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Category > Accounting Posted 30 Jul 2017 My Price 14.00

essence of capital budgeting

Case Study

The Investment Detective

The essence of capital budgeting and resource allocation is a search for good investments in which to invest the firmAc€?cs capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital budgeting analyst is necessarily, therefore, a detective who must winnow good evidence from bad. Much of the challenges is knowing what quantitative analysis to generate in the first place.

Supposed you are a new capital budgeting analyst for a company considering investments in the eight projects listed in Exhibit 1. The chief financial officer of your company has asked you to rank the projects and recommend the "four best" that the company should accept

Part I

For the first part of this assignment only quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 7 and 8 are mutually exclusive.

All projects require the same initial investment, $2,000,000. Moreover, all are believed to be of the same risk class. The weighted average cost of capital for the first part is 10%. To simulate your analysis, consider the following questions:

Can you rank the projects simply by inspecting the cash flows?

What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why?

What is the ranking you found by using quantitative methods? Does this ranking differ from the ranking obtained by simple inspection of the cash flows?

What kinds of real investment projects have cash flows similar to those in the exhibit?

Project cash flows in (00)

 

Project1

Project2

Project3

Project4

Project5

Project6

Project7

Project8

Initial Investment

$2,000

$2,000

$2,000

$2,000

$2,000

$2,000

$2,000

$2,000

Year

                

1

$330

$1,666

  

$160

$280

$2,200

$1,200

$(350)

2

$330

$334

  

$200

$280

  

$900

$(60)

3

$330

$165

  

$350

$280

  

$300

$60

4

$330

    

$395

$280

  

$90

$350

5

$330

    

$432

$280

  

$70

$700

6

$330

    

$440

$280

$4,000

  

$1,200

7

$330

    

$442

$280

    

$2,250

8

$1,000

    

$444

$280

      

9

      

$446

$280

  

$2,000

  

10

  

$5,000

  

$448

$280

      

11

      

$450

$280

      

12

      

$451

$280

      

13

      

$451

$280

      

14

      

$452

$280

      

15

    

$9,000

$(2,000)

$280

      

Sum of Cash Flow

                

Benefits

$3,310

$7,165

$9,000

$3,561

$4,200

$6,200

$4,560

$4,150

Excess of cash flow

                

Over investment

$1,310

$5,165

$7,000

$1,562

$2,200

$4,200

$2,560

$2,150

 

Answers

Maurice Tutor
(5)
Status NEW Posted 30 Jul 2017 08:07 PM My Price 14.00

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