The Finance Director of Kawabwa Construction plc recently overhauled the control system and designed a new method of assessing capital investments that applies the NPV rule to all new investment proposals and will assess performance of current of investments by the same method. He has created a report that will go to the board of directors monthly. This will give an NPV estimation to the cash flows produced and expected by each investment, and CFO plans to use this as a signaling device on the performance of all investments. This, he claims, will introduce rigour into the whole use of capital process. The Chairman ventured the opinion that this approach was a receipt for disaster. Why do you think he felt this way?

The Finance Director of Kawabwa Construction plc recently overhauled the control system and designed a new method of assessing capital investments that applies the NPV rule to all new investment proposals and will assess performance of current of investments by the same method. He has created a report that will go to the board of directors monthly. This will give an NPV estimation to the cash flows produced and expected by each investment, and CFO plans to use this as a signaling device on the performance of all investments. This, he claims, will introduce rigour into the whole use of capital process. The Chairman ventured the opinion that this approach was a receipt for disaster. Why do you think he felt this way?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter11: Capital Budgeting And Risk

Section: Chapter Questions

Problem 28P

See similar textbooks

Similar questions

The management of Ryland International Is considering Investing in a new facility and the following cash flows are expected to result from the investment: A. What Is the payback period of this uneven cash flow? B. Does your answer change if year 6s cash inflow changes to $920,000?
The management of Kawneer North America is considering investing in a new facility and the following cash flows are expected to result from the investment: A. What is the payback period of this uneven cash flow? B. Does your answer change if year 10s cash inflow changes to $500,000?
Understanding the IRR and NPV The net present value (NPV) and internal rate of return (IRR) methods of investment analysis are interrelated and are sometimes used together to make capital budgeting decisions. Consider the case of Blue Hamster Manufacturing Inc.: Last Tuesday, Blue Hamster Manufacturing Inc. lost a portion of its planning and financial data when both its main and its backup servers crashed. The company’s CFO remembers that the internal rate of return (IRR) of Project Delta is 11.3%, but he can’t recall how much Blue Hamster originally invested in the project nor the project’s net present value (NPV). However, he found a note that detailed the annual net cash flows expected to be generated by Project Delta. They are: Year Cash Flow Year 1 $1,800,000 Year 2 $3,375,000 Year 3 $3,375,000 Year 4 $3,375,000 The CFO has asked you to compute Project Delta’s initial investment using the information currently available to you. He has offered the…
You are the investment manager of an appliance company. The industry is currently in the expansion face and the CEO would like to capture as much of the market share as possible. You asked your analysts to submit project proposals as summarized below. Project Discount Rate Investment Annual Cash Flow Project Life (Years) 10 3M 1M 5 12 4M 1M 8 8 5M 2M 4 8 3M 1.5M 3 12 3M 1M 6 Which projects should the manager choose? If you were given unlimited capital, which projects should be implemented? ABCDE
QUESTION 2. management whether it should be accepted or rejected. The weighted average cost of capital (WACC) of the firm is Evaluate the following investment project according to the internal rate of return and advise the 21%. Year Cash Outflows Year Cash Inflows 250.000,00 1 1 100.000,00 2 150.000,00 3 1.250.000
The CEO asked you to take charge of the following projects for the company. However, he told you that because of the limited funds available, you have to pursue the projects one at a time. Using the profitability index, decide on which of the projects you are going to accomplish first, second, and third. Project 1 requires an initial investment of P500,000, will provide future cash inflow of P1,300,000, and present value of the future cash inflow of P850,000. Project 2 requires an initial investment of P1,000,000, will provide future cash flow of P3,000,000, and present value of the future cash flow is P1,550,000 Project 3 requires an initial investment of P1,500,000, will provide future cash flow of P5,000,000 and the present value of the future cash flow is P2,835,000.
The management of Que-B Bhd is targeting to accumulate funds to finance its projects. The strategy is to keep several portfolios with the specific intention to obtain the gains if the value of the investment appreciates in the future. Security portfolios I and Il are held at the end of Que-B Bhd's first year of operations and are shown in the following table: Year-End Security Cost Market Value RM36,000 RM39,000 || RM17,000 RM20,000 d) As soon as adjusting the securities' values to their corresponding market values, Que-B Bhd elects to reclassify Security I as an FVTOCI security. On the date of the transfer, security l's market value is RM19,000. i. Explain how this should be accounted for by Que-B Bhd. ii. Show the relevant journal entries.
Question 2: A-Rod Manufacturing Company is trying to calculate its cost of capital for use in making a capital budgeting decision. Mr. Jeter, the vice president of finance, has given you the following information and has asked you to compute the weighted average cost of capital. The company currently has outstanding a bond with a 10.6 percent coupon rate and another bond with an 8.2 percent rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 11.5 percent. The common stock has a price of $65 and an expected dividend (D1) of $1.50 per share. The historical growth pattern (g) for dividends is as follows: $1.40 1.54 1.69 1.85 Compute the historical growth rate, round it to the nearest whole number, and use it for g The preferred stock is selling at $85 per share and pays a dividend of $8.50 per share. The corporate tax rate is 25 percent. The flotation cost is 2.6 percent of the selling price for preferred stock. The…
Your firm is evaluating a capital budgeting project. The estimated cash flows appear below. The board of directors wants to know the expected impact on shareholder wealth. Knowing that the estimated impact on shareholder wealth equates to net present value (NPV), you use your handy calculator to compute the value. What is the project's NPV? Assume that the cash flows occur at the end of each year. The discount rate (i.e., required rate of return, hurdle rate) is 12.9%. (Round to nearest penny) Year 0 cash flow -96,000 Year 1 cash flow 48,000 Year 2 cash flow 47,000 Year 3 cash flow 31,000 Year 4 cash flow 38,000 Year 5 cash flow 19,000
Your firm is evaluating a capital budgeting project. The estimated cash flows appear below. The board of directors wants to know the expected impact on shareholder wealth. Knowing that the estimated impact on shareholder wealth equates to net present value (NPV), you use your handy calculator to compute the value. What is the project's NPV? Assume that the cash flows occur at the end of each year. The discount rate (i.e., required rate of return, hurdle rate) is 15.4%. (Round to nearest penny) Year O cash flow Year 1 cash flow Year 2 cash flow Year 3 cash flow Year 4 cash flow Year 5 cash flow Answer: -113,000 45,000 34,000 58,000 33,000 35,000
The management of Que-B Bhd is targeting to accumulate funds to finance its projects. The strategy is to keep several portfolios with the specific intention to obtain the gains if the value of the investment appreciates in the future. Security portfolios I and II are held at the end of Que-B Bhd’s first year of operations and are shown in the following table: Year-End Security Cost Market Value I RM36,000 RM39,000 II RM17,000 RM20,000 a) Provide the necessary journal entries to record the adjustments of the securities portfolios to market value.
In Management Accounting, there are some investment appraisal methods to analyse the performance of investment projects. The following table lists out the financial data of two projects for London Technology Ltd: Projects/Methods A B Payback Period 2 year and 4 months 2 year and 9 months Accounting Rate of Return 27.6% 15.44% Net Present Value £23,040 £21,798 Required: Which project should company accept? In the discussion, please explain which method can lead to better decision.