Finance Final

The minimum return that must be earned on a project in order to leave the firm’s value unchanged is The discount rate
The conventional cash flow pattern associated with capital investment projects consists of an initial outflow followed by A series of inflows
The first step in the capital budgeting process is Proposal generation
Steps to the capital budgeting process Proposal generationIdentify relevant cash flowsAnalyze the project using tools such as NPV, IRR, and payback
To evaluate differences in project scale, a financial manager should always use _____________ as the primary capital budgeting evaluation tool. NPV
A firm is evaluating a proposal which has an initial investment of $45,000 and has cash flows of $5,000 in 1 year, $20,000 in year 2, $15,000 in year 3, and $10,000 in year 4. The payback period of the project is? 3.5 years
One weakness of the payback period is that it Ignored cash flows that occur after the end of the payback period
Capital budgeting is the process of Evaluating a firm’s investment choices
A firm must choose from 5 capital budgeting proposals outlined below. The firm is subject to capital rationing and has a capital budget of $500,000. The firm’s cost of capital is 12%. Using the net present value approach to ranking projects, which projects should the firm accept? 1, 2, 3, & 5
Net present value decision rule Accept any project with a positive NPV, and project with a positive NPV makes at least the minimum required return.
Chris has been offered the chance to invest $120,000 in a partnership, which is expected to return $25,000 per year. If Chris is in the 30% tax bracket and limits investments to those with a payback of six years, should Chris invest? No, because the payback period is 6.86 years. To calculate the payback you need to calculate Chris’ annual cash return which is equal to $25,000(1-0.30)=$17,500 per year in after-tax proceeds from the investment. Given that annual amount, his payback is equal to $120,000/$17,500 = 6.86 years. Since the payback exceeds his six year cut off he should not make the invesetment
Which of the following decision rules is always correct because it is directly tied to the goal of maximizing shareholder wealth? NPV rule
NPV Any project that generates positive NPV will provide the firm’s required return since is was used as the discount rate to compute the present value of the project’s cash flow. Positive NPV will continue to increase shareholder wealth since a positive number means it generates returns even higher that the required return.
The IRR can lead to incorrect project rankings because projects with much higher NPVs may also have Longer project lives
Capital rationing is the process of Using limited cash to select among investments available. Firms must select what projects are appropriate to invest in and which ones to exclude
MIRR is used when Cash flows of a project change sign
_______ are projects where the acceptance of one project automatically means we are rejecting other options Mutually exclusive projects
Unlike the IRR criteria, the NPV approach assumes an interest rate equal to the Firm’s cost of capital
Projects that do not compete with one another so that the accepetance of one project will have no bearing on the accepetance of other projects being considered by the firm Independent projects
Software Design Inc. is considering a number of capital budgeting projects. However, the company is currently constrained by the number of programmers that it employs. The company has 20 programmers on its staff and will not be able to hire any new programmers in the near future. Which of the following methods should the company use to choose which projects to accept? Rank the projects on profitability index (PI) and select the highest PIs.
A firm is evaluating an investment proposal, which has an initial investment of $8,000 and discounted cash flows valued at $6,000. The net present value of this investment is -$2,000Present valie of the project’s cash flows minus the initial investment. $6,000-$8,000=-$2,000Project should be rejected since it has a negative NPV
Jenna is considering an investment which has a price of $16,000. She expects to receive $3,000 for eight years. What is the investment’s internal rate of return? 10%PV = -16000N = 8 PMT = 3000CPT I/Y = 10%
When resources are limited you should select the projects with the Highest NPV
A firm that is earning profits over and above what should be considered normal for that line of business is earning a(n) Pure economic profit
A firm that is earning normal return, or that return that investors demand for the level of risk is earning a(n) Zero economic profi
A firm is earning above the amount it is said to be earning, it is an economic proft
Whether or not a firm shows a profit when creating financial statements using generally accepted accounting procedures (GAAP) Accounting profit
An NPV profile is A graph of a project’s NPV over a range of different discount ratesIt is useful when there is uncertainty surrounding a project’s cost of capital. Some firms may use different costs of capital for projects with different levels of risks. When this is the case, NPV profile provides some additional information regarding the discount rate where the NPV turns negative.
The profitability index is a ratio of NPV to investment cost The PI is calculated by taking a project’s NPV and dividing it by the cost. This gives us a measure of how much NPV you will generate per unit of resources (costs) consumes. The PI allows you to rank projects if resources are limited.
Cash flows of any project Initial investmentOperating cash inflowsTerminal cash flow
Net working capital (NWC) Current assets – Current liabilitiesCurrent assets – cash, accounts receivable, inventory, Current liabilities – Accounts payable, accruals, notes payable
Change in networking capital Difference between a change in current assets and a change in current liabilities
Which of the following cash flows should be included in incremental free cash flows? Capital expenditures necessary to fund the new project.
