Question

11-1 How are project classifications used in the capital budgeting process?

11-2 What are three potential flaws with the regular payback method? Does the discounted payback method correct all three flaws? Explain.

11-3 Why is the NPV of a relatively long-term project (one for which a high percentage of its cash flows occurs in the distant future) more sensitive to changes in the WACC than that of a short-term project?

11-4 What is a mutually exclusive project? How should managers rank mutually exclusive projects?

11-5 If two mutually exclusive projects were being compared, would a high cost of capital favor the longer-term or the shorter-term project? Why? If the cost of capital declined, would that lead firms to invest more in longer-term projects or shorter-term projects? Would a decline (or an increase) in the WACC cause changes in the IRR ranking of mutually exclusive projects? Explain.

Answer 1

11-1

capital budgeting process is planning process of analyzing the capital project before making investment. this analysis use initial investment, cost fo capital life of project and future cash flow from project.

Various project classifications used in the capital budgeting process are mention below:

1. Net present value method

2. Internal rate of return method

3. Modified Internal rate of return method

4. Payback period method

5. Discounted payback method

6. Profitability index method.

11-2

Payback period method

Payback period is easy to calculate method for capital budgeting.

three potential flaws with the regular payback method is mention below:

1. It does not consider discounting factor

2. It does not consider cash flow flows after payback period