chap 12 - After reading this chapter, the student should be...

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Unformatted text preview: After reading this chapter, the student should be able to: Use the replacement chain method to compare projects with unequal lives. Explain why conventional NPV analysis may not capture a projects impact on the firms opportunities. Define the term option value, and identify four different types of embedded real options. Explain what an abandonment option is, and give an example of a project that includes one. Explain what a decision tree is and provide an example of one. Explain what an investment timing option is, and give an example of a project that includes one. Explain what a growth option is, and give an example of a project that includes one. Explain what a flexibility option is, and give an example of a project that includes one. List the steps a firm goes through when establishing its optimal capital budget in practice. Learning Objectives: 12 - 1 Chapter 12 Other Topics in Capital Budgeting LEARNING OBJECTIVES This chapter covers some important but relatively technical topics. Note too that this chapter is more modular than most, i.e., the major sections are discrete, hence they can be omitted without loss of continuity. Therefore, if you are experiencing a time crunch, you could skip sections or even the entire chapter. Assuming you are going to cover the entire chapter, the details of what we cover, and the way we cover it, can be seen by scanning Blueprints , Chapter 12. For other suggestions about the lecture, please see the Lecture Suggestions in Chapter 2, where we describe how we conduct our classes. DAYS ON CHAPTER: 2 OF 58 DAYS (50-MINUTE PERIODS) Lecture Suggestions: 12 - 2 LECTURE SUGGESTIONS 12-1 Generally, the failure to employ common life analysis or the equivalent annual annuity approach in such situations will bias the NPV against the shorter project because it gets no credit for profits beyond its initial life, even though it could possibly be renewed and thus provide additional NPV. 12-2 Postponing the project means that cash flows come later rather than sooner; however, waiting may allow you to take advantage of changing conditions. It might make sense, however, to proceed today if there are important advantages to being the first competitor to enter a market. 12-3 Timing options make it less likely that a project will be accepted today. Often, if a firm can delay a decision, it can increase the expected NPV of a project. 12-4 Having the option to abandon a project makes it more likely that the project will be accepted today. Answers and Solutions: 12 - 3 ANSWERS TO END-OF-CHAPTER QUESTIONS 12-1 a. Project A: 0 1 2 | | |-10,000 6,000 8,000 Using a financial calculator, input the following data: CF = -10000, CF 1 = 6000, CF 2 = 8000, I = 10, and then solve for NPV A = $2,066.12....
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chap 12 - After reading this chapter, the student should be...

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