LSU questions
MBA702 Spring 2024, AP1 PRACTICAL APPLICATION 2 8. Discussion (No outside sources required all necessary information has been presented in Module 4 in Moodle) a) Using what you have learned in the lecture notes and having just analyzed each of the projects using the four key capital budgeting techniques, describe the reinvestment assumptions for each of the methods. (2 pts) Hint, the reinvestment rate assumptions have to do with how (if) the cash flows are discounted during analysis. i. NPV ii. IRR iii. Profitability Index (PI) iv. Payback period b) For an independent project, which of the capital budgeting analysis techniques will always have the accept/reject decision, and why. Be precise in your explanation of “why” the techniques would agree. Hints: Keep it simple, don’t go down the “but what if…..” road. Independent projects – accepting one doesn’t mean you have to reject another one. Don’t assume financial constraints (you could theoretically fund all viable projects). Assume “normal” cash flows (only 1 sign change in other words, the outlay is considered negative and all future cash flows are positive), so that there is only a single IRR. (2 pts) c) How would a change in the required rate of return affect the project’s calculated internal rate of return (IRR)? Explain. Would the accept/reject decision change using the IRR analysis method? Explain. (2 pts) d) Think about changes that happen in a project once it has been accepted and moving forward. Here are 3 potential scenarios. For each, describe what you expect to happen to a project’s expected NPV, and WHY that is your expectation. (2 pts for each of the following). As MBA students, just being able to calculate NPV isn’t sufficient. You should be able to consider what the effects of various market or project changes on the project’s viability. LOOK AT EACH SITUATION INDIVIDUALLY AND ASSUME THAT THERE ARE NO OTHER CHANGES FOR THE FIRM. 1 MBA702 Spring 2024, AP1 PRACTICAL APPLICATION 2 i. Your firm has a project with lower risk than your firm’s “regular” project. The project has been tentatively accepted for development, assuming a required rate of return of 13%. That required rate of return was estimated one year ago, before the FED began its interest rate hikes. The risk free rate has increased by 2.5% from that used in the original projection. ii. Due to a (lucky) miscalculation by the marketing folks, demand for your project’s products has increased in the early years of the project, but that “stole” sales from future years. The same total inflows were achieved, but the timing was more front-loaded than anticipated. iii. Once construction began on the project, a rare black-footed ferret was found nearby. Environmental groups have demanded that the project halt operations for 9 months while the ferrets are found and relocated. Once the ferrets were moved, operations continued as originally planned, but with all cash flows shifted out by 12 months. e) Your firm is looking at three mutually exclusive projects. Describe how you would decide which project(s) to accept, be very clear on which capital budgeting techniques you would use and how you make your decision. (2 pts) The lecture notes cover this one, review as needed. 2
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