The firms objective is to use its budget to generate

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Unformatted text preview: se its budget to generate the highest present value of inflows. Assuming that any unused portion of the budget does not gain or lose money, the total NPV for projects B, C, and E would be $106,000 ($336,000 $230,000), whereas for projects B, C, and A the total NPV would be $107,000 ($357,000 $250,000). Selection of projects B, C, and A will therefore maximize NPV. Review Questions 10–8 Explain why a mere comparison of the NPVs of unequal-lived, ongoing, mutually exclusive projects is inappropriate. Describe the annualized net present value (ANPV) approach for comparing unequal-lived, mutually exclusive projects. 10–9 What are real options? What are some major types of real options? 10–10 What is the difference between the strategic NPV and the traditional NPV? Do they always result in the same accept–reject decisions? 10–11 What is capital rationing? In theory, should capital rationing exist? Why does it frequently occur in practice? 10–12 Compare and contrast the internal rate of return approach and the net present value approach to capital rationing. Which is better? Why? S U M M A RY FOCUS ON VALUE Not all capital budgeting projects have the same level of risk as the firm’s existing portfolio of projects. In addition, mutually exclusive projects often possess differing levels of risk. The financial manager must therefore adjust projects for differences in risk when evaluating their acceptability. Without such adjustment, management could mistakenly accept projects that destroy shareholder value or could reject projects that create shareholder value. To ensure that neither of these outcomes occurs, the financial manager must make sure that only those projects that create shareholder value are recommended. Risk-adjusted discounts rates (RADRs) provide a mechanism for adjusting the discount rate so that it is consistent with the risk–return preferences of market participants and thereby accepting only value-creating projects. Procedures for comparing projects with unequal lives, procedures for explicitly recognizing real options embedded in capital projects, and procedures for selecting projects under capital rationing enable the financial manager to refine the capital budgeting process further. These...
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This document was uploaded on 01/19/2014.

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