Capital Budget Paper

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Integrative Problem and Study Questions Mark Camagong FIN 370 January 20, 2010 Art Philibert Week 4 Assignment Integrative Problem and Study Questions 1. Why is the capital-budgeting process so important? Capital budgeting decisions involve investments requiring large cash outlays at the beginning of the life of the project and commit the firm to a particular course of action over a relatively long period of time. As such, they are costly and difficult to reverse, both because of: (1) their large cost and (2) the fact that they involve fixed assets, which cannot be liquidated easily. 2. Why is it difficult to find exceptionally profitable projects? It is hard to…show more content…
Only by examining cash flows are we able to correctly analyze the timing of the benefit or cost. Also, we are only interested in these cash flows on an after tax basis as only those flows are available to the shareholder. The incremental cash flows interest us because, looking at the project from the point of the company as a whole, the incremental cash flows are the marginal benefits from the project and, as such, are the increased value to the firm from accepting the project. 10-4. How do sunk cost affect the determination of cash flows associated with an investment proposal? When evaluating a capital budgeting proposal we are interested in only the incremental after-tax cash flows to the company as a whole. Regardless of the decision made on the investment at hand, the sunk costs will have already occurred, which means these are not incremental cash flows. Therefore, they are irrelevant. 10-6. What are common reasons for capital rationing? Is capital rationing rational? There are three principal reasons for imposing a capital rationing constraint. First, the management may feel that market conditions are temporarily adverse. The second reason is a manpower shortage, that is, a shortage of qualified managers to direct new projects. The final reason involves intangible considerations. Whether or not this is a rational move depends upon the extent of the rationing. If it is minor and non-continuing,
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