shareholders--the debt holders' claims are fixed, so the shareholders' wealth will be increased by $18.79 if franchise L is accepted. Similarly, Axis's