PRIN.OF CORPORATE FINANCE >BI<
12th Edition
ISBN: 9781260431230
Author: BREALEY
Publisher: MCG CUSTOM
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Chapter 9, Problem 7PS
Fudge factors John Barleycorn estimates his firm’s after-tax WACC at only 8%. Nevertheless, he sets a 15% companywide discount rate to offset the optimistic biases of project sponsors and to impose “discipline” on the capital budgeting process. Suppose Mr. Barleycorn is correct about the project sponsors, who are, in fact, optimistic by 7% on average. Explain why the increase in the discount rate from 8% to 15% will not offset the bias.
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Midwest Water Works estimates that its WACC is 10.5%. The companyis considering the following capital budgeting projects:Project Size Rate of ReturnA $1 million 12.0%B 2 million 11.5C 2 million 11.2D 2 million 11.0E 1 million 10.7F 1 million 10.3G 1 million 10.2Assume that each of these projects is just as risky as the firm’s existing assets and thatthe firm may accept all the projects or only some of them. Which set of projects should beaccepted? Explain.
Vang Enterprises, which is debt-free and finances only with equity from retained earnings, is considering 7 equal-sized capital budgeting projects. Its CFO hired you to assist in deciding whether none, some, or all of the projects should be accepted. You have the following information: rRF = 4.50%; RPM = 5.50%; and b = 0.98. The company adds or subtracts a specified percentage to the corporate WACC when it evaluates projects that have above- or below-average risk. Data on the 7 projects are shown below. If these are the only projects under consideration, how large should the capital budget be?
Expected
Project
Risk
Risk factor
return
Cost (millions)
1
Very low
-2.00%
7.60%
$25
2
Low
-1.00%
9.15%
$25
3
Average
0.00%
10.10%
$25
4
High
1.00%
10.40%
$25
5
Very high
2.00%
10.80%
$25
6
Very high
2.00%
10.90%
$25
7
Very high
2.00%
13.00%
$25
a. $75 million
b. $100 million
c. $50 million
d. $125…
The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions.
Consider the case of Cute Camel Woodcraft Company:
Last Tuesday, Cute Camel Woodcraft Company lost a portion of its planning and financial data when both its main and its backup servers crashed. The company’s CFO remembers that the internal rate of return (IRR) of Project Lambda is 13.8%, but he can’t recall how much Cute Camel originally invested in the project nor the project’s net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Lambda. They are:
Year
Cash Flow
Year 1
$1,600,000
Year 2
$3,000,000
Year 3
$3,000,000
Year 4
$3,000,000
The CFO has asked you to compute Project Lambda’s initial investment using the information currently available to you. He has offered the following suggestions and observations:
•
A…
Chapter 9 Solutions
PRIN.OF CORPORATE FINANCE >BI<
Ch. 9 - (VAR.P and STDEV.P) Choose two well-known stocks...Ch. 9 - (AVERAGE, VAR.P and STDEV.P) Now calculate the...Ch. 9 - (SLOPE) Download the Standard Poors index for the...Ch. 9 - Company cost of capital Suppose a firm uses its...Ch. 9 - Prob. 2PSCh. 9 - Definitions Define the following terms: a. Cost of...Ch. 9 - Asset betas EZCUBE Corp. is 50% financed with...Ch. 9 - Prob. 6PSCh. 9 - Fudge factors John Barleycorn estimates his firms...Ch. 9 - Asset betas Which of these projects is likely to...
Ch. 9 - True/false True or false? a. The company cost of...Ch. 9 - Certainty equivalents A project has a forecasted...Ch. 9 - Company cost of capital The total market value of...Ch. 9 - Company cost of capital Nero Violins has the...Ch. 9 - Measuring risk The following table shows estimates...Ch. 9 - Company cost of capital You are given the...Ch. 9 - Measuring risk Look again at Table 9.1. This time...Ch. 9 - Prob. 16PSCh. 9 - WACC Binomial Tree Farms financing includes 5...Ch. 9 - Prob. 18PSCh. 9 - Prob. 19PSCh. 9 - Prob. 20PSCh. 9 - Certainty equivalents A project has the following...Ch. 9 - Prob. 22PSCh. 9 - Beta of costs Suppose that you are valuing a...Ch. 9 - Fudge factors An oil company executive is...
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