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s08 - Chapter 8: Capital Budgeting and Cash Flow Analysis...

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Chapter 8: Capital Budgeting and Cash Flow Analysis 8-1 Chapter 8 CAPITAL BUDGETING AND CASH FLOW ANALYSIS ANSWERS TO QUESTIONS: 1. a. Personnel managers -- the value of insurance programs and pension plans can be evaluated using discounted cash flow techniques. b. Research and development staffs -- investments in new product research and product improvement research, having benefits that accrue over several years, can be evaluated using the methodology of capital budgeting. c. Advertising executives -- advertising campaigns normally generate benefits (increased sales) that extend over several years. Hence investments in these campaigns can be evaluated using capital budgeting methodology. 2. Mutually exclusive projects -- the acceptance of one precludes the acceptance of another, e.g., the decision to buy one model of drillpress over a competing model. Independent projects -- the acceptance of one project neither precludes the acceptance of another nor requires the acceptance of another, e.g., the decision to buy a replacement truck for deliveries is independent of the decision to buy a new data processing system. Contingent projects -- the acceptance of one project requires ( is contingent upon) the acceptance of another project, e.g., the decision to build additional brewery capacity may be contingent on the decision to expand the company's marketing and distribution area. 3. Capital rationing is normally not consistent with shareholder wealth maximization, because some potentially profitable projects (projects offering an expected return greater than the required return) may not be undertaken. 4. The primary types of investment projects are projects generated by growth opportunities, projects generated by cost-reduction opportunities, and legally mandated projects. In all cases the appropriate framework for analysis is to compare the discounted benefits of the project with the project's cost. If benefits exceed costs, then the project should be undertaken. Normally growth opportunity projects will be riskier than cost- reduction projects, and hence a differential risk analysis approach should be used. 5. The objective of capital budgeting analysis is to estimate the total change in the firm's cash flows that result because a project is undertaken. Hence indirect effects on the costs and/or revenues associated with a firm's other projects that occur as a result of the acceptance of a new project should be considered when evaluating the cash flows from a new project. 6. The factors that should be considered when estimating a project's net investment include the new project cost plus shipping and installation charges, required increases in working capital at project inception, the net proceeds from the sale of old assets (in the case of replacement decisions) and the taxes associated with the sale of the old asset
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Chapter 8: Capital Budgeting and Cash Flow Analysis 8-2 and/or the purchase of the new one.
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This document was uploaded on 11/12/2008.

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s08 - Chapter 8: Capital Budgeting and Cash Flow Analysis...

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