PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
expand_more
expand_more
format_list_bulleted
Concept explainers
Videos
Textbook Question
Chapter 9, Problem 18PS
Fudge factors John Barleycorn estimates his firm’s after-tax WACC at only 8%. Nevertheless, he sets a 15% companywide discount rate to offset the optimistic biases of project sponsors and to impose “discipline” on the capital budgeting process. Suppose Mr. Barleycorn is correct about the project sponsors, who are, in fact, optimistic by 7% on average. Explain why the increase in the discount rate from 8% to 15% will not offset the bias.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions.
Consider the case of Blue Hamster Manufacturing Inc.:
Blue Hamster Manufacturing Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Sigma’s expected future cash flows. To answer this question, Blue Hamster’s CFO has asked that you compute the project’s payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year.
Complete the following table and compute the project’s conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.)
Year 0
Year 1
Year 2
Year 3
Expected cash flow
-$6,000,000
$2,400,000
$5,100,000…
Hardchoice Corp. is a firm considering prospective capital budgeting projects. Selected data on the projects follow: Image attached
1b) Ignoring the information in question (1a), assume instead that projects A and C are independent, Hardchoice is subject to capital rationing (i.e., it may not be able to afford both projects), and the relevant discount rate is 10%.
a) What is the IRR of Project A? Project C?
b) How would you rank Project A compared to Project C?
Pls show formula used.
Final dollar answers should be rounded to two decimal places. Interest rate answers should be rounded to 6 decimal places if expressed as a decimal or 4 decimal places if expressed as a percent.
Use timeline if necessary. No excel .Thanks!
All parts are under 1 questions, therefore per your policy all parts can be answered.
6. The payback period
The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions.
Consider the case of Blue Hamster Manufacturing Inc.:
Blue Hamster Manufacturing Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Delta’s expected future cash flows. To answer this question, Blue Hamster’s CFO has asked that you compute the project’s payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year.
A. Complete the following table and compute the project’s conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in…
Chapter 9 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 9 - (VAR.P and STDEV.P) Choose two well-known stocks...Ch. 9 - (AVERAGE, VAR.P and STDEV.P) Now calculate the...Ch. 9 - (SLOPE) Download the Standard Poors index for the...Ch. 9 - Definitions Define the following terms: a. Cost of...Ch. 9 - True/false True or false? a. The company cost of...Ch. 9 - Company cost of capital Quark Productions (Give...Ch. 9 - Company cost of capital The total market value of...Ch. 9 - Company cost of capital You are given the...Ch. 9 - Company cost of capital Nero Violins has the...Ch. 9 - WACC A company is 40% financed by risk-free debt....
Ch. 9 - WACC Binomial Tree Farms financing includes 5...Ch. 9 - Prob. 10PSCh. 9 - Measuring risk The following table shows estimates...Ch. 9 - Prob. 12PSCh. 9 - Asset betas Which of these projects is likely to...Ch. 9 - Asset betas EZCUBE Corp. is 50% financed with...Ch. 9 - Prob. 15PSCh. 9 - Prob. 16PSCh. 9 - Prob. 17PSCh. 9 - Fudge factors John Barleycorn estimates his firms...Ch. 9 - Prob. 19PSCh. 9 - Prob. 20PSCh. 9 - Certainty equivalents A project has a forecasted...Ch. 9 - Certainty equivalents A project has the following...Ch. 9 - Prob. 23PSCh. 9 - Beta of costs Suppose that you are valuing a...Ch. 9 - Fudge factors An oil company executive is...
