Concept explainers
Capital budgeting process* True or false?
- a. The approval of a firm’s capital budget allows managers to go ahead with any project included in the budget.
- b. Capital budgets and project authorizations are mostly developed “bottom up.” Strategic planning is a “top-down” process.
- c. Project sponsors are likely to be overoptimistic.
a)
To discuss: The items whether true or false on the bases of capital budgeting process.
Explanation of Solution
False. Firm’s capital budget isn’t the ultimate sign-off for the specific projects. Most firms need each project appropriation requests and includes more detailed analysis. The capital budgeting is often pruned and revised according to the market conditions.
b)
To discuss: The item whether true or false on the bases of capital budgeting process.
Explanation of Solution
False, the firm’s capital budget should reflect both bottom-up operational detail as well as top-down strategic views.
c)
To discuss: The item whether true or false on the bases of capital budgeting process.
Explanation of Solution
True because cash flow forecasts are regularly overstated.
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Chapter 11 Solutions
PRIN.OF CORPORATE FINANCE
- Which of the following statements is FALSE? A. When evaluating a capital budgeting decision, we generally include interest expense. B. Only include as incremental expenses in your capital budgeting analysis the additional overhead expenses that arise because of the decision to take on the project. C. Many projects use a resource that the company already owns. O D. As a practical matter, to derive the forecasted cash flows of a project, financial managers often begin by forecasting earnings.arrow_forwardCapital budgeting can be affected by factors such as exchange rate risk, political risk, transfer pricing, and strategic risk. Select a mid- or large-sized business organization and explain how each of these factors can affect its capital budgeting. Which factor poses the greatest threat to your selected organization and why? What measures can stakeholders take to reduce adverse impacts of these factors?arrow_forwardDistinguish among beta (or market) risk, within-firm (or corporate) risk, and stand-alone risk for a project being considered for inclusion in the capital budget. In theory, market risk should be the only “relevant” risk. However, companies focus as much on stand-alone risk as on market risk. What are the reasons for the focus on stand-alone risk?arrow_forward
- Statement 1: Capital budgeting refers to a group of methods used by a company to analyze possible capital projects to invest in. Statement 2: "capital budgeting" is called as such because capital-whether debt, equity, or retained earnings-is a limited resource. Select the correct response: Both statements are correct. Only statement 1 is correct. only statement 2 is correct Neither statement is correct.arrow_forwardWhich approach requires management to justify all its expenditures? A. bottom-up approach B. zero-based budgeting C. master budgeting D. capital allocation budgetingarrow_forwardCapital budgeting techniques aid businesses with investment decision-making. Many approaches can be used, with some being more advanced than others. Describe the payback period approach to capital budgeting. Explain 1 advantage and 1 disadvantage of the technique. Explain why it would be wise for a financial manager to learn advanced capital budgeting techniques.arrow_forward
- Which of the following is a problem associated with capital budgeting? Select all that apply. Long-term strategic planning for resource allocation Unsustainable budget infrastructure that will have an impact on future generations Miscalculating or poor estimation of projected costs Fluctuating economics and financial marketsarrow_forwardA preference decision in capital budgeting: O is concerned with whether a project clears the minimum required rate of return hurdle. comes before the screening decision. O is concerned with determining which of several acceptable alternatives is best. O involves using market research to determine customers' preferences.arrow_forwardTraditional NPV analysis usually does not address the decisions that managers have after a project has been accepted. In reality, capital budgeting and project management is typically dynamic, rather than static in nature and Real options exist Define Real Options Identify and explain two Real Optionsarrow_forward
- The decision process Before making capital budgeting decisions, finance professionals often generate, review, analyze, select, and implement long-term investment proposals that meet firm-specific criteria and are consistent with the firm's strategic goals. Companies often use several methods to evaluate the project's cash flows and each of them has its benefits and disadvantages. Based on your understanding of the capital budgeting evaluation methods, which of the following conclusions about capital budgeting are valid? Check all that apply. O Managers have been slow to adopt the IRR, because percentage returns are a harder concept for them to grasp. For most firms, the reinvestment rate assumption in the NPV is more realistic than the assumption in the IRR. IRR The discounted payback period improves on the regular payback period by accounting for the time value of money. NPV is the single best method to use when making capital budgeting decisions.arrow_forwardBETTER FORECASTING FOR LARGE CAPITAL PROJECTSLarge capital investments that are completed on schedule and within their budgets are probably the exception rather thanthe rule—and even when completed many fail to meet expected revenues. Executives often blame projectunderperformance on foreseeable complexities and uncertainties having to do with the scope of and demand for the project,the technology or project location, or even stakeholder opposition. No doubt, all of these factors at one time or anothercontribute to cost overruns, benefit shortfalls, and delays.But knowing that such factors are likely to crop up, why do project planners, on average, fail to forecast their effect on thecosts of complex projects? We’ve covered this territory before but continue to see companies making strategic decisionsbased on inaccurate data. Deliberately or not, costs are systematically underestimated, and benefits are overestimatedduring project preparation—because of delusions or honest mistakes on…arrow_forwardThe decision process Before making capital budgeting decisions, finance professionals often generate, review, analyze, select, and implement long-term investment proposals that meet firm-specific criteria and are consistent with the firm’s strategic goals. Companies often use several methods to evaluate the project’s cash flows and each of them has its benefits and disadvantages. Based on your understanding of the capital budgeting evaluation methods, which of the following conclusions about capital budgeting are valid? Check all that apply. For most firms, the reinvestment rate assumption in the MIRR is more realistic than the assumption in the IRR. The discounted payback period improves on the regular payback period by accounting for the time value of money. Because the MIRR and NPV use the same reinvestment rate assumption, they always lead to the same accept/reject decision for mutually exclusive projects. True or False: Sophisticated firms use only…arrow_forward
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