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We use WACC as discount rate to find the present value of fu

-We use WACC as discount rate to find the present value of future cash flows emerging from a project, so it is of immense importance to calculate the correct WACC.

And you are also aware that if the WACC is incorrect it may lead to serious consequences.

Could you expand on this?

2-If a firm decides it will only fund projects with a specific high rate of return what might happen to the risks and cost of funds for the firm over time?

3-Why would a company focus on short term cash inflows and use the payback method as a capital project decision-making tool?

4- Why would the payback method still be used frequently in companies? Are there times when the payback method can be used effectively and for what types of projects?

5-If we consider how sunk costs relate to making business decisions, how do sunk costs figure into incremental analysis?

6-Can anyone think of examples of how we make use of sensitivity analysis in our job functions and decision-making?

7-In thinking of how our organizations approach new project decision-making, what process is used? What types of tools are used to evaluate projects and are there guidelines used for expected returns?

8- Using a SWOT analysis is a good part of the strategic planning process. Once a list of potential projects are selected is there a means of forecasting financial results through the use of payback, IRR, MIRR, or NPV?

Solution Preview

-We use WACC as discount rate to find the present value of future cash flows emerging from a project, so it is of immense importance to calculate the correct WACC.
And you are also aware that if the WACC is incorrect it may lead to serious consequences.
Could you expand on this?

The WACC used for capital budgeting purposes is the firm's marginal, after-tax cost of capital. When a company calculates the WACC incorrectly, the valuation of the project or other analysis used in the capital budgeting is also incorrect. The WACC calculation itself is a measure of the cost of capital based on proportion that includes multiple components, such as stocks, bonds, and debt. Because the WACC increases the rate of return, an increased WACC causes a decrease in valuation and an increase in risk. If the WACC is incorrectly calculated, it will erroneously increase or decrease the risk, based on which way the WACC was calculated in error. This can then lead to even more problems, because decisions are being made off the rate of return and the risk involved, both of which are erroneous, due to the improper WACC calculation. In addition, further financing decisions are made based on the firm's current WACC. The firm analyzes this information, combined with other financial information, to determine if additional capital should be financed through equity or through debt. If the WACC is incorrect, it will also lead to errors in the decision making process for additional capital, and will waste both time and resources in having to recalculate the WACC to the correct numbers.

2-If a firm decides it will only fund projects with a specific high rate of return what might happen to the risks and cost of funds for the firm over time?

If the company is only funding projects with only a specific high rate of return, over time the company will spend more money. The cost of funds will automatically be higher, because the firm is only funding projects with a high rate of return, and not funding projects that have a lower risk, and a better chance for a return on investment. In general, whether it's an individual investing in a project or financial asset, or a business investing in a capital project or financial asset, the riskier the investment is, and the greater the chances that the firm or individual will lose money. If the company is only putting their money into high-risk projects, the firm's money is not generating the return that it could, on the low and medium risk projects. Although the cost of funds may be less in many instances for the high rate of return, the chances of payout are diminished. By tying up the firm's money, it is costing the firm more in funds because of their selective process being so stringent. The firm is not allowing their money to make money, and over time, the investors will likely begin to pull out due to the aggressive decision-making that the firm is using, in which case the firm will have less capital to work with, for projects. The firm ...

Solution Summary

We use WACC as discount rate to find the present value of future cash flows emerging from a project, so it is of immense importance to calculate the correct WACC.

And you are also aware that if the WACC is incorrect it may lead to serious consequences.

Could you expand on this?

2-If a firm decides it will only fund projects with a specific high rate of return what might happen to the risks and cost of funds for the firm over time?

3-Why would a company focus on short term cash inflows and use the payback method as a capital project decision-making tool?

4- Why would the payback method still be used frequently in companies? Are there times when the payback method can be used effectively and for what types of projects?

5-If we consider how sunk costs relate to making business decisions, how do sunk costs figure into incremental analysis?

6-Can anyone think of examples of how we make use of sensitivity analysis in our job functions and decision-making?

7-In thinking of how our organizations approach new project decision-making, what process is used? What types of tools are used to evaluate projects and are there guidelines used for expected returns?

8- Using a SWOT analysis is a good part of the strategic planning process. Once a list of potential projects are selected is there a means of forecasting financial results through the use of payback, IRR, MIRR, or NPV?

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