Which of the following is least likely to cause a problem when analyzing a capital budgeting project? A) Using standardized templates to analyze capital projects considered by a firm. B) Basing investment decisions on the impact on earnings per share. C) Incorporating actions taken by competitors in the capital budgeting analysis. D) Using the firm’s weighted average cost of capital for the discount rate on all projects.
Agreed C it is
I would say D, because the question asks for the “least” liquely problem. How would you include actions taken by competitors?
D is wrong because in many cases you have to use Project specific WACC (Adj. WACC)
I say B. + NPV projects increase shareholder value (read: higher EPS) So I think using this as the ultimate basis for decisions is least likely to cause a problem. I could see C working if you use it as an opportunity cost… what is the right answer?
sterling76 Wrote: ------------------------------------------------------- > I say B. > > + NPV projects increase shareholder value (read: > higher EPS) > > So I think using this as the ultimate basis for > decisions is least likely to cause a problem. > > I could see C working if you use it as an > opportunity cost… what is the right answer? You do not “base” the decision on EPS results but that is an outcome of the positive NPV decision.
B is also wrong because it is strictly an accounting measure, in other words a project could lower near term EPS due to large near term depreciation charges, however this would actually be a good thing because of the tax savings.
dang - stupid words… So is it C because it is viewed as a valid opportunity cost (the cost of not doing something your competitor is)?
If your major competitors are adopting some technology…like say UPC scanners…you’d definitely have to take that into consideration when running an NPV on whether you should install them (just ask Kmart) as quicker checkout could potentially lure your customers over the competitors.
Conversely, for C another reason competitors need to be taken into account is perhaps more importantly their REACTION. If you impliment a successful project that you believe will yield high profit margins, you have to consider competitor reaction in determining how long those high profits will last. If you have a great new successful project, it will be a short matter of time before your competitors catch on, impliment it themselves, and squeeze your future cash flows and profit margins.
^^yup…on the flipside of my comment - ask Walmart.
I’m no Corp Finance god, but I say A. A) As long as the template has the flexibility to accomodate things like expansion or abandonment options, WACC and its components, current debt-to-equity ratio, and NPV, it could be a good starting point. B) Short term EPS may not look good for a positive NPV project C) Competitors could have a completely different set of circumstances so the best decision for them probably has nothing to do with me. This is without considering who has a comparative advantage at the project. D) you should use the required rate of return for the project, which can be found from the company’s beta or preferably the project-specific beta. B,C, and D all seem to problematic but A doesn’t necessarily have any problems. It certainly could though if the template is flawed from the beginning.
The books specifically cites A as a potential problem.
it’s definitely not A Read carefully it says “standardized templates” - that itself is a reason for a big No No… You cannot use the same template - because each project has it’s own unique attributes and just making small adjustments within the template will not necessarily give you a true picture…
Yes they all are potential problems. But (A) seems to me to be the LEAST likely to cause a problem. What would make this problem more clear is if they had more detailed descriptions of each of the choices. Based on the way I read the question, I choose A. But depending on the specifics of choice C, I might choose that. Applying the same sort of analysis might not be bad as long as your competitors’ analysis is sound. What is the right answer by the way?
Black Swan Wrote: ------------------------------------------------------- > Conversely, for C another reason competitors need > to be taken into account is perhaps more > importantly their REACTION. If you impliment a > successful project that you believe will yield > high profit margins, you have to consider > competitor reaction in determining how long those > high profits will last. If you have a great new > successful project, it will be a short matter of > time before your competitors catch on, impliment > it themselves, and squeeze your future cash flows > and profit margins. BS is correct - GOOD WORK!
as are several others…