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    Capital Budgeting Choices

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    Some capital-budgeting choices require managers to decide between upgrading high-technology research equipment and not upgrading.

    Respond to the following questions:

    1. How would financial managers at a drug manufacturing company use discounted-cash-flow models in their decision-making process?

    2. If the equipment is not replaced, what would be the impact on future operating cash flows used in the model?

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    Solution Preview

    1. The distinguishing characteristic of the discounted cash flow capital budgeting techniques is that they take into consideration time value of money while evaluating the costs and benefits of a project. In one form or other these methods require cash flows to be discounted at a certain rate called the cost of capital. The discount rate used is generally the appropriate Weighted average cost of capital (WACC), that reflects The discount rate reflects two things:
    The time value of money (risk-free rate) -investors would rather have cash immediately than having to wait and must therefore be compensated by paying for the delay.
    A risk premium - reflects the extra return investors demand because they want to be compensated for the risk that the cash flow might not materialize after all.
    An ...

    Solution Summary

    The solution discusses capital budgeting choices.