ch12 - Chapter 12 Strategic Investment Decisions LEARNING...

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Chapter 12 Strategic Investment Decisions LEARNING OBJECTIVES Chapter 12 addresses the following questions: Q1 How are strategic investment decisions made? Q2 What cash flows are relevant for strategic investment decisions? Q3 How is net present value (NPV) analysis performed and interpreted? Q4 What are the uncertainties and limitations of NPV analysis? Q5 What alternative methods (IRR, payback, and accrual accounting rate of return) are used for strategic investment decisions? Q6 What additional issues should be considered for strategic investment decisions? Q7 How do income taxes affect strategic investment decision cash flows? Q8 How are the real and nominal methods used to address inflation in an NPV analysis? (Appendix 12A) These learning questions (Q1 through Q8) are cross-referenced in the textbook to individual exercises and problems. COMPLEXITY SYMBOLS The textbook uses a coding system to identify the complexity of individual requirements in the exercises and problems. Questions Having a Single Correct Answer: No Symbol This question requires students to recall or apply knowledge as shown in the textbook. e This question requires students to extend knowledge beyond the applications shown in the textbook. Open-ended questions are coded according to the skills described in Steps for Better Thinking (Exhibit 1.10): Step 1 skills (Identifying) Step 2 skills (Exploring) Step 3 skills (Prioritizing) Step 4 skills (Envisioning)
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12-2 Cost Management QUESTIONS 12.1 After a number of years, the present value factors for all discount rates become quite small, and the incremental affect of future cash flows is therefore small. According to the present value tables, after about 15 years, the incremental values at rates above 8 to 10% are small (less than 20% of the original value). If these cash flows are small, but include error, the size of error would also be small and likely have little effect on the overall analysis. 12.2 If several projects are being analyzed, their NPVs can be summed to determine the NPV for that group or portfolio of projects, whereas IRR can be neither summed nor averaged. In addition, NPV provides information about the value of the projects in terms of today’s dollars. If projects are of different sizes, requiring large and small investments, NPV reflects these differences. IRR provides only a rate of return, and comparing rates of return does not take into consideration the size of return. In addition, the net present value method is computationally simpler than the internal rate of return method. Determining IRR can be time consuming, particularly for projects having uneven cash flows. However, the use of a spreadsheet reduces the effort considerably. An important difference between the two methods is that the IRR method assumes cash inflows can be reinvested to earn the same return that the project would generate.
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