Reading 29: Capital Budgeting-LOS g 习题精选 capital, following, budgeting, class

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Session 8: Corporate Finance
Reading 29: Capital Budgeting

LOS g: Discuss common capital budgeting pitfalls.

 

 

Which of the following is most likely to cause a problem when evaluating a capital budgeting project?

A) Including overhead costs in the total cost of a capital project.

B) Avoiding the use of IRR when evaluating mutually exclusive projects.

C) Taking on the pet projects of management without going through the complete capital budgeting process.

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Pet projects that influential managers want the company to invest in will ideally receive the same scrutiny received by other investments. Another potential concern with management’s pet projects is that overly optimistic projections will make the project appear more profitable than it really is. Note that using IRR for mutually exclusive projects will tend to steer management toward smaller, short term projects with high IRRs and may not lead management to the same decision as the more appropriate NPV method. Overhead costs are often difficult to estimate, but should be included in the cost of a capital project.

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Which of the following is least likely to cause a problem when analyzing a capital budgeting project?

A) Incorporating actions taken by competitors in the capital budgeting analysis.

B) Using the firm’s weighted average cost of capital for the discount rate on all projects.

C) Basing investment decisions on the impact on earnings per share.

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One of the common pitfalls when analyzing capital projects is not incorporating economic responses from competitors. Economic responses to an investment often affect profitability.

Note that managers who make decisions based on short-term EPS considerations may fail to consider projects that do not boost accounting numbers in the short-run, but are in the best long term interests of the business. The discount rate for a project should be adjusted for the project’s risk.