CFM4 Solns Chap 11

CFM4 Solns Chap 11 - CORPORATE FINANCIAL MANAGEMENT Fourth...

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CORPORATE FINANCIAL MANAGEMENT, Fourth Edition Solutions Manual , Chapter 11 Chapter 11 Questions 1. There are six main areas to look for options. An expansion option is the ability to change the size of a project. A price- setting option is the ability to change the cash flows of a project by changing a product’s price. An abandonment option is the ability to quit a project if it is more profitable than continuing. A postponement option is the ability to wait for more information before making a decision. The replacement option is the ability to continue using equipment or buy new equipment. Future investment options arise because a capital budgeting project may not be profitable in and of itself, but it may give rise to future positive-NPV projects. 2. Capital rationing is putting one or more types of limits on capital expenditures. 3. “Hard” capital rationing sets a maximum amount of money to be invested that cannot be violated under any circumstances. “Soft” capital rationing sets a maximum amount of money to be invested that management might be willing to violate under certain circumstances. 4. Capital rationing can be used for managerial planning because the firm can engage in sensitivity analysis of any of its limits on spending for capital budgeting projects, and get a good picture of the tradeoffs among alternative projects. 5. Postaudits are important because actual cash flows can be compared to the estimates. This comparison can help improve the ability of the analysts that made the estimates. One of the pitfalls of postaudits is the difficulty of measuring opportunity costs and options. Also, measuring and identifying cash flows from a decision may be impossible. 6. The pricing of a product has important implications for capacity because price affects demand. If a firm raises the price of its product, it will sell less of the product. Likewise, if a firm lowers the price, it will sell more of the product. The pricing of a product can affect the decision of whether to expand or not because the decision to raise the price and not expand may have a higher NPV than the decision to keep pricing constant and expand plant capacity. 7. Abandonment is important to firms engaged in capital rationing because of opportunity costs. A firm engaged in capital rationing may choose to abandon a positive NPV project and invest the proceeds in a project with an even greater NPV. A firm not using capital rationing would simply invest in both projects. 8. There are many factors that are difficult to quantify in a capital budgeting NPV calculation. One factor is the value of options that are part of a project. Another factor that is difficult to quantify is any enhancement or erosion of existing projects due to the selection of a new project. The likelihood of technological advances, which can make the opportunity to postpone investment valuable, is also difficult to estimate. Costs and benefits connected with relationships with suppliers are not simple to quantify and can have an effect on the success of a project. Another cost that is difficult to
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This note was uploaded on 09/18/2011 for the course FIN 303 taught by Professor Bernile during the Spring '11 term at University of Miami.

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CFM4 Solns Chap 11 - CORPORATE FINANCIAL MANAGEMENT Fourth...

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