The Objective of Capital Budgeting
Chapter 12 Questions
1. What is the objective of capital budgeting?
2. 9. How is the weighted average cost of capital determined?
19. Why does the use of real options improve capital investment analysis? Under
which circumstances would you recommend using real options?
Chapter 13 Questions
5. A U.S. importer purchases a currency option. If the foreign currency does not
rise to the strike price, what should the importer do?
9. Why should a government be concerned with the pricing of products that a
company transfers to an affiliate in another country?
Problem 1
The Great Computer Company, a US corporation, has a subsidiary in the
Netherlands. It is deciding whether to invest $2 million of its (the parent)
funds in a 3-year project in the Netherlands.
The after tax cash flows to the subsidiary are estimated to be as follow (in
euros):
___________________________________
Year 1 500,000
Year 2 800,000
Year 3 900,000
The entire cash flows of the subsidiary are remitted to the parent annually.
There is no additional tax (nor credit) in the parent country.
The exchange rate today is 1/$1.20. The exchange rate forecast for the next 3
years is the following
Year 1 1/$1.15
Year 2 1/$1.10
Year 3 1/$1.05
The cost of capital for both the parent and the subsidiary is 13 percent.
a. What is the NPV of this project to the Netherlands subsidiary?
b. What is the NPV of this project to the U.S. parent?
c. Should the project be accepted?
Chapter 14 Questions
1. What is the rationale for government involvement in the market economy? (Cite
the five points presented at the outset of this chapter.)
5. “The reason the government has to step in and internalize benefit and
cost externalities is because people are basically selfish. Do you agree with
this statement? Explain.
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