Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows.
The CFO also made subjective risk assessments of each project, and he concluded that both projects have risk characteristics that are similar to the firm’s average project. Allied’s WACC is 10%.
You must determine whether one or both of the projects should be accepted.
a. What is capital budgeting? Are there any similarities between a firm’s capital budgeting decisions and an individual’s investment decisions?
b. What is the difference between independent and mutually exclusive projects? Between projects with normal and non-normal cash flows?
c.
1. Define the term net present value (NPV). What is each project’s NPV?
2. What is the rationale behind the NPV method? According to NPV, which project(s) should be accepted if they are independent? Mutually exclusive?
3. Would the NPVs change if the WACC changed? Explain.
d.
1. Define the term internal rate of return (IRR). What is each project’s IRR?
2. How is the IRR on a project related to the YTM on a bond?
3. What is the logic behind the IRR method? According to IRR, which project(s) should be accepted if they are independent? Mutually exclusive?
4. Would the projects’ IRRs change if the WACC changed?
