[Solution]FINANCIAL MANAGEMENT: Application of Investment Decision Techniques

The essence of capital budgeting and resource allocation is a search for good investments in which to place the firm’s capital. The process can be…

The essence of capital budgeting and resource allocation is a search for good investments in which to place the firm’s capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital-budgeting analyst, therefore, is necessarily a detective who must winnow good evidence from bad. Much of the challenge is in knowing what quantitative analysis to generate in the first place.
Suppose you are a new capital-budgeting analyst for a company considering investments in the seven projects listed in Exhibit 1. The chief financial officer of your company has asked you to rank the projects and recommend the “three best” that the company should accept.
In this assignment, only the quantitative considerations are relevant. No other project characteristics are deciding factors in the selection, except that management has determined that projects 4 and 5 are mutually exclusive.
All the projects are believed to be of the same risk class. The firm’s weighted-average cost of capital of the firm has never been estimated. In the past, analysts have simply assumed that 9 percent was an appropriate discount rate (although certain officers of the company have recently asserted that the discount rate should be much higher).
EXHIBIT 1 Project Free Cash Flows (UAE Dirhams in thousands)
Project number:
1
2
3
4
5
6
7
Year
0
(5,000)
(10,000)
(15,000)
(25,000)
(25,000)
(30,000)
(35,000)
1
1,000
1,000
1,700
1,000
11,000
(3,000)
(9,000)
2
1,000
2,000
1,700
1,200
10,000
10,000
(3,000)
3
1,000
2,000
1,700
3,000
9,000
9,000
6,000
4
800
3,000
1,700
4,000
8,000
6,000
6,000
5
800
3,000
1,700
5,000
7,000
6,000
8,000
6
700
4,000
1,700
6,000
6,000
6,000
12,000
7
600
4,000
1,700
7,000
5,000
4,500
12,000
8
600
2,000
1,700
8,000
4,000
4,500
14,000
9
500
2,000
1,700
9,000
3,000
3,000
14,000
10
500
2,000
1,700
11,000
(5,000)
3,000
14,000
Sum of cash-flow benefits
7,500
25,000
17,000
55,200
58,000
49,000
74,000
Excess of cash flow over initial investment
2,500
15,000
2,000
30,200
33,000
19,000
39,000
To stimulate your analysis, consider the following questions: 1. Can you rank the projects simply by inspecting the cash flows? 2. What criteria might you use to rank the projects? Which quantitative ranking methods are better? Why? (Brief explanation of various methods expected) 3. What is the ranking you found by using quantitative methods? Does this ranking differ from the ranking obtained by simple inspection of the cash flows?

Finally recommend the ‘three best’ that the company should accept (project 4 and 5 are mutually exclusive).
The post FINANCIAL MANAGEMENT: Application of Investment Decision Techniques

Assignment status: Solved by our experts

>>>Click here to get this paper written at the best price. 100% Custom, 0% plagiarism.<<<

Leave a Reply

Your email address will not be published. Required fields are marked *