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Applying Capital Budgeting and Risk Evaluation

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In choosing a particular project, there is a lot of financial planning that must take place. In the Marine Corps, we also use a planning process in developing plans for appropriate action. This process consists of six parts: problem framing, the course of action development, the course of action war-gaming, the course of action comparison / decision, orders development and transitioning.

- During the problem framing stage, it is determined exactly what the problem is by gathering all required intelligence on the issue at hand and why it occurred.
- Next, it is on to course of action (COA) development, where a "think tank" comes up with an array of plans to solve the problem.
- After that, the team "war games" or experiments with the COA's, to determine the pros and cons of each.
- When complete, all findings are brought to the table and feasible solutions are discussed, thus resulting in COA revision/decision.
- Orders for the ways ahead are then established for the accomplishment of the objective and issued to the right personnel for the job.
- Lastly, during the transition phase members of the unit assigned the task to begin to prepare for the mission.
We can equate this process to a project manager's decision-making practice, in that there is a lot of information that is gathered and framed, planned, experimented with, compared, revised/decided upon, drafted and executed.

References:
MCWP 5-1, Marine Corps Planning Process retrieved from:
https://www.mca-marines.org/files/MCWP%205-1%20MCPP.pdf

Ross, S. Westerfield, R. and Jordan, B. (2013) Fundamentals of Corporate Finance standard edition 10th edition. McGraw-Hill/Irwin

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evaluation of capital budgets

1)
The managers of United Med tronics are evaluating the following four projects for the coming budget period. The firm's corporate cost of capital is 14 percent.
Project Cost IRR
A $20,000 17%
B $15,000 16%
C $12,000 15%
D $18,000 13%
a. What is the firm's optimal capital budget?
b. Now, suppose Medtronic's managers want to consider differential risk in the capital budgeting process. Project A has average risk, B has below-average risk, C has above-average risk, and D has average risk. What is the firm's optimal capital budget when differential risk is considered? (Hint: The firm's managers lower the IRR of high-risk projects by 3 percentage points and raise the IRR of low-risk projects by the same amount.)
c. Return to the original assumption that all projects have average risk. If United Medtronics are only approved for $30,000 towards their project budget, which project or projects would you accept? (Hint: Any money not used for a project will not receive any return).

2)
The MIT Whitehead Institute must choose between two cDNA microarray machines to expand their high-throughput genomic laboratory. Both of these machines have the same function, and the firm will only choose on vendor from which to purchase their machines.
The first machine, manufactured by Amersham Pharmacia (machine 1), will cost $250,000. The second machine, manufactured by PE Applied Bio systems (machine 2), will cost $200,000.
The cost of capital for both of these investments is 10%. The life for both machines is estimated to be 5 years. During this period, cash flows for machine 1 will be $80,000 per year and cash flows for machine 2 will be $65,000 per year. These cash flows include depreciation expenses. Calculate NPV and IRR for each machine and select the best choice for the MIT Whitehead Institute.

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