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Finance Questions Npv Irr Pi

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Running head: FINANCE QUESTIONS 1

Finance Questions

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FINANCE QUESTIONS 2

Finance Questions

1. Why should the cost of capital used in capital budgeting be calculated as a weighted

average of the various types of funds the firm uses, not the value of the specific financing

used to fund a particular project?

Calculation of cost of capital used in capital budgeting is done using a weighted average

as opposed to specific financing cost for a given project because a company may be financed by

use of different types of financing. Various methods can be applied when financing such as by

use of bonds, or stocks. Considering a company may have received varying amounts of funding

from multiple sources, there lacks uniformity since one source may have provided more funding

compared to another. A weighted average will, therefore, be a useful tool in such cases as it helps

the organization know how much it would cost it to raise the funds that it requires on things such

as inventory, and other equipment.

2. Should capital budgeting decisions be made solely on the basis of project’s NPV?

Capital budgeting decision should not only depend on the projects Net Present Value

(NPV) this is because NPV depends on several assumptions and estimates which may breed

some error in the analysis. The estimated variables include things like the costs of investment,

the discount rates and expected returns. A normal scenario when it comes to businesses is that

various unforeseen expenses have to be incurred during different phases of operations, by only

relying on NPV investors may rely on deceptive information and make the wrong choice (Liu

and Wu, 1990). Other tools can be used for more accuracy such as the Payback Period and the

Internal Rate of Return (IRR). A Payback Period will give a much more straightforward analysis,

but the drawback is that it is restricted to a specified period which is the amount of time when the

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Running head: FINANCE QUESTIONS 1 Finance Questions Name Institution Instructor Date FINANCE QUESTIONS 2 Finance Questions 1. Why should the cost of capital used in capital budgeting be calculated as a weighted average of the various types of funds the firm uses, not the value of the specific financing used to fund a particular project? Calculation of cost of capital used in capital budgeting is done using a weighted average as opposed to specific financing cost for a given project because a company may be financed by use of different types of financing. Various methods can be applied when financing such as by use of bonds, or stocks. Considering a company may have received varying amounts of funding from multiple sources, there lacks uniformity since one source may have provided more funding compared to another. A weighted average will, therefore, be a useful tool in such cases as it helps the organization know how much it would cost it to raise the funds that it requires on things such as inventory, and other equipment. 2. Should capital budgeting decisions be made solely on the basis of project’s NPV? Capital budgeting decision should not only depend on the projects Net Present Value (NPV) this is because NPV depends on several assumptions and estimates which may breed some error in the analysis. The estimated variables include things like the costs of investment, the discount rates and expected returns. A normal scenario when it comes to businesses is that various ...
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