Part 5
Long-Term Investment Decisions
Chapters in This Part
Chapter 10 Capital Budgeting Techniques
Chapter 11 Capital Budgeting Cash Flows and Risk Refinements
Chapter 10
Capital Budgeting Techniques
Instructor Resources
Chapter Overview
This chapter is the first of three dealing with long-term investment decisions; the focus is on the basics of
capital budgeting. The discussion begins with an overview of the capital-budgeting process and then moves to
a detailed exploration of the three approaches to project evaluation—Payback Period, Net Present Value
(NPV), and Internal Rate of Return (IRR). After reviewing the pros and cons of each approach, the chapter
concludes by endorsing the NPV method—noting that it is more closely aligned with a financial-manager’s
goal of maximizing shareholder wealth.
Answers to Review Questions
10-1 The financial manager’s goal is to maximize shareholder wealth. To do so, she should accept all long-
term investment projects that add to shareholder wealth (and, hence, boost the firm’s stock price). The
capital-budgeting process comprises five distinct but interrelated steps to translate potential
10-2 The payback period is the time necessary for project cash inflows to cover the firm’s initial dollar
investment. When annual cash inflows are constant, payback period in years is calculated by dividing
10-3 Weaknesses of payback-period criterion for capital budgeting include (1) lack of a firm connection to
10-4 Net present value (NPV) is the sum of the present values of all relevant cash outflows and inflows
10-5 Under the NPV method, the firm should accept a project if its NPV > 0, and reject a project if its
NPV < 0, reject. NPV is the also the specific dollar amount an investment project will add (or, if
202 Zutter/Smart • Principles of Managerial Finance Brief, Eighth Edition
Suggested Answer to Focus on Ethics Box:
“Baby You Can Drive My Car—Just Not a VW Diesel”
What role did VW’s desire to be the world’s largest automaker play in the emissions scandal?
The U.S.offers the world’s largest auto market but also the world’s toughest emission standards. VW could
not surpass Toyota without increasing U.S. market share, which required meeting U.S. emission standards.
The public commitment of the CEO to industry leadership by 2018 put enormous pressure of firm’s engineers
to find a way to make certain U.S.-bound diesel cars were environmentally friendly. When internal testing
showed the cars were not, those engineers used an “end around” so as not to interfere with the CEO’s goal.
What role did insider succession play in the scandal?
E10-1 Payback period
E10-2 NPV
