Chapter 12 finance Study guide

What is the first step in the capital budgeting process Idea development
Why do you use cash flow in capital budgeting instead of net income ? a. cash rather than income is used to purchase new machinesb. cash outlays need to be evaluated in terms of the present value of the resultant cash inflows c. To ignore the tax shield provided from depreciation would ignore the cash flow provided by the machine, which should be reinvested to replace older machines
What are four steps in the capital budgeting process? 1. search for and discovery of investment opportunities2.collection of data3. evaluation and decision making4. reevaluation and adjustment
What is capital budgeting primarily concerned with? Evaluating investment alternatives.
Which of the 3 methods for ranking investments is not “Time adjusted”? The payback method
What are the three methods for ranking investments? • Payback methoda. Advantages b. Disadvantages: does not consider the time value of money, fails to choose the optimum or most economical solution to a capital budgeting problem and it ignores cash inflows after the payback period • Net present value methoda. Advantages:b. Disadvantages:• Internal rate of return method (IRR)a. Advantages:b. Disadvantages:
If a firm has no capital rationing constraint and the firm’s investment alternatives are not mutually exclusive, which investment alternatives should the firm accept? Those that have a positive net present value
What does it mean when projects are ‘mutually exclusive”? The selection of one alternative precludes the selection of other alternatives
The internal rate of return assumes that funds are reinvested at what rate at the rate of the internal rate of return
If interest rates increase, this would not change the capital budgeting choices a firm would make using which of the three methods for ranking investments? Payback method analysis
Why is the NPV method more conservative than the IRR method? Because IRR assumes that the fund willl be reinvested at the rate of IRR
What happens to the project selection process as the cost of capital increases fewer costs will be accepted
what does capital rationing asssume a limited amount of capital is available
is depreciation more or less beneficial at higher tax rates more beneficial

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