Your boss, the chief financial officer (CFO) for Southern Textiles, has just handed you the estimated...

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Finance

Your boss, the chief financial officer (CFO) for Southern Textiles,has just handed you the estimated cash flows for two proposedprojects. Project L involves adding a new item to the firm’s fabricline. It would take some time ti build ip the marketnfie thisproduct, sonthe cash inflows woukd increase over time. Project Sinvolves an add-on to an existing line, and its cash flows woulddecrease over time. Both projects have 3-year lives becauseSouthern is planning to introducenan entirely new fabric at thattime.
Here are the net cash flow estimates (in thousands ofdollars):

Expectes Net Cash Flows
Year. Project L. Project S
0. $(100). $(100)
1. 10. 70
2. 60. 50
3. 80. 20

The CFO also made subjective risk assessments of each project,and he concluded that the projects both have risks characteristicsthat are similar to the firms average project. Southern’s requiredrate of return is 10%. You must now determine whether one or bothof the projects should be accepted. Start by answering thefollowing questions:
a. What is capital budgeting? Are there any similitariesbetween a firm’s capital budgeting decisions and individual’sinvestment decisions?
b. What is the difference between independent and mutuallyexclusive projects? Between projects with conventional cash flowsand projects with unconventional cash flows?
c. (1) Whatnisnthe payback period? Findnthe traditionalpayback measure? According to the payback criterion, which projector projects should be accepted if the firm’s maximum acceptablepayback is two years and Project L and Project S are independent?Mutually exclusive?
(3) What is the differencenbetweenbthe traditional payback andthe discounted payback? What is each project’s discountedpayback?
(4) What are the main disadvantages of the traditionalpayback? Is the payback method of any real usefulness in capitalbudgeting decisions?
d. (1) Define the term net present value (NPV). What is eachproject’s NPV?
(2) What is the rationale behindnthe NPV method? According toNPV, which project or projects should be accepted if they areindependent? Mutually exclusive?
(3) Would the NPVs changenifnthe requirednratenof returnchanged?

Answer & Explanation Solved by verified expert

3.9 Ratings (413 Votes)

a Capital budgeting is a strategic allocation process in which a company identifies potential investment opportunities assembles the proposed investments and then make decisions In simple words capital budgeting is that process which a firm undertakes so as to be able to evaluate different projects in which it can make investments Yes there are similarities between a firms capital budgeting decisions and individuals investment decisions In both cases the investments are ranked as per preset criteria and the funds are parked in those investments that will lead to maximum benefits or greatest returns b Independent projects are those projects whose cash flows have no impact on the acceptance or rejection of other projects Projects are mutually exclusive if acceptance of any one of the See Answer

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Your boss, the chief financial officer (CFO) for Southern Textiles,has just handed you the estimated cash flows for two proposedprojects. Project L involves adding a new item to the firm’s fabricline. It would take some time ti build ip the marketnfie thisproduct, sonthe cash inflows woukd increase over time. Project Sinvolves an add-on to an existing line, and its cash flows woulddecrease over time. Both projects have 3-year lives becauseSouthern is planning to introducenan entirely new fabric at thattime.Here are the net cash flow estimates (in thousands ofdollars):Expectes Net Cash FlowsYear. Project L. Project S0. $(100). $(100)1. 10. 702. 60. 503. 80. 20The CFO also made subjective risk assessments of each project,and he concluded that the projects both have risks characteristicsthat are similar to the firms average project. Southern’s requiredrate of return is 10%. You must now determine whether one or bothof the projects should be accepted. Start by answering thefollowing questions:a. What is capital budgeting? Are there any similitariesbetween a firm’s capital budgeting decisions and individual’sinvestment decisions?b. What is the difference between independent and mutuallyexclusive projects? Between projects with conventional cash flowsand projects with unconventional cash flows?c. (1) Whatnisnthe payback period? Findnthe traditionalpayback measure? According to the payback criterion, which projector projects should be accepted if the firm’s maximum acceptablepayback is two years and Project L and Project S are independent?Mutually exclusive?(3) What is the differencenbetweenbthe traditional payback andthe discounted payback? What is each project’s discountedpayback?(4) What are the main disadvantages of the traditionalpayback? Is the payback method of any real usefulness in capitalbudgeting decisions?d. (1) Define the term net present value (NPV). What is eachproject’s NPV?(2) What is the rationale behindnthe NPV method? According toNPV, which project or projects should be accepted if they areindependent? Mutually exclusive?(3) Would the NPVs changenifnthe requirednratenof returnchanged?