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    Project classification scheme & reinvestment rate assumption

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    13-2 How is a project classification scheme (for example, replacement, expansion into new markets, and so forth) used in the capital budgeting process?

    13-3 Explain why the NPV of a relatively long-term project, defined as one for which a high percentage of its cash flows are expected in the distant future, is more sensitive to changes in the cost of capital than is the NPV of a short-term project.

    13-4 Explain why, if two mutually exclusive projects are being compared, the short-term might have the higher ranking under the NPV criterion if the cost of capital is high, but the long-term project might be deemed better it the cost of capital is low. Would changes in the cost of capital ever cause a change in the IRR ranking of two such projects?

    13-5 In what sense is a reinvestment rate assumption embodied in the NPV, IRR and MIRR method? What is the assumed reinvestment rate of each method?

    13-12 Your company is considering two mutually exclusive projects, X and Y, whose costs and cash flows are shown below:

    Year X Y
    0 (1,000) (1,000)
    1 100 1,000
    2 300 100
    3 400 50
    4 700 50

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    Solution Preview

    Please see the attached files.

    13-2 How is a project classification scheme (for example, replacement, expansion into new markets, and so forth) used in the capital budgeting process?
    The capital budgeting used project classification schemes to formulate policies and help consitency in project evaluation. It is used to:
     How much analysis is required to evaluate a particular project type
     The approving authority for such projects for investment within the firm
     The risk class for such project
     The cost of capital to be used to evaluate such project
    Thus it helps in consistency in project appraisals and approvals.

    13-3 Explain why the NPV of a relatively long-term project, defined ...

    Solution Summary

    This post answers five short questions in corporate finance area on capital investment analysis. This post can be used as a good practice to clear certain conceptual issues on investment analysis.

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