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Financial Management: Theory and Practice Chapter 10 Minicase

1125 words
5 pages

The Basics of Capitol Budgeting: Evaluating Cash Flows

Mini Case

a. Capital budgeting is the process of analyzing projects and determining which ones to accept and include in the capital budget.

b. Independent projects are ones that can both be accepted without either affecting the other. Mutually exclusive projects are ones that if one is accepted the other must be rejected.

c.

1. The net present value is the projects present value of inflows minus its cost. It shows us how much the project contributes to the shareholders wealth. The NPV of each franchise are: a. NPV of Franchise L – $17.08 (In thousands) b. NPV of Franchise S – $18.17 (In thousands) 2. The rationale behind the NPV method is
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Also the MIRR eliminates the multiple IRR problem. Since their can only be one MIRR it can be easily compared to cost of capital. Against the NPV the MIRR’s disadvantage is that the NPV more accurately shows how to maximize value for a project. h. The profitability index measure the relative profitability of any project by showing the present value per dollar of initial cost. The PI for Franchises L and S are: 1. PI for Franchise L – 1.19 2. PI for Franchise S – 1.20 i. 1. The payback period is the number of years required to recover the funds invested in a project. The payback periods for Franchises L and S are: a. Payback Period for Franchise L – 2.38 b. Payback Period for Franchise S – 1.60 2. The rationale behind the payback period method is that this method shows which project will take longer to pay for itself. If the maximum payback is 2 years Franchise S should be selected for both if they are independent or mutually exclusive because Franchise L has a payback of higher than 2 years. 3. Discounted payback is where the cash flows are discounted at the WACC and then the cash flows are used to determine the payback period. 4. The main disadvantage of discounted payback is that it disregards cash flows past the payback year. The payback methods are useful in that they provide information on liquidity and risk.

j. 1. Normal cash