Chapter 10 Solution-Corporate Finance

CHAPTER 10

Project Analysis

8. We assume that the idea for a new obfuscator machine originates with a plant manager in the Deconstruction Division. (Keep in mind however that, in addition to bottom-up proposals, such as the obfuscator machine proposal, top-down proposals also originate with divisional managers and senior management.) Other steps in the capital budgeting process include the following:

• Many large firms begin the process with forecasts of economic variables, such as inflation and GDP growth, as well as variables of particular interest to the industry, such as prices of raw materials and industry sales projections.

• The plant manager, often in consultation with the division manager, prepares the proposal in the form of an appropriation request; the appropriation request typically includes an explanation of the need for the expenditure, detailed forecasts, discounted cash flow analysis and other supporting detail such as sensitivity analysis.

• Depending on the size of the investment, the appropriation request is reviewed and approved by the divisional manager, senior management or, in the case of major expenditures, the board of directors.

• The forecast expenditure is included as part of the annual capital budget, which is approved by top management and the board of directors.

• Major cost over-runs typically require a supplementary appropriation request, which includes an explanation of the reason why the additional expenditure was not anticipated.

• When the machine is finally up and running, most firms conduct a postaudit to identify problems and to assess forecast accuracy; the main purpose of the postaudit is to improve the process in the future.

9. a.

[pic]

= $2,584.67

[pic]$7,560

b. [pic] $2,110.19

[pic]$1,000

c. The 18% discount rate would give an approximation to the correct NPVs for projects with all (or most) of the inflows...