24 Jul WHAT IS ITS INTERNAL RATE OF RETURN?
s been 2 months since you took a position as an assistant financial analyst at Caledonia Products Show more Its been 2 months since you took a position as an assistant financial analyst at Caledonia Products. Although your boss has been pleased with your work he is still a bit hesitant about unleashing you without supervision. Your next assignment involves both the calculation of the cash flows associated with a new investment under consideration and the evaluation of several mutually exclusive projects. Given your lack of tenure at Caledonia you have been asked not only to provide a recommendation but also to respond to a number of questions aimed at judging your understanding of the capital- budgeting process. The memorandum you received outlining your assignment follows: To: The Assistant Financial Analyst From: Mr. V. Morrison CEO Caledonia Products Re: Cash Flow Analysis and Capital Rationing We are considering the introduction of a new product. Currently we are in the 34 percent marginal TAX BRACKET with a 15 percent required rate of return or cost of capital. This project is expected to last 5 years and then because this is somewhat of a fad product be terminated. The information at the bottom of page 376 describes the new project a. Should Caledonia focus on cash flows or accounting profits in making its capital- budgeting decisions? Should the company be interested in incremental cash flows incremental prof-its total free cash flows or total profits? b. How does depreciation affect free cash flows? c. How do sunk costs affect the determination of cash flows? d. What is the projects initial outlay? e. What are the differential cash flows over the projects life? f. What is the terminal cash flow? g. Draw a cash- flow diagram for this project. h. What is its net present value? i. What is its internal rate of return? j. Should the project be accepted? Why or why not? k. In capital budgeting risk can be measured from three perspectives. What are those three measures of a projects risk? l. According to the CAPM which measurement of a projects risk is relevant? What complications does reality introduce into the CAPM view of risk and what does that mean for our view of the relevant measure of a projects risk? m. Explain how simulation works. What is the value in using a simulation approach? n. What is sensitivity analysis and what is its purpose? Show less
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