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Finance: capital budgeting, cost of capital, issuing bonds, dividend policy, M&A

CORPORATE FINANCE. Eighth edition from: Ross. Westerfield. And Jaffe.
ISBN 978-0-07-310590-1
MHID 0-07-310590-2
Part of
ISBN 978-0-07-333718-0
MHID 0-07-333718-8

Please answer each of the following questions using the short answer format. The ideal responses for each question will be free of writing errors and must include academically valid course material citations in APA format to link responses to text concepts. Include a Reference page.

1. Explain the use of at least two financial decision-making techniques utilized in capital budgeting. What are at least one strength and weakness of each technique? The response may include the lease-versus-buy decision.

2. Select one approach to arriving at the cost of capital as it relates to the optimal capital structure of the corporation. Provide the rationale as to why this approach is applicable in certain situations.

3 Describe the similarities and differences in issuing bonds and stocks into the primary market.

4 Provide at least two different rationales with respect to an organization's dividend policy.

5 When do the following make sense for an organization and when do they not make sense (mergers, acquisition, and bankruptcy)?

Solution Preview

Answer 1:
In the financial world there are many decisions which the finance manager has to take on short term and long term projects of the organization. Every dollar invested in the organization has a cost attached to it and therefore it is very important to analyze every project which the firm has to maximize the return on the investment and this analysis is referred to as capital budgeting. Following are some of the financial decision-making techniques utilized in capital budgeting:
 Net Present Value Analysis (NPV) : The net present value analysis shows the difference between the present value of all cash inflows and cash outflows and to ascertain whether the net amount is positive or negative. Since the cost of capital is used to compute the present value this analysis also shows whether the project will be able to yield the minimum return equal to cost of capital.
Strength: One of the biggest advantages is that this method measures whether the firm's value will increase / decrease with the undertaking of the project
Weaknesses: One of the most important elements is cost of capital. Estimating true cost of capital is a big challenge and therefore the NPV computed may be wrong.
 Payback Period1: Payback period is computed to determine how many years will the project require for return of the initial investment. In case there are constant inflows and there is only one outflow at the beginning of the project, the payback period will be (Cost of the Project / Annual cash Flows). In case the inflows are not equal each year, excel formulas or hit and trial methods are used to compute payback period.
Strength: This is easy to compute and also provide some idea about the risk involved in the project.
Weaknesses: This technique ignores any benefits that occur after the payback period and, therefore, does not measure ...

Solution Summary

The expert explains the use of at least two financial decision-making techniques utilized in capital budgeting. One approach to arriving at the cost of capital as it relates to the optimal capital structure of a corporation is determined.

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