BRD12 - Chapter 12 Discussion Questions 12-1. What are the...

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Chapter 12 Discussion Questions 12-1. What are the important administrative considerations in the capital budgeting process? Important administrative considerations relate to: the search for and discovery of investment opportunities, the collection of data, the evaluation of projects, and the reevaluation of prior decisions. 12-2. Why does capital budgeting rely on analysis of cash flows rather than on net income? Cash flow rather than net income is used in capital budgeting analysis because the primary concern is with the amount of actual dollars generated. For example, depreciation is subtracted out in arriving at net income, but this non- cash deduction should be added back in to determine cash flow or actual dollars generated. 12-3. What are the weaknesses of the payback method? The weaknesses of the payback method are: a. There is no consideration of inflows after payback is reached. b. The concept fails to consider the time value of money. 12-4. What is normally used as the discount rate in the net present value method? The cost of capital as determined in Chapter 11. 12-5. What does the term mutually exclusive investments mean? The selection of one investment precludes the selection of other alternative investments because the investments compete with one another. For example if a company is going to build one new plant and is considering 5 cities, one city will win and the others will lose. 12-6. How does the modified internal rate of return include concepts from both the traditional internal rate of return and the net present value methods? The modified internal rate of return calls for the determination of the interest rate that equates future inflows to the investment as does the traditional internal rate or return. However, it incorporates the reinvestment rate assumption of the net present value method. That is that inflows are reinvested at the cost of capital. S12-1
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12-7. If a corporation has projects that will earn more than the cost of capital, should it ration capital? From a purely economic viewpoint, a firm should not ration capital. The firm should be able to find additional funds and increase its overall profitability and wealth through accepting investments to the point where marginal return equals marginal cost. 12-8. What is the net present value profile? What three points should be determined to graph the profile? The net present value profile allows for the graphic portrayal of the net present value of a project at different discount rates. Net present values are shown along the vertical axis and discount rates are shown along the horizontal axis. The points that must be determined to graph the profile are: a. The net present value at zero discount rate. b. The net present value as determined by a normal discount rate.
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This note was uploaded on 04/10/2011 for the course ADM 474 taught by Professor Stewart during the Spring '10 term at Indiana Wesleyan.

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BRD12 - Chapter 12 Discussion Questions 12-1. What are the...

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