Question 12 10 pts Part 3 Next you attend an investment committee where your boss, the Chief Executive Office (CEO), and other executives meet to discuss capital budgeting. The investment committee is evaluating the profitability indexes (PI) of the projects the firm is considering. Based on Pl only, which project would be the most profitable relative to the projects cash outlay? Project PI 1 .98 2 1.98 3 1.00 4 2.34 O4 03 0 1 O2 Question 13 10 pts Part 3 Next you attend an investment committee where your boss, the Chief Executive Office (CEO), and other executives meet to discuss capital budgeting. The investment committee reviews two projects that are mutually exclusive. The CEO notices that one project has a higher NPV and the other a higher IRR. The CEO wants your opinion on which project should be chosen: Project A Project B NPV +2,450,000 +1,230,000 IRR 9% 13% Neither project should be chosen because the discount rate (WACC) is likely higher than the IRRs. O NPV should be the deciding factor and project A should be chosen. IRR should be the deciding factor and project B should be chosen. Both projects should be chosen. Question 14 10 pts Part 3 Next you attend an investment committee where your boss, the Chief Executive Office (CEO), and other executives meet to discuss capital budgeting. The committee begins discussing the cost structure of a project. Three comments are made by various executives. Comment 1: If the project has high variable costs in relation to fixed costs, its accounting profits will be more sensitive to any change in revenues. Comment 2: If the project has high fixed costs, it will have a higher Degree of Operating Leverage (DOL) and its profits will be more sensitive to revenue changes. Comment 3: The project with a DOL of 1.73 is more risky than a project with a DOL of 5.23. Which comment is correct? Comment 1 O Comment 2 Comment 3 O All of the comments are correct. Question 15 10 pts Part 3 Next you attend an investment committee where your boss, the Chief Executive Office (CEO), and other executives meet to discuss capital budgeting. On one of the projects submitted for investment committee approval you notice that the cash flows look like this: Year o Year 1 Year 2 Year 3 Year 4 -10,245,000 +1,234,000 +5,350,000 -253,000 +25,000,000 What is the concern with these cash flows: We need the discount rate to solve for IRR. The project will definitely have a positive NPV since $25,000,000 in the future is more than the costs. There is no concern because the NPV is positive. O A change in sign more than once could produce an invalid IRR. Question 16 10 pts Part 3 Next you attend an investment committee where your boss, the Chief Executive Office (CEO), and other executives meet to discuss capital budgeting. A new finance intern was invited to experience how investments decisions are made for a firm. The intern notices that none of the projects include interest expense in the cash flow calculation. The intern wants to make an impression and points out the error in the cash flows. Without embarrassing the intern, you respond: If we included the interest expense we would be double counting the interest since we use debt cost of capital in the discount rate to value firm projects. You must have been asleep in your finance classes at ASU. O We only include interest expense when we have bank loans. The interest expense is accounted for in depreciation
