Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 10, Problem 1PS
Capital budgeting process True or false?
- a. The approval of a capital budget allows managers to go ahead with any project included in the budget.
- b. Capital budgets and project authorizations are mostly developed “bottom up.” Strategic planning is a “top-down” process.
- c. Project sponsors are likely to be overoptimistic.
Expert Solution & Answer
Summary Introduction
To discuss: Whether the given statements are true or false.
Explanation of Solution
a) The capital budget is not a complete sign-off for particular projects. Many of the firms need a correct request for individual project with a brief analysis.
Hence, option A is false.
b) The strategic planning needs to consider the alternatives. The project authorizations and capital budgets are generally developed “bottom up”. The strategic planning is a “top-down process”.
Hence, option B is true.
c) The sponsors of the project are mostly overoptimistic and the forecasts of the cash flow are often overstated.
Hence, option C is true.
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Students have asked these similar questions
1. Since capital budgeting decisions involve the estimation of a project’s future cash flows and the rate at which they should be discounted is still a relatively subjective process, the behavioral traits of managers still affect this process. Please explain this statement and suggest how managers can better improve their ability to eliminate biases in their forecasting.
Multiple choice:
Capital budgeting is the process of deciding whether or not to commit resources to projects with costs and benefits spread over several time periods. Capital budget is the same as operating budget. • Both statements are incorrect.• Only the second statement is correct.• Both statements are correct.• Only the first statement is correct.
Which of the following is a problem associated with capital budgeting? Select all that apply.
Long-term strategic planning for resource allocation
Unsustainable budget infrastructure that will have an impact on future generations
Miscalculating or poor estimation of projected costs
Fluctuating economics and financial markets
Chapter 10 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 10 - Capital budgeting process True or false? a. The...Ch. 10 - Prob. 2PSCh. 10 - Prob. 3PSCh. 10 - Project analysis True or false? a. Sensitivity...Ch. 10 - Prob. 5PSCh. 10 - Real options True or false? a. Decision trees can...Ch. 10 - Prob. 7PSCh. 10 - Prob. 9PSCh. 10 - Prob. 10PSCh. 10 - Break-even analysis Break-even calculations are...
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Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Distinguish among beta (or market) risk, within-firm (or corporate) risk, and stand-alone risk for a project being considered for inclusion in a firm’s capital budget.arrow_forwardThe decision process Before making capital budgeting decisions, finance professionals often generate, review, analyze, select, and implement long-term investment proposals that meet firm-specific criteria and are consistent with the firm’s strategic goals. Companies often use several methods to evaluate the project’s cash flows and each of them has its benefits and disadvantages. Based on your understanding of the capital budgeting evaluation methods, which of the following conclusions about capital budgeting are valid? Check all that apply. The discounted payback period improves on the regular payback period by accounting for the time value of money. Managers have been slow to adopt the IRR, because percentage returns are a harder concept for them to grasp. For most firms, the reinvestment rate assumption in the NPV is more realistic than the assumption in the IRR. True or False: Sophisticated firms use only the NPV method in capital budgeting decisions.…arrow_forwardDistinguish among beta (or market) risk, within-firm (or corporate) risk, and stand-alone risk for a project being considered for inclusion in the capital budget. In theory, market risk should be the only “relevant” risk. However, companies focus as much on stand-alone risk as on market risk. What are the reasons for the focus on stand-alone risk?arrow_forward
- The decision process Before making capital budgeting decisions, finance professionals often generate, review, analyze, select, and implement long-term investment proposals that meet firm-specific criteria and are consistent with the firm’s strategic goals. Companies often use several methods to evaluate the project’s cash flows and each of them has its benefits and disadvantages. Based on your understanding of the capital budgeting evaluation methods, which of the following conclusions about capital budgeting are valid? Check all that apply. For most firms, the reinvestment rate assumption in the MIRR is more realistic than the assumption in the IRR. The discounted payback period improves on the regular payback period by accounting for the time value of money. Because the MIRR and NPV use the same reinvestment rate assumption, they always lead to the same accept/reject decision for mutually exclusive projects. True or False: Sophisticated firms use only…arrow_forwardA project team is in the process of developing an approximation of the monetary resources needed to complete project work for a large-scale multinational project. Previous projects of this nature have been plagued with cost overruns and the Project Manager has decided to take a different approach to develop the budget for the current project. He has decided to use the Zero-based budgeting approach. A. Critically assess the value of using this approach (Zero-based budgeting), as against other approaches, in developing the budget for this project. B. Briefly outline TWO (2) aims of Zero-based budgetingarrow_forwardWhich of the following is NOT a major step in the capital budgeting process? a. generating investment project proposals b. analyzing the effect of a project on the firm's financial ratios c. performing a project post-audit and review d. estimating cash flowsarrow_forward
- Case Study: Identifying Errors in Capital Budgeting Decisions Introduction: Capital budgeting decisions play a crucial role in the financial success of a company, impacting its long-term viability. Managers strive to make accurate and informed decisions when evaluating potential investment projects. However, errors can occur, and it is essential to implement effective procedures to identify and rectify these mistakes. This case study explores various procedures and their efficacy in identifying errors in capital budgeting decisions. Background: Company XYZ, a manufacturing firm, recently implemented a capital budgeting decision involving a significant investment in upgrading its production facilities. The decision-making process was intricate, considering factors such as projected cash flows, discount rates, and risk assessments. Despite thorough analysis, the management recognizes the importance of post-evaluation procedures to identify potential errors and enhance…arrow_forwardThe purpose of capital budgeting is to: Group of answer choices Avoid all projects that involve risk control the short-term financing used by a firm. determine the correct mix of debt and equity for a firm. identify assets/projects that produce value in excess of their cost.arrow_forwardWhy does capital budgeting rely on an analysis of cash flows rather than on net income? Base your answer on the accounting principles of recognizing and reporting revenue and expenses.Describe two capital budgeting decisions based on the time value of money. Which of the two methods would you select for a capital budgeting project and why?arrow_forward
- The WACC is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that the WACC is only an appropriate discount rate for a project of average risk—in other words, a project that has the same beta as the company. If a project has less risk than the overall company risk, it should be evaluated with a lower discount rate; if a project is riskier than the overall company risk, it should be evaluated using a discount rate higher than the company WACC. Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. It has a before-tax cost of debt of 11.1%, and its cost of preferred stock is 12.2%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 14.7%.…arrow_forwardWhen evaluating projects for consideration in capital budgeting identifying the appropriate cash flows is a critically important first step. In general, should the following be included in the cash flow projections of a project? Revenues, Cost of Sales, Depreciation, Cannibalization of other firm sales, Interest, Profits, Overhead and Taxes. Why or why not?arrow_forwardA project team is in the process of developing an approximation of the monetary resources neededto complete project work for a large-scale multinational project. Previous projects of this naturehave been plagued with cost overruns and the Project Manager has decided to take a differentapproach to develop the budget for the current project. He has decided to use the Zero-basedbudgeting approach. A. Critically assess the value of using this approach (Zero-based budgeting), as against otherapproaches, in developing the budget for this project.arrow_forward
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