Question

Conduct a comparative analysis of the capital budgeting process for new projects versus replacement decisions. The objective is to maximize shareholder wealth.

Question:

Utilize the analysis to predict project success/failure in terms of shareholder wealth and other relevant factors. For example, if the net present value of a project is positive, then the project should be undertaken and the expected result will be that shareholder wealth will increase upon the announcement and execution of the project.

Answer 1

The capital budgeting decisions can be used for different predictions which are as follows-

A. When the internal rate of return is higher than overall cost of capital of the company, it means that the project is to be accepted as it would increase the the overall wealth of the shareholders, as the cost is lower than the benefits which is attributed to the company.

B. if the payback period is lower, it means that project is yielding benefits in quicktime, and it is also breaking even in quicktime, so it will add to the overall project benefits and shareholders value in quicktime.

C.if the profitability index is greater than 1, it means that the project is to be accepted because the cash inflows of the projects are higher than cash outflows and it will mean that it will add to shareholders wealth in the long run

D. If Net present value of the project is positive, it means that it will add to the shareholders wealth and if it is negative, it means that the project is not to be accepted because the cost is higher.