Finance 3504

NPV the difference between an investment’s market value and its cost. how much value is created or added today by undertaking an investment
A project should be _____ when its NPV is greater than zero accepted
The three attributes of NPV are that it: 1. uses all the cash flows of a project2. uses cash flows3. discounts the cash flows properly
If the IRR is greater than _____ _____, we should accept the project. required return
IRR must be compared to the ____ in order to determine the acceptability of a project. required return
True or false: two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing true
When cash flows are conventional, NPV is ___ 1. Positive for discount rates below the IRR2. equal to zero when the discount rate equals the IRR3. negative for discount rates above the IRR
The decision making process for accepting and rejecting projects capital budgeting
The IRR is the discount rate that makes the NPV of a project equal to ___ zero
The profitability index is calculated by dividing the PV of the ____ cash flows by the initial investments future
What are the advantages of the payback period method for management? 1. The payback period method is easy to use2. the payback period method is ideal for short projects3. it allows lower level managers to make small decisions effectively
What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%? NPV=-$95+(107/1.06)=$5.94
Why can the payback period lead to incorrect decisions if it is used to literally? ignores cash flows after the cutoff date
In capital budgeting, the net ____ determines the value of a project to the company present value
What is the PI for a project with an initial cash outflow of $30 and a subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12%? =((80/1.12)+(20/1.12^2))/30=2.91
When cash flows are conventional, NPV is ____ if the discount rate is above the IRR negative
What are the weaknesses of the payback method? 1. Time value of money principles are ignored2. Cash flows received after the payback period are ignored3. the cutoff date is arbitrary
What are the weaknesses of the discounted payback period? 1. loss of simplicity as compared to the payback method2. exclusion of some cash flows3. arbitrary cutoff date
What capital budgeting method allows lower management to make smaller, everyday financial decisions effectively? payback method
One of the weaknesses of the payback period is that the cutoff date is a(n) ____ standard. arbitrary
For a project with normal cash flows, the NPV is ____ if the required return is less than the IRR, and it is ____ if the required return is greater than the IRR. positive, negative
NPV accounts for the size of the project and eliminates the effects of _____. scale
How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the project’s lifetime an increase in the size of the first cash inflow will decrease the payback period, all else held constant
If a project’s payback period is less than or equal to a particular cutoff date, the payback period rule suggests… accepting
What method differs from NPV because it evaluates a project by determining the time needed to recoup the initial investment payback method
According to the average accounting return rule, a project is acceptable if its average accounting return exceeds: a target average accounting return
Operating cash flow is a function of: taxes, EBIT, depreciation
Incremental cash flows come about as a(n) ____ consequence of taking a project under consideration direct
Using your personal savings to invest in your business is considered to have an ____ because you are giving up the use of these funds for other investments or uses, such as, a vacation or paying off a debt opportunity cost
Once cash flows have been estimated, which investment criteria can be applied to them? NPV, payback period, IRR
The difference between a firm’s current assets and its current liabilities is known as ____ net working capital
Identify the three main sources of cash flows over the life of a typical project: 1. net cash flows from sales and expenses over the life of a project2. net cash flows from salvage value at the end of the project3. cash outflows from investment in plant and equipment at the inception of the project
According to the _____ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a “minifirm.” stand-alone
Erosion will _____ the sales of existing products reduce
Side effects from investing in a project refer to cash flows from: 1. beneficial spillover effects2. erosion effects
The first step in estimating cash flow is to determine the ______ cash flows relevant
When evaluating cost-cutting proposals, how are operating cash flows affected? 1. there is an additional depreciation deduction2. the decrease in costs increases operating income
According to the top-down approach, what is the operating cash flow if sales are $200,000, total cash costs are $190,636, and the tax bill is $1,144? 200,000-190,636-1144= 8,220
What are considered to be relevant cash flows? 1. cash flows from erosion effects2. cash flows from beneficial spillover effects3. cash flows from opportunity costs
Opportunity costs are classified as _____ costs in project analysis relevant
Among the 3 main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast? the operating cash flows from net sales over the life of the project
Opportunity costs are ____. benefits lost due to taking on a particular project
Investment in networking capital arises when _____. 1. inventory is purchases2. cash is kept for unexpected expenditures3. credit sales are made
When using ____ all of the variables except one are frozen in order to determine how sensitive the NPV estimate is to changes in that particular variable sensitivity analysis
What is a sunk cost? a cost incurred in the past that is irrelevant to the capital investment decision process
What is the total number of inputs that change while doing sensitivity analysis? 1
In a competitive market, positive NPV projects are: uncommon
What is the relationship between variable costs and output? total variable costs are directly related to the level of output
Scenario analysis the determination of what happens to NPV estimates when we ask what if questions. Best case/worst case/base case
Sensitivity analysis investigation of what happens to NPV when only one variable is changed
Simulation analysis a combination of scenario and sensitivity analysis.
Variable costs cost that change when the quantity of output changes
How to calculate total variable cost? VC=Q*Cost/unit
Fixed costs cost that do not change when the quantity of output changes during a particular time period
How to calculate fixed costs? TC=VC+TC
Marginal or incremental cost the change in costs that occurs when there is a small change in output
Marginal or incremental revenue The change in revenue when there is a small change in output
Accounting break-even the sales level that results in zero project net income
How to calculate break even? (FC+D)/(P-v)
Sunk costs R&D- inmaterial, marketing cost. Should do NPV analysis before spending
FCF= EBIT-TAX+DEPR-Change in NWC-CX
OCF= EBIT-TAX+DEPR
Opportunity cost Cost of capital
Externalities Cannebalization (erosion)
Salvage value if you resell, what it will be worth
Overhead cost CEO salary, other expenses to a company that won’t change because of a project
inflation cost of capital already includes inflation

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