Describe how income taxes affect the cash flows of a strategic investment.
12.2 Suppose a company has five different capital budgeting projects from which to choose, but has constrained funds and
cannot implement all of the projects. Explain why comparing the projects’ NPVs is better than comparing their IRRs.
12.3 Describe the pros and cons of each of the capital budgeting methods learned in this chapter: (a) net present value, (b)
internal rate of return, (c) payback, and (d) accrual accounting rate of return.
12.4 When projects have longer lives, it is more difficult to accurately estimate the cash flows and discount rates over the life
of the project. Explain why this statement is true.
12.5 If a firm has unlimited funds, what quantitative criterion should be used to determine which projects to invest in?
12.6 An international firm requires a rate of return of 15% domestically and in developed countries, but 25% in less–
developed countries. Does this requirement mean that the firm is exploiting the less–developed countries?
12.7 When we learned CPV analysis in Chapter 3, we calculated the amount of pretax profit needed to achieve a given level of
after–tax profit. We could calculate a pretax rate of return given an after–tax rate of return. Why would it be inappropriate to use a pretax discount rate in capital budgeting? (For example, if a firm requires an after–tax return of 10% and has a
marginal income tax rate of 50%, why not use a 20% pretax rate of return and ignore the separate income tax
calculations?)
12.8 A well–known clinic in the Midwest operates as a not–for–profit organization. Typical capital expenditure decisions
involve acquiring equipment that will perform medical tests beyond those currently possible at the clinic (hence, adding
revenues) and/or perform tests more efficiently than currently (hence, decreasing expenses). To evaluate such
expenditures, the clinic uses a discount rate equal to the return on its investment trust portfolio. Explain, briefly, why
they do so.
12.9 As the time period for an NPV analysis gets longer, what happens to each incremental present value factor? Refer to a
present value chart. At 15% interest, beyond what year do the discount factors get so small that very little value is added
by annual incremental cash flows?
12.10 Refer to the present value of an annuity table. As the time period in an analysis using annuity factors gets longer, what
happens to each incremental factor? Explain why this is different from the changes for present value factors.
12.11 Explain why top managers might establish the following types of boundaries for strategic investment decisions made by
subordinates: (1) required rate of return, (2) types of capital projects to consider, and (3) maximum capital budget that
can be spent without top management approval.
12.12 Why is the terminal value of an asset adjusted for income taxes before it is discounted?
12.13 (Appendix 12A) The present value of a given cash flow gets smaller as the number of periods gets larger, regardless of
whether cash flow is discounted with a real rate or nominal rate. Explain why this relationship happens and what it
means from an economic perspective.
12.14 (Appendix 12A) Two methods can be used to incorporate the effects of inflation or deflation into an NPV analysis. In your
own words, explain how a nominal discount rate is different from a real discount rate. Why are analyses using the
nominal approach potentially more accurate than those using the real approach?
12.15 (Appendix 12A) How might inflation influence a decision to acquire an asset now rather than later?
