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Capital budgeting and estimating cash flows

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1. What are the pros and cons of the decision rules for the NPV, the IRR, the MIRR, and the payback methods? Which is the most accurate method and why?

2. What are sunk costs? Should they be included in the cash flow estimation when making a capital budgeting decision? Why or why not?

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a) Net Present Value (NPV)
Pros:
- It considers time value of money
- It accommodates different risk levels over the projects lifetime
- Can tell if the investment will increase the firms value
- It considers all cash flows

Cons:
- It is difficult to compare projects that are not similar
- Requires the estimate of the cost of capital in order to compute net present value
- It is expressed in terms of the currency (dollars) and not in percentages

Internal Rate of Return (IRR)
Pros:
- It considers the time value of money
- It allows comparisons of projects that are not similar
- Can tell if the investment will increase the firms value
- Considers all cash flows of the project

Cons:
- Does not reflect varying risk levels over ...

$2.19
See Also This Related BrainMass Solution

Capital Budgeting - Estimating Cash Flow

Every company has capital projects.

- Verizon wireless is building a data center in Niagara County NY. The initial investment breaks down like this:
- Land and utilities, $60 million.
- Estimated building cost, $500 million.
- Phase 1 equipment, 2011-13, $640 million.
- Phase 2 equipment, 2014-15, $800 million.
- Phase 3 equipment, 2016-21, $2 billion.
- Equipment maintenance and miscellaneous, $500 million.

Once you have identified the new possible investment item, what problems are you going to have in estimating the cash flow that might be emanating from the initial investment and problems in getting it funded? Issues might be:

Risk
Cost
Politics (getting it through committees)
Public Relations

Write a short summary of the problems you see in getting the funding to see it through.

It must discuss both the estimates of the initial investments and the annual incremental after-tax cash flow that is expected to emanate from the investment.

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