According to the theoretical framework presented, how is the optimal capital budget for a firm determined?
Explanation
The optimal capital budget is found at the intersection of the investment opportunity schedule (ranked by IRR) and the marginal cost of capital schedule (WACC). This is the point at which the firm has accepted all profitable projects, and the return on the last project accepted is equal to the cost of the funds used to finance it.
Other questions
What are real options, as distinguished from financial options?
Which of the following best describes the type of real option Anheuser-Busch (AB) utilized in its initial investments in South America?
A project is being considered without a growth option. It has a 50 percent probability of a 'Good' outcome with a Net Present Value (NPV) of 603,000 dollars and a 50 percent probability of a 'Bad' outcome with an NPV of negative 358,000 dollars. What is the project's expected NPV?
A project includes a growth option. The 'Good' outcome, with a 50 percent probability, has an NPV of 3,364,000 dollars. The 'Bad' outcome, also with a 50 percent probability, has an NPV of negative 358,000 dollars. What is the project's expected NPV with the growth option?
The expected NPV of a project without a growth option is 122,000 dollars. With the growth option, the expected NPV is 1,503,000 dollars. What is the value of this growth option?
What is an abandonment option in the context of capital budgeting?
A project without an abandonment option has three possible outcomes: a 'Best Case' with a 25 percent probability and an NPV of 1,348,000 dollars; a 'Base Case' with a 50 percent probability and an NPV of 298,000 dollars; and a 'Worst Case' with a 25 percent probability and an NPV of negative 1,888,000 dollars. What is the project's expected NPV?
A project with an abandonment option has the following outcomes: 'Best Case' (NPV 1,348,000 dollars, 25 percent probability), 'Base Case' (NPV 298,000 dollars, 50 percent probability), and an abandoned 'Worst Case' (NPV negative 1,089,000 dollars, 25 percent probability). The original worst case is no longer possible. What is the new expected NPV?
If a project's expected NPV without an abandonment option is 14,000 dollars and its expected NPV with the abandonment option is 214,000 dollars, what is the value of the abandonment option?
How does incorporating an abandonment option into a project analysis typically affect the project's expected NPV and its perceived risk?
What is an investment timing option?
A project, if undertaken today, has a 50 percent chance of an NPV of 1,804,000 dollars and a 50 percent chance of an NPV of negative 1,919,000 dollars. What is the expected NPV of this project?
A firm has the option to delay a project for one year to learn about market conditions. If conditions are good (50 percent probability), the project will have an NPV of 339,000 dollars. If conditions are bad (50 percent probability), the firm will not invest, resulting in an NPV of 0 dollars. What is the expected NPV of the project with the timing option, as of today?
A project has an expected NPV of negative 58,000 dollars if undertaken today. If the firm has a timing option to wait one year, the expected NPV increases to 170,000 dollars. What is the value of this investment timing option?
What is a potential disadvantage or trade-off a firm faces when it decides to delay a project by exercising an investment timing option?
A flexibility option, such as the one used by BMW in its Spartanburg plant, permits a firm to do what?
In the graphical analysis of the optimal capital budget, what does the IRR schedule represent?
What is capital rationing?
Which of the following is a primary purpose of performing a post-audit on a capital project?
A firm is considering a project with an initial cost of 25,000 dollars and a WACC of 12 percent. Without abandonment, there is a 25 percent chance of a 'Best Case' outcome with an NPV of 18,233 dollars, a 50 percent chance of a 'Base Case' outcome with an NPV of 3,822 dollars, and a 25 percent chance of a 'Worst Case' outcome with an NPV of negative 44,215 dollars. What is the project's expected NPV without the abandonment option?
What is a major challenge or complication associated with the post-audit process?
Which of the following is NOT one of the five major types of real options listed in the chapter?
Singh Development Co. is evaluating Project X, which costs 11 million dollars. There's a 50 percent chance of a 'Good' outcome (annual after-tax cash flows of 7 million dollars for 3 years) and a 50 percent chance of a 'Bad' outcome (annual after-tax cash flows of 1 million dollars for 3 years). The company's WACC is 9 percent. What is the project's expected NPV, considering no other options?
Marble Construction has a WACC of 10 percent from retained earnings. It will exhaust retained earnings at 2,500,000 dollars of capital. The firm is considering several independent projects: A (Cost 650k, IRR 14.0 percent), B (Cost 1,050k, IRR 13.5 percent), C (Cost 1,000k, IRR 11.2 percent), and D (Cost 1,200k, IRR 11.0 percent). What is the company's optimal capital budget?