Capital budgeting Essay

A Capital budgeting is an analysis of potential additions to fixed assets, it is part of the long full term ratiocinations taken by the top management and involve large expenditures. The capital budgeting is very important to firms future. The dissentence between capital budgeting and souls investment decisions are in the estimation of hard currency flows, risk, and determination of the appropriate discount. B The difference between interdependent and mutually exclusive projects is that the free-living projects cash flows are not affected by the acceptance of the other, although the mutually exclusive can be adversely impacted by the acceptance of the other. the difference between normal and no normal cash flow stream projects occurs in the signs since for the normal cash flows if the cost ( negative CF) followed by a series of positive cash flows volition lead to one change of sign.On the other hand the non-normal project cash flows have devil or more changes of sign C 1 N PV is the sum of all cash inflows and outflows of a project C 2 The rationale behind the NPV regularity is that it is equal to PV of inflows minus the cost which is the net gain in wealth. If the projects are mutually exclusive we leave alone exact the project with the highest NPV and here in our pillow slip we will choose project S since it has a greater NPV compared to project S (19.9818.79). If the projects are independent we will choose both. C 3 The NPV will change if the WACC change if the WACC increases the NPV will decrease on the other hand if the WACC decreases the NPV will increase. D 1 Internal judge of return (IRR) is the discount rate that forces PV inflows equal to cost, and the NPV = 0. IRR using excel for project LIRR18.13%For project SIRR23.6%D 2 A project IRR is the same as a stick tos YTM. The YTM on the bond would bethe IRR of the bond project. D 3 If IRR WACC, the projects return exceeds its costs and there is some return left hand over to boost s tockholders returns. If IRR WACC, the project is accepted and if IRR WACC, the project is reject. If projects are independent, we accept both of them, as both IRR WACC. If projects are mutually exclusive, we accept the one with the highest IRR. D 4 IRR do not depend on the WACC, so if the WACC changes, the IRR for both projects will remain the same. E 1Excel=NPV(rate,CF1CFn) + CF 0WACCNPV LNPV S0%$50.00$40.005%$33.05$29.2910%$18.78$19.9815%$6.67$11.8320%($3.70)$4.63Cross over rate is equal to 8.7%.CF Differences0-601060IRR = 8.7%E 2 For independent projects, both IRR and NPV will lead to the same decision. If projects are mutually exclusive, there is a conflict between the IRR and the NPV. Since we said that NPV is the best method to use in case of conflict, project L will be selected based on this method. F 1 The slope of the NPV profile depends entirely on the timing of the cash flows long-term projects have excessive NPV profiles than short-term projects. We conclude that NPV profiles can cross in two situations, first when mutually exclusive projects differ in size the smaller project frees up funds at t = 0 for investment. The higher the opportunity cost, the more valuable these funds, so a high WACC favors small projects, and second when the projects cash flows differ in terms of the timing pattern of their cash flows the project with faster payback provides more CF in early years for reinvestment. If WACC is high, early CF especially good, NPVs NPV L (projects studied in class). F 2The reinvestment rate assumptions-NPV method assumes Cfs are reinvested at the WACC.-IRR method assumes CFs are reinvested at the IRR.-Assuming Cfs are reinvested at the opportunity cost of capital is more realistic, so NPV method is the best. NPV method should be used to choose between mutually exclusive projects. -Perhaps a hybrid of the IRR that assumes cost of capital reinvestment is needed. F 3 Some projects will result in different IRR and NPV. The NPV will b e selected to decide if the project is going to be accepted or not. We do not use the IRR first because it does not take into account ever-changing discount rates, so it is j not adequate for longer-term projects with discount rates that are will probably vary. Second, the IRR ineffective is a project with a non-normal cash flow streams (mixture of positive and negative cash flows). G 1 MIRR assumes reinvestment at the opportunity cost =WACC. MIRR also avoids the multiple IRR problem.G 2 MIRR does not of all time lead to the same decision as NPV when mutually exclusive projects are being considered. In particular, small projects often have a higher MIRR, still a lower NPV, than larger projects. Thus, MIRR is not a perfect substitute for NPV, and NPV remains the single best decision rule.H 1 Payback stop consonant is the number of years required to recover a projects cost, or how long does it take to get our money back?H 2 The payback period tells us when the project will break even in a cash flow sense. With a required payback of 2 years, Project S is acceptable, but Project L is not. Whether the two projects are independent or mutually exclusive makes no difference in this case. H 3 Discounted payback is similar to payback except that discounted rather than raw cash flows are used. H 4 Discounted payback still fails to consider cash flows after the payback period and it gives us no specific decision rule for acceptance. However, payback is not generally used as the primary decision tool. Rather, it is used as a rough measure of a projects liquidity and riskiness. I 123CF-8000005000000-5000000WACC0,1To drive NPV we used excelExcel =NPV(rate,CF1CFn)+CFONPV(386 776,86 DT)Excel =IRR(CF0CFn,Rate)IRR25%Excel =MIRR(CF0CFN,Rate)MIRR5,6%7