Gitman: Principl Manageri Finance_15 (15th Edition) (What's New in Finance)
15th Edition
ISBN: 9780134476315
Author: Chad J. Zutter, Scott B. Smart
Publisher: PEARSON
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Textbook Question
Chapter 12.1, Problem 12.1RQ
Are most mutually exclusive capital budgeting projects equally risky? If you think about a firm as a portfolio of many different kinds of investments, how can the acceptance of a project change a firm’s overall risk?
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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
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?
What is the connection between capital budgeting decisions and the enterprise’s cost of capital? Would an enterprise ever decide to embark on a project whose rate of return would be less than its cost of capital? Why or why not?
Chapter 12 Solutions
Gitman: Principl Manageri Finance_15 (15th Edition) (What's New in Finance)
Ch. 12.1 - Are most mutually exclusive capital budgeting...Ch. 12.2 - Prob. 12.2RQCh. 12.2 - Describe how each of the following behavioral...Ch. 12.3 - Briefly explain how the following items affect the...Ch. 12.4 - Describe the basic procedures involved in using...Ch. 12.4 - Explain why a firm whose stock is actively traded...Ch. 12.4 - Prob. 12.8RQCh. 12.5 - Explain why a mere comparison of the NPVs of...Ch. 12.5 - What are real options? What are some major types...Ch. 12.5 - What is the difference between the strategic NPV...
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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
- 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 projectsarrow_forwardWhich of the following is true about the WACC? It’s the appropriate discount rate for all new projects with the same risk level as the existing assets of the firm The optimal capital structure is the one that minimizes the WACC The value of the firm will be maximized when the WACC is minimized Since discount rates and values move in the same direction, minimizing the WACC will minimize the value of the firms cash flows A, B, and C are truearrow_forwardDiscuss the connection between capital budgeting decisions and the enterprise’s cost of capital. Would an enterprise ever decide to embark on a project whose rate of return would be less than its cost of capital? Why or why not?arrow_forward
- What is the typical discount rate used with the Net Present Value (NPV) when project risk is the same as firm risk? Which capital budgeting methods should managers of firms use to evaluate a project? Why?arrow_forwardIn our capital budgeting examples, we assumed that a firm would recover all of the working capital it invested in a project. Is this a reasonable assumption? When might it not be valid?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 goal of the capital budgeting decisions is to select capital projects that will decrease the value of the firm. True Falsearrow_forwardThe cost of capital is: the required rate of return for new projects that have risk that is similar to that of the overall firm. the rate of return a firm earns on its investments to satisfy the required rate of return for the firm’s investors. the opportunity cost of using funds on projects. all of the above.arrow_forwardThe 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_forward
- If you could only have one piece of information to help you understand the discount rate for evaluating a project at hand, which of the following would you prefer? The project has different systematic risk than the firm overall. Group of answer choices How the project's expected cash flows are effected by the overall economy The firm's credit rating The firm's cost of equity The firm's WACCarrow_forwardWhy is the capital budgeting decision crucial and important for a firm? State why the capital budgeting errors are so costly?arrow_forward“The stand-alone risk of an individual corporate project may be quite high, but viewed in the context of its effect on stockholders’ risk, the project’s true risk may be much lower." How does the correlation between returns on a project and returns on the firm’s other assets affect the project’s risk?arrow_forward
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