From a financial manager’s perspective, discuss the capital-budgeting process used to identify projects that add to the firm’s value? How do capital-budgeting decisions help to define a firm’s strategic direction?
When two mutually exclusive projects are being compared, explain why the short-term project might be higher ranked under the NPV criterion if the cost of capital is high; whereas, the long-term project might be deemed better if the cost of capital is low. Would changes in the cost of capital ever cause a change in the IRR ranking of two such projects? Explain.
Assignment -Unit 5
Problem (9-10)The earnings, dividends, and stock price of Shelby Inc. are expected to grow at 7% per year in the future. Shelby’s common stock sells for$23 per share, its last dividend was $2.00, and the company will pay a dividend of$2.14 at the end of the current year.
a. a. Using the discounted cash flow approach, what is its cost of equity?
b. If the firm’s beta is 1.6, the risk-free rate is 9%, and the expected return on the market is 13%, then what would be the firm’s cost of equity based on the CAPM approach?
c. c. If the firm’s bonds earn a return of 12 %, then what would be your estimate of rs using the over-own-bond-yield-plus-judgmental-risk-premium approach? (Hint: Use the midpoint of the risk premium range.)
d. On the basis of the results of parts a through c, what would be your estimate of Shelby’s cost of equity?
Problem (10-1) a project has an initial cost of $40,000 expected net cash inflows of $90,00 per year for 7 years, and a cost of capital of 11%. What is the project’s NPV? (hint: Begin by constructing a time line).
(10-2) Refer to problem 10-1. What is the project’s IRR?
(10-3) Refer to problem 10-1. What is the project’s MIRR?
(10-4) Refer to problem 10-1. What is the project’s PI?
(10-5) Refer to problem 10-1. What is the project’s payback period?
(10-6) Refer to problem 10-1. What is the project’s discounted payback period?
(10-7) Your division is considering two investment projects, each of which requires an up-front expenditure of $15 million. You estimate that the investments will produce the following net cash flows:
Year….Project A…………. Project B
1……… $5,000,000……….. $20,000,000
2……… $10,000,000……… $10,000,000
3……… $20,000,000……… $6,000,000
a. What are the two projects’ net present values, assuming the cost of capital is 5%, 10%, and 15%?
b. what are the two projects’ IRR at these same costs of capital?