Discuss the following statement: If a firm has only independent projects, a constant WACC,and projects with normal cash flows, the NPV and IRR methods will always lead to identicalcapital budgeting decisions. What does this imply about the choice between IRR and NPV?If each of the assumptions were changed (one by one), how would your answer change?

Discuss the following statement: If a firm has only independent projects, a constant WACC,and projects with normal cash flows, the NPV and IRR methods will always lead to identicalcapital budgeting decisions. What does this imply about the choice between IRR and NPV?If each of the assumptions were changed (one by one), how would your answer change?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter13: Capital Budgeting: Estimating Cash Flows And Analyzing Risk

Section: Chapter Questions

Problem 8Q

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If a firm has only independent projects, a constant WACC, and projects with normal cash flows, the NPV and IRR methods always lead to identical capital budgeting decisions. What does this imply about the choice between IRR and NPV? If each of the assumptions were changed (one by one), how would your answer change?
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%.…
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.
Which of the following statements is correct regarding the payback method? Takes account of differences in size among projects. If a project’s payback is positive, then the project should be accepted because it must have a zero NPV. Ignores cash flows beyond the payback period. Has an objective, market-determined benchmark for making decisions. Directly account for the time value of money.
Suppose a firm uses the WACC as the single hurdle rate in determining the value of capital budgeting projects rather than using risk adjusted hurdle rates. Choose the statement that actually completes the sentence describing the possible outcomes for the firm: the firm will tend to Accept profitable, low risk projects and reject unprofitable, high risk projects Accept profitable, low risk projects and accept unprofitable, high risk projects Reject profitable, low risk projects and reject unprofitable high risk projects Become less risky overtime Reject profitable, low risk projects and accept unprofitable, high risk projects
A 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.
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
Would a failure to recognize growth options tend to cause a firm’s actual capital budget tobe above or below the optimal level? Would your answer be the same for abandonment,timing, and flexibility options? Explain.
Comment on the following statement. The reason we are seeing fewer market-creating innovations is because using NPV and IRR to make capital budgeting decisions will result in only accepting projects with short payoff periods.
Suppose a firm uses a constant WACC in determining the value of capital budgeting projects rather than using a project beta. The firm will tend to A. accept profitable, low risk projects and reject unprofitable, high risk projects B. accept profitable, low risk projects and accept unprofitable, high risk projects C. reject profitable, low risk projects and accept unprofitable, high risk projects D. reject profitable , low risk projects and reject unprofitable, high risk projects
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. For most firms, the reinvestment rate assumption in the NPV is more realistic than the assumption in the IRR. 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 the NPV method in capital budgeting decisions.
H5. Discuss the following statement: If a firm has only independent projects, a constant WACC, and projects with normal cash flows, the NPV and IRR methods will always lead to identical capital budgeting decisions. What does this imply about the choice between IRR and NPV? If each of the assumptions were changed (one by one), how would your answer change? Explain with details