CASH FLOW ESTIMATION AND RISK ANALYSIS
Home Depot Keeps Growing
Refer to Table 12-1 and answer these questions:
(1) If the WACC increased to 15 percent, what would the new NPV
be? ($2,877)
(2) Look at Part 1, Input Data. In what direction would NPV be
changed by an increase in each input variable?
(3) If the equipment had to be depreciated over a 10-year life rather
than a 5-year life, but other aspects of the project were unchanged,
would the NPV increase or decrease? Why?
(4) It is relatively easy to determine the effect of an increase in the
WACC.
Would it be equally easy to quantify the effects of changes in the other variables if (a) you were working with a calculator or (b) you were working with an Excel spreadsheet? Why?
Why should companies use project cash flow rather than accounting
income when finding the NPV of a project?
Explain the following terms: incremental cash flow, sunk cost,
opportunity cost, externality, and cannibalization.
Give an example of a “good” externality, that is, one that makes a
project look better.
What are the three types of project risk?
Which type of project risk is theoretically the most relevant? Why?
Explain the classification scheme many firms use when developing
subjective risk-adjusted costs of capital.
Explain briefly how one does a sensitivity analysis, and what the
analysis is designed to show.
What is a scenario analysis, what is it designed to show, and how
does it differ from a sensitivity analysis?
What is Monte Carlo simulation? How does a simulation analysis
differ from a simple scenario analysis?
How might capital structure issues affect capital budgeting decisions?
What are certainty equivalents and risk-adjusted discount rates? How is each used to incorporate project risk into the capital budgeting decision process? Which is used most often in practice? Why