project’s IRR increases as the cost of capital declines. b. All else equal‚ a project’s NPV increases as the cost of capital declines. c. All else equal‚ a project’s MIRR is unaffected by changes in the cost of capital. d. Statements a and b are correct. e. Statements b and c are correct. Ranking conflicts 2. Answer: a Diff: E Which of the following statements is most correct? a. The NPV method assumes that cash flows will be reinvested at the cost of capital‚ while the IRR method
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FINANCIAL MANAGEMENT: CAPITAL BUDGETING MINI CASE 1 CAPITAL BUDGETING (MINI CASE) QUESTION A What is capital budgeting? Solution: Capital budgeting is a required managerial tool. One duty of a financial manager is to choose investments with satisfactory cash flows and rates of return. Therefore‚ a financial manager must be able to decide whether an investment is worth undertaking and be able to choose intelligently between two or more alternatives. To do this‚ a sound procedure to evaluate
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value (NPV)‚ internal rate of return (IRR)‚ modified IRR (MIRR)‚ profitability index (PI)‚ payback and discounted payback. Each approach provides a different piece of information‚ so it is better to look at all of them when evaluating projects. Each one of them has it’s own strengths and weaknesses‚ which may help us to understand each project return liquidity and risk. Financial Theory: Six capital budgeting decision criteria are used in this case: NPV‚ IRR‚ MIRR‚ PI‚ payback and discounted payback
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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
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A Comparison of Capital Budgeting Techniques Capital budgeting deals with setting the criteria and prescribing the process required for making capital investment choices. Choosing an investment project‚ that is‚ making a capital investment choice is ultimately a cost/benefit analysis. It requires valuing the project by comparing the payoff to its costs. Problem Value‚ rank and select investment projects Example 1. Project A Required rate year 1: year 2 year 3 year 4 year 5 Initial
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of capital 12% A. payback?‚ NPV?‚ IRR? Payback: The amount of time required for a firm to recover its initial investment. by dividing the initial investment by the annual cash inflow. In our case $35.000/$5000= 7years NPV: Investment- the PV of its cash inflows discounted at a rate( the firm’s cost of capital) NPV= -$35.000- $34.054= -$946 so NPV less than $0‚ the project rejected IRR: discount rate‚ with IRR the NPV=0 IRR= 11‚49% IRR less than the cost of capital (12%)‚ we
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for Tremont. This is because while the lease option offers a remotely smaller‚ it is also much less risky. To start‚ the lease option has a much higher IRR (around 45%) and the IRR barely fluctuates from scenario to scenario. This means that no matter how much the discount rate changes the project is still safe. On the other Hand the base IRR for the build option is about 22% and fluctuates greatly from scenario to scenario. There is a scenario in which the WACC changes independently off all
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CAPITAL BUDGETING Cost of Capital Evaluating Cash Flows Payback‚ discounted payback NPV IRR‚ MIRR The Cost of Capital • Cost of Capital Components – Debt – Common Equity • WACC Should we focus on historical (embedded) costs or new (marginal) costs? The cost of capital is used primarily to make decisions which involve raising and investing new capital. So‚ we should focus on marginal costs. What types of long-term capital do organizations use? nLong-term debt nEquity Weighted
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StudyThere are at least six capital budgeting tools a firm can use in analyzing a capital expenditure. They are: net present value (NPV)‚ internal rate of return (IRR)‚ profitability index (PI)‚ payback period (PB)‚ discounted payback period (DRP)‚ and modified internal rate of return (MIRR). This case study will focus mainly on NPV and IRR‚ in addition to the remaining four capital budgeting tools. Net Present Value (NPV) The NPV of an investment proposal for a project is the same as the” present
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the strengths and weaknesses of the Cash Payback Period‚ Discounted Cash Payback Period‚ NPV‚ IRR and MIRR capital expenditure budgeting methods. Prepare a recommendation for Stewart regarding the capital budgeting method or methods to use in evaluating the expansion alternatives. Support your answer. Capital budgeting techniques such as payback period‚ net present value (NPV)‚ internal rate of return (IRR) and modified internal rate of return (MIRR) all offer particular strengths and weaknesses. The
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