THE BASICS OF CAPITAL BUDGETING
Competition in the Aircraft Industry
How is capital budgeting similar to security valuation? How is it
different?
What are some ways firms generate ideas for capital projects?
Identify the major project classification categories, and explain why
and how they are used
Why is the NPV regarded as being the primary capital budgeting
decision criterion?
What’s the difference between “independent” and “mutually exclusive” projects?
What are the NPVs of Projects SS and LL if both have a 10 percent
cost of capital and the indicated cash flows? (NPV SS $77.61;
NPV LL $89.63)
Which project or projects would you recommend if they are (a) independent or (b) mutually exclusive?
In what sense is the IRR on a project related to the YTM on a bond?
The cash flows for projects SS and LL are shown below.
What are the projects’ IRRs, and which one would the IRR method select if the firm has a 10 percent cost of capital and the projects are (a) independent or (b) mutually exclusive? (IRR SS 18.0%; IRR LL 15.6%)
Describe in words how a project’s NPV profile is constructed. What
is the Y-axis intercept equal to?
Do the NPV and IRR criteria lead to conflicting recommendations
for normal independent projects? For mutually exclusive projects?
What is the “crossover rate,” and how does it interact with the cost
of capital to determine whether or not a conflict exists between NPV
and IRR?
What two characteristics can lead to conflicts between the NPV and
the IRR when evaluating mutually exclusive projects?
What reinvestment rate assumptions are built into the NPV and
IRR? Which assumption is better for firms (a) with good access to
external capital or (b) with no access to external capital?
What characteristic must a project’s cash flow stream have for more
than one IRR to exist?
Project MM has the cash flows shown below. Calculate MM’s NPV
at discount rates of 0, 10, 12.2258, 25, 122.1470, and 150 percent.
What are MM’s IRRs? If the cost of capital were 10 percent, should
the project be accepted or rejected? (NPVs range from $350 to $164
and back to $94; the IRRs are 12.23 and 122.15 percent)
What is the primary difference between the MIRR and the regular
IRR?
What advantages does the MIRR have over the regular IRR?
What conditions can cause MIRR and NPV to produce conflicting
rankings?
Projects S and L have the following cash flows, and their cost of capital is 10 percent.
What are the projects’ IRRs, MIRRs, and NPVs?
Which project would each method select? (IRR S 23.1%, IRR L
19.1%, MIRR S 16.8%, MIRR L 18.7%, NPV S $128.10, NPVL
$165.29)
0 1 2
S $1,000 $1,150 $ 100
L 1,000 100 1,300
What two pieces of information does the payback convey that are
absent from the other capital budgeting decision methods?
Describe the advantages and disadvantages of the five capital budgeting methods discussed in this chapter.
Should capital budgeting decisions be made solely on the basis of a
project’s NPV?
What trends in capital budgeting methodology can be seen from
Table 11-1?
What is done in the post-audit?
Identify several benefits of the post-audit.
What are some factors that complicate the post-audit process?