Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 10, Problem 1PS
Capital budgeting process True or false?
- a. The approval of a capital budget allows managers to go ahead with any project included in the budget.
- b. Capital budgets and project authorizations are mostly developed “bottom up.” Strategic planning is a “top-down” process.
- c. Project sponsors are likely to be overoptimistic.
Expert Solution & Answer
Summary Introduction
To discuss: Whether the given statements are true or false.
Explanation of Solution
a) The capital budget is not a complete sign-off for particular projects. Many of the firms need a correct request for individual project with a brief analysis.
Hence, option A is false.
b) The strategic planning needs to consider the alternatives. The project authorizations and capital budgets are generally developed “bottom up”. The strategic planning is a “top-down process”.
Hence, option B is true.
c) The sponsors of the project are mostly overoptimistic and the forecasts of the cash flow are often overstated.
Hence, option C is true.
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Case Study: Identifying Errors in Capital Budgeting Decisions
Introduction:
Capital budgeting decisions play a crucial role in the financial success of a company, impacting its long-term viability. Managers strive to make accurate and informed decisions when evaluating potential investment projects. However, errors can occur, and it is essential to implement effective procedures to identify and rectify these mistakes. This case study explores various procedures and their efficacy in identifying errors in capital budgeting decisions.
Background:
Company XYZ, a manufacturing firm, recently implemented a capital budgeting decision involving a significant investment in upgrading its production facilities. The decision-making process was intricate, considering factors such as projected cash flows, discount rates, and risk assessments. Despite thorough analysis, the management recognizes the importance of post-evaluation procedures to identify potential errors and enhance…
Budgeting is an important process as managerial decisions involving budgets may have far-reaching impacts on multiple levels within an organization. Hence, such decisions must be considered thoroughly before being implemented. For this forum, identify four reasons that capital budgeting decisions are risky. Ensure to justify your answer.
Which of the following statements is false?
A. Net incomes are not cash flows. Financial Managers should focus on the cash flows when making capital budgeting decisions.
B. Incremental earnings are the amount by which the firm's earnings are expected to change as a result of the investment decision.
C. To the extend that overhead costs are fixed and will be incurred in any case, they are not incremental to the project and should be excluded in the capital budgeting analysis.
D. Depreciation is not a cash expense paid by the firm.
E. None of the above.
Chapter 10 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 10 - Capital budgeting process True or false? a. The...Ch. 10 - Prob. 2PSCh. 10 - Prob. 3PSCh. 10 - Project analysis True or false? a. Sensitivity...Ch. 10 - Prob. 5PSCh. 10 - Real options True or false? a. Decision trees can...Ch. 10 - Prob. 7PSCh. 10 - Prob. 9PSCh. 10 - Prob. 10PSCh. 10 - Break-even analysis Break-even calculations are...
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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
- Which of the following is not a part of budgeting? A. planning B. finding bottlenecks C. providing performance evaluations D. preventing net operating lossesarrow_forwardWhich approach requires management to justify all its expenditures? A. bottom-up approach B. zero-based budgeting C. master budgeting D. capital allocation budgetingarrow_forwarda. Assume that all the division managers do overstate cash flow projections in their proposals. What would you do if you were recently promoted to division manager and had to compete for funding under these circumstances. What controls might be implemented to discourage the overstatement of capital budgeting estimates by division manager.arrow_forward
- BETTER FORECASTING FOR LARGE CAPITAL PROJECTSLarge capital investments that are completed on schedule and within their budgets are probably the exception rather thanthe rule—and even when completed many fail to meet expected revenues. Executives often blame projectunderperformance on foreseeable complexities and uncertainties having to do with the scope of and demand for the project,the technology or project location, or even stakeholder opposition. No doubt, all of these factors at one time or anothercontribute to cost overruns, benefit shortfalls, and delays.But knowing that such factors are likely to crop up, why do project planners, on average, fail to forecast their effect on thecosts of complex projects? We’ve covered this territory before but continue to see companies making strategic decisionsbased on inaccurate data. Deliberately or not, costs are systematically underestimated, and benefits are overestimatedduring project preparation—because of delusions or honest mistakes on…arrow_forwardWhich of the following is true of budgeting? a.Budgeting relies on the control cycle to design the planning cycle for future action. b.Budgeting eradicates the need for keeping a buffer against uncertainties in demand. c.Budgeting focuses only on long-term objectives as covered by the planning cycle. d.Budgeting forces management to plan for the future. e.Budgeting creates a plan of action only in terms of production units.arrow_forwardMultiple choice: Capital budgeting is the process of deciding whether or not to commit resources to projects with costs and benefits spread over several time periods. Capital budget is the same as operating budget. • Both statements are incorrect.• Only the second statement is correct.• Both statements are correct.• Only the first statement is correct.arrow_forward
- Using accrual accounting to evaluate the performance of a manager may create conflicts with the use of DCF methods for capital budgeting. Frequently, the decision made using a DCF method will not report good “operating income” results in the project’s early years under accrual accounting. For this reason, managers are tempted to not use DCF methods even though the decisions based on them would be in the best interests of the company as a whole over the long run. True False: Using accrual accounting to evaluate the performance of a manager cannot create conflicts with the use of DCF methods for capital budgeting. False: Frequently, the decision made using a DCF method will report good “operating income” results in the project’s early years under accrual accounting. False: managers consistently use DCF methods even though the decisions based on them would be in the worst interests of the company as a whole over the long run. B, C, and Darrow_forwardWhich of the following is NOT true of a task budget process for research? Multiple Choice Research costs can be covered by discretionary reserves of an organization. Research funds come from the manager’s own operating budget. Research costs can be covered by the operating budget of an in-house research operations. It is competitive; only well-advocated projects get funded. Internal politics sometimes prevent great research projects from getting funded.arrow_forward‘Budgeting has a number of different purposes including: Planning; Control; Performance evaluation; Motivation. Some managers believe that zero-based budget is more beneficial than other types of the budget for firms.’ Critically discuss the above statement with reference to academic literature. In your discussion, you should refer to the budgeting systems zero-based and incremental.arrow_forward
- Ethical Considerations. Budget projections always involve a degree of judgment because managers can neverpredict the future with total accuracy. For instance, onemanager with an optimistic view and another with apessimistic view could look at the same set of facts andarrive at distinctly different conclusions about the company’s financial prospects. When budgets will influencedecisions made by investors or lenders, how should thepeople who prepare the budgets deal with the variancebetween optimistic and pessimistic viewpoints? On theone hand, being too pessimistic could result in lowerlevels of funding, which could be detrimental to employees, existing investors, existing creditors, and otherfinancial stakeholders. On the other hand, being toooptimistic could be detrimental to prospective investors or creditors. How do you find the right balance?arrow_forwardb) ‘Budgeting has a number of different purposes including: Planning; Control; Performance evaluation; Motivation. Some managers believe that zero-based budget is more beneficial than other types of the budget for firms.’ Required: Critically discuss the above statement with reference to academic literature. In your discussion, you should refer to the budgeting systems you learned in this module.arrow_forwardThe capital budgeting is associated with Select one: a. None of the options b. Short term assets c. working capital d. Liabilities e. Loansarrow_forward
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