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.
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Would a failure to recognize growth options tend to cause a firm’s actual capital budget to
be above or below the optimal level? Would your answer be the same for abandonment,
timing, and flexibility options? Explain.
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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 projectsExplain the following: The WACC is a weighted average of the costs of debt, preferred stock, and common equity.Would the WACC be different if the equity for the coming year came solely in the formof retained earnings versus some equity from the sale of new common stock? Would thecalculated WACC depend in any way on the size of the capital budget? How mightdividend policy affect the WACC? Assume that the risk-free rate increases. What impact would this have on the cost of debt?What impact would it have on the cost of equity? Note: Explain Shortly And To the Point AnswerSuppose 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
- Distinguish 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?Why is the capital budgeting decision crucial and important for a firm? State why the capital budgeting errors are so costly?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
- 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?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?Which of the following is a problem with using discounted payback period for capital budgeting decisions arbitrary cutoff choice bias against short term projects in favor of long term projects time value of money conceptual violation
- What is the major short coming of using the payback period as the only criterion in making capital budgeting decisions?Suppose a company uses the NPV method, alongwith risk-adjusted WACCs, to calculate projectNPVs. However, it has not been considering realoptions in its capital budgeting decisions. Nowsuppose the company changes its capital budgeting process to take account of four types of realoptions investment timing, flexibility, growth,and abandonment. Would this decision be likelyto affect some of the calculated NPVs? Explainyour answerWhich of the following statements is false? A. Net incomes are not cash flows. Financial Managers should focus on the cash flows when making capital budgeting decisions. B. Incremental earnings are the amount by which the firm's earnings are expected to change as a result of the investment decision. C. To the extend that overhead costs are fixed and will be incurred in any case, they are not incremental to the project and should be excluded in the capital budgeting analysis. D. Depreciation is not a cash expense paid by the firm. E. None of the above.