1     Explain why the cost of capital is referred to as the “hurdle” rate in capital budgeting.

2     a.   A company is building a new plant on the outskirts of Smallesville. The town has offered to donate the land, and as part of the agreement, the company will have to build an access road from the main highway to the plant. How will the project of building the road be classified in capital budgeting analysis?

b.   Sykes, Inc., is considering two projects: a plant expansion and a new computer system for the firm’s production department. Classify these projects as independent, mutually exclusive, or contingent projects and explain your reasoning.

c.   Your firm is currently considering the upgrading of the operating systems of all the firm’s computers. The firm can choose the Linux operating system that a local computer services firm has offered to install and maintain. Microsoft has also put in a bid to install the new Windows operating system for businesses. What type of project is this?

3     In the context of capital budgeting, what is “capital rationing”?

4 Provide two conditions under which a set of projects might be characterized as mutually exclusive.

5 a. A firm invests in a project that would earn a return of 12 percent. If the appropriate cost of capital is also 12 percent, did the firm make the right decision. Explain.

b. What is the impact on the firm if it accepts a project with a negative NPV?

6  Identify the weaknesses of the payback period method..

7     What are the strengths and weaknesses of the accounting rate of return (ARR) approach?

8     Under what circumstances might the IRR and NPV approaches have conflicting results?

9     The modified IRR (MIRR) alleviates two concerns with using the IRR method for evaluating capital investments. What are they?

10. Elkridge Construction Company has an overall (composite) cost of capital of 12 percent. This cost of capital reflects the cost of capital for an Elkridge Construction project with average risk. However, the firm takes on projects of various risk levels. The company experience suggests that low-risk projects have a cost of capital of 10 percent and high-risk projects have a cost of capital of 15 percent. Which of the following projects should the company select to maximize shareholder wealth?

1.      Why capital investments are considered the most important decisions made by a firm’s management?

2.     What are the differences between capital projects that are independent, mutually exclusive, and contingent?

3.     What is the NPV of a project?

4.   If a firm accepts a project with a $10,000 NPV, what is the effect on the value of the firm?

5.     What are the five steps used in NPV analysis?

6.   The five-step process used in the NPV analysis can be listed as follows:

7.   What is the payback period?

8.  Why does the payback period provide a measure of a project’s liquidity risk?

9.   What are the main shortcomings of the payback method?

10.   What are the major shortcomings of using the ARR method as a capital budgeting method?

11.  What is the IRR method?

12.  In capital budgeting, what is a conventional cash flow pattern?

13.   Why should the NPV method be the primary decision tool used in making capital investment decisions?

14.   What changes have taken place in the capital budgeting techniques used by U.S. companies?