Explain why you agree or disagree with each of the following statements. Tom bel

Question

Explain why you agree or disagree with each of the following statements. Tom believes all noncash expenses should be ignored when making capital budgeting decisions because they have no impact on cash flows. Jonathan is offered two mutually exclusive choices: invest $1 today and receive $2 one year from today, or invest $10 today and receive $13 one year from today. The IRR for choice #1 is 100%, while the IRR for choice #2 is 30%. Jonathan believes both are great deals as the required rate of return is 10%. He likes choice #1 due to its higher IRR. If real options exist, traditional NPV may understate the true NPV of an investment. Two firms have the same asset beta (B_a) and tax rate but different equity betas. The firm with the higher equity beta must employ more financial leverage. The "feasible set" and "efficient set" differ because the feasible set consists of all possible portfolios of assets, whereas the efficient set includes only those portfolios which maximize expected return for any given level of volatility (assume the risk-free rate does not exist).

Explanation / Answer

a) Non cash expense like depreciation has to be considered whil taking capital budgeting decisions. This has to be added back becuase inital investment is recovered through Depreciation only.

b) Yes I agree with this statment, becuase the amount is getting double within a year and thus IRR is 100% . This project is more profitable.

c) Yes if real option exist traditional NPV may understate the true NPV of an investment. because traditional NPV is claulcated on the bsis of assumed required rate of return.

d) No, it is necssary akways the case the firm with high equity beta would employ more financial levrage.

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