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Green Caterpillar Garden Supplies Inc.: Green Caterpillar Garden Supplies Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Alpha’s expected future cash flows. To answer this question, Green Caterpillar’s CFO has asked that you compute the project’s payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year. Complete the following table and compute the project’s conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.) Year 0 Year 1 Year 2 Year 3 Expected cash flow -$4,500,000…arrow_forwardThe payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cute Camel Woodcraft Company: Cute Camel Woodcraft Company is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Sigma's expected future cash flows. To answer this question, Cute Camel's CFO has asked that you compute the project's payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year. Complete the following table and compute the project's conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.) Expected cash flow Cumulative cash flow Conventional payback period: $ Cash flow Discounted cash flow Cumulative…arrow_forwardThe payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cute Camel Woodcraft Company: Cute Camel Woodcraft Company is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Alpha’s expected future cash flows. To answer this question, Cute Camel’s CFO has asked that you compute the project’s payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year. Complete the following table and compute the project’s conventional payback period. Round the conventional payback period to two decimal places. For negative values, be sure to include a minus sign in your answer. For full credit, complete the entire table. Year 0 Year 1 Year 2 Year 3 Expected cash flow -4,500,000 $1,800,000 $3,825,000 $1,575,000 Cumulative cash flow year0? year1?…arrow_forward
- The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cute Camel Woodcraft Company: Cute Camel Woodcraft Company is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Sigma's expected future cash flows. To answer this question, Cute Camel's CFO has asked that you compute the project's payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year. Complete the following table and compute the project's conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.) Expected cash flow Cumulative cash flow Conventional payback period: $ Year 0 -$5,000,000 years Year 1 $2,000,000 Year…arrow_forwardThe payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cold Goose Metal Works Inc.: Cold Goose Metal Works Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Beta’s expected future cash flows. To answer this question, Cold Goose’s CFO has asked that you compute the project’s payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year. Complete the following table and compute the project’s conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.) Year 0 Year 1 Year 2 Year 3 Expected cash flow -$4,500,000 $1,800,000 $3,825,000 $1,575,000…arrow_forwardSuppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4-year payback regardless of economic conditions. Other things held constant, which of the following statements is most likely to be true? O It will accept too many long-term projects and reject too many short-term projects (as judged by the NPV). O The firm will accept too many projects in all economic states because a 4-year payback is too low. O The firm will accept too few projects in all economic states because a 4-year payback is too high. O If the 4-year payback results in accepting just the right set of projects under average economic conditions, then this payback will result in too few long-term projects when the economy is weak. O It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV).arrow_forward
- The WACC is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that the WACC is an appropriate discount rate only for a project of average risk. Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. It has a before-tax cost of debt of 8.2%, and its cost of preferred stock is 9.3%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 12.4%. However, if it is necessary to raise new common equity, it will carry a cost of 14.2%. A. If its current tax rate is 25%, how much higher will Turnbull’s weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the…arrow_forwardThe WACC is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that the WACC is an appropriate discount rate only for a project of average risk. Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. It has a before-tax cost of debt of 8.2%, and its cost of preferred stock is 9.3%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 12.4%. However, if it is necessary to raise new common equity, it will carry a cost of 14.2%. If its current tax rate is 25%, how much higher will Turnbull’s weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds…arrow_forward. The payback period The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cold Goose Metal Works Inc.: Cold Goose Metal Works Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Delta’s expected future cash flows. To answer this question, Cold Goose’s CFO has asked that you compute the project’s payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year. Complete the following table and compute the project’s conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.) Year 0 Year 1 Year 2 Year 3 Expected cash flow -$6,000,000…arrow_forward
- 6. The payback period The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Green Caterpillar Garden Supplies Inc.: Green Caterpillar Garden Supplies Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Alpha's expected future cash flows. To answer this question, Green Caterpillar's CFO has asked that you compute the project's payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year. Complete the following table and compute the project's conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.) Expected cash flow Cumulative cash flow Conventional payback period:…arrow_forwardThe WACC is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that the WACC is an appropriate discount rate only for a project of average risk. Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. It has a before-tax cost of debt of 8.2%, and its cost of preferred stock is 9.3%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 12.4%. However, if it is necessary to raise new common equity, it will carry a cost of 14.2%. If its current tax rate is 25%, how much higher will Turnbull’s weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds…arrow_forwardThe payback period The payback method helps firms establish and identify a maximum acceptable payback period that helps in their capital budgeting decisions. Consider the case of Cold Goose Metal Works Inc.: Cold Goose Metal Works Inc. is a small firm, and several of its managers are worried about how soon the firm will be able to recover its initial investment from Project Delta’s expected future cash flows. To answer this question, Cold Goose’s CFO has asked that you compute the project’s payback period using the following expected net cash flows and assuming that the cash flows are received evenly throughout each year. Complete the following table and compute the project’s conventional payback period. For full credit, complete the entire table. (Note: Round the conventional payback period to two decimal places. If your answer is negative, be sure to use a minus sign in your answer.) Year 0 Year 1 Year 2 Year 3 Expected cash flow -$6,000,000…arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
Capital Budgeting Introduction & Calculations Step-by-Step -PV, FV, NPV, IRR, Payback, Simple R of R; Author: Accounting Step by Step;https://www.youtube.com/watch?v=hyBw-NnAkHY;License: Standard Youtube License