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MGAB03H3 Chapter Notes -Nominal Interest Rate, Risk Premium, Tax Shield

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lavenderdonkey6
9 Jan 2011
School
UTSC
Department
Financial Accounting
Course
MGAB03H3
Professor
Liang Chen

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Document Summary

Relevant cash flows (a) develop or expand products or services (b) decision to replace or reorganize assets, products, or services. Present value of a series of cash flows. N profitability index and npv method always accept and reject the same project, but index allows managers to rank order projects it provides a simple way to identify which projects are expected to earn higher returns. N the payback method has some important disadvantages. N it does not incorporate tvm future cash flows are not discounted to reflect opportunity cost of using funds for other projects. N this method does not value the cash flows that are received after the investment has been recovered. N in addition, it imposes an arbitrary cut-off period, which favours projects with shorter payback periods. N however, the payback method is used extensively as it is easy to calculate and easy to understand.

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Related Questions

PLEASE HELP WITH A RESPONSE TO THE POST BELOW. Thank you :)

  1. How do we traditionally define capital budgeting infinance?
  • Capital budgeting is a technique used in Finance by companiesto evaluate and rank the investment projects. These are the largeexpenditure projects including the purchase of plant and equipment,investment in new business, construction of buildings etc.
  1. What is the purpose of capital budgeting in the business firm,and how is it used?
  • Capital budgeting calculation involves cash flows withconversion into time value of money and arriving at a profit. Thereare several methods used for evaluating capital budgeting projects.Payback period method, Net present value method, internal rate ofreturn method and profitability index. All of these methods help amanager to analyze and select the projects based on profitabilityand returns. It is used to help the managers in arriving atinvestment decisions compared with the cost of capital. They alsogive the knowledge of time period within which cash outflows willbe returned. Large businesses rely on NPV and IRR to takeinvestment decisions. This technique provides a real return valuefor a business rather than just calculating the profits.Traditional accounting involves making decisions based on profitswithout considering the time value of money. Capital budgetingtechnique helps the manager to take decisions with present valuesof future returns.

For most of us, a capital budgeting decision would be buying a house, which is a purchase with a long-term investment. For organizations, long-term investments can be acquiring another company, building a larger factory, developing a new product line, etc. Think of a company you’ve heard about recently that has revealed their next capital budgeting decision. What is that decision?

  1. Review the types of assumptions used in sensitivity andscenario analysis. Describe how the options to expand or abandon aproject are integrated in the capital budgeting process. Explainhow decision trees are used to value investment alternatives.