1. You have been asked to make a short presentation at your company’s annual cap
ID: 2758811 • Letter: 1
Question
1. You have been asked to make a short presentation at your company’s annual capital budget meeting to present an analysis of the strengths and weaknesses of the following capital budgeting selection methodologies: NPV, payback, IRR. Describe how you would respond to this request at the meeting.
2. The senior executives were impressed with your presentation on capital budgeting methodologies. They have asked you to present a follow up discussion regarding the company’s weighted average cost of capital (WACC). Specifically, they want to know how it is calculated and, most importantly, how it should be used. Discuss your responses.
Explanation / Answer
NPV:Advantages : 1) it considers all cash flows 2) its true measure of profitability 3) it is based on the concept of the time value of money 4) NPV satisfies the value additivity principle 5) this method is consistent with wealth maximisation principle
Disadvantages: 1) the estimation of cash flows is a tideous work 2) it is sensitive to discount rates
PAYBACK PERIOD:Advantages 1) easy to understand and compute 2) Emphasises Liquidity 3) easy to cope with risk 3) uses cash flow information
Disadvantages: 1) it ignores the time value of money and also ignores the cash flows after payback perio.2) it is not measure of profitability 3) no relation to wealth maximisation principle
IRR: ADv.1) considers all cash flows 2) True measure of profitability 3) it is based on the concept of the tme value of money 4) generally consistent with wealth maximisation principle
Dis adv:1) working with cashflows a tedious task 2) does not hold the value additivity principle 3) sometimes failes to indicat correct choice between mutually exclusive projects 4) relatively difficult to compute
WACC: once the costs of various sources of funds calculated ,they are multiplied by the weights of the various sources of funds to obtain a weighted cost of capital.
By taking an weighted average cost of capital we can determine that how much intrest a copmany owes for each dollar it finances.
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