Sunk costs are: previous cash outflows not relevant to the project decision. Should not be included in a projects incremental cash flows
The installed cost of an asset minus its accumulated depreciation is known as __________. Book value
The sale of an ordinary asset for its book value results in: No tax benefit
A firm can identify the best time to expand by forecasting future firm values assuming expansion occurs in each year and selecting the year __________. that generates the highest future firm value
Firms considering expansion into countries with high levels of political risk can adjust for this risk by: Using risk-adjusted discount rates for the project evaluation.
The major components of a project’s cash flows are an initial investment, operating cash flows, and __________. A terminal cash flow
An incremental cash flow valuation considers: all project cash flows including cannibalization.
Grover Manufacturing Inc. is considered the acquisition of a new piece of machinery for $45,000 that will cost another $10,000 to have shipped and installed. What is the cost of this new asset for project evaluation purposes? $55,000$45,000+$10,000=$55,000
When a firm acquires existing capital assets in another country it is called __________. Foreign direct investment
An increase in the risk adjusted discount rate (RADR) will result in: A decrease in NPV
Which of the following is a relevant opportunity cost that should be considered an incremental cash flow? Lost facility rental income
Which of the following is an example of a sunk cost? Amount spent on a test market
When a firm expands operations it will also require additional investment in __________. Net working capital
Assume you have two projects with different lives. Project A is expected to generate present value cash flows of $5.2 million and will last 7 years. Project B is expected to generate present value cash flows of $3.8 million and will last 5 years. Given a required return of 9%, Project A has an equivalent annual annuity of __________ which is __________ than Project B. $1.03319 million, betterProject A:PV = -$5.2; N = 7; I / Y = 9%; FV = 0; CPT PMT and you get $1.03319 million
Simulation analysis is useful because the financial manager can specify a range of values for numerous inputs and then determine __________. The probability of a positive outcome
Behavioral approaches for dealing with project risk may be used to __________. Get a “feel” for the level of risk
Dedra used scenario analysis to determine the following possible outcomes:Best case project NPV = $4,500Expected case project NPV = $1,200Worst case project NPV = $550Given this information Dedra should Accept the project
A method for evaluating a project that uses a number of possible values for a given variable, such as cash inflows, to assess its impact on the firm’s return is: Sensitivity analysis
A financial manager that creates an investment opportunities schedule an then imposes a budget constraint to determine which capital budgeting projects to accept is using the _______ internal rate of return approach
A statistically based behavior approach to project analysis that applies predetermined probability distributions is the: simulation method
A common use of break-even analysis is to determine: How many units of sales are needed to cover all costs
Firms often have the option to reduce the scale of operations at some point in the future, which is known as a(n) abandonment option
We only want to consider incremental earnings in the capital budgeting process. Incremental earnings are the: additional sales and costs associated with the project
Capital budgeting evaluating long term investments that will maximize owner’s wealth
Capital expenditure an outlay of funds by the firm that is expected to produce benefits over a period of time greater than 1 year
Operating expenditure an outlay of resulting benefits received within 1 year.
Motives for capital expenditures expand operations, replace or renew fixed assets,
Proposal generation Proposals for new investment projects are made at all levels within the business organization and are reviewed by finance personnel.
Review analysis financial managers perform formal review and analysis to assess the merits of investment proposals.
Decision making The decisions are based on dollar limits, plant managers are given authority to make decisions necessar to keep the production line moving
Implementation Following approval, expenditures are made and projects are implemented.
Follow-up Results are monitored, and actual costs and benefits are compared with those that were expected.
unlimited funds A firm is able to accept all independent projects that provide an acceptable return
Capital rationing When a firm has a fixed budget available for capital expenditure, and projects will be competing for these dollars.
Accept-reject approach Evaluation of capital expenditure proposals to determine whether they meet the firms minimum acceptance criterion
Ranking approach The ranking of capital expenditure based on the predetermined measure (rate of return)
Relevant cash flows The incremental cash outflow and resulting subsequent inflows associated with a proposed capital
Incremental cash flows Represent the additional cash flows, expected to result from a proposed capital expenditure.
Cash flows of any project may include 3 basic components All have the first twoAn initial investment, operating cash flows, and terminal cash flows
Initial investment the relevant cash outflow for a proposed project at time zero. Initial investment needed to acquire new asset – after-tax cash inflows from liquidation of old asset
Operating cash inflows The incremental after-tax cash inflows resulting from implementation of a project during its lifeOperating cash flows from new asset – operating cash flows from old asset
Terminal cash flow The after-tax non-operating cash flow occurring in the final year of a project. It is usually attributable to liquidation of the projectAfter-tax cash flows from termination of new asset – after tax cash flows from termination of old asset
Opportunity costs Cash flows that could be realized from the best alternative use of an asset that is already in place. Should be included as cash outflows when one is determining a projects incremental cash flows
Installation costs any added costs that are necessary to place an asset into operation
Installed cost of new asset Cost of new asset+its installation costs = the assets depreciable value
After-tax proceeds from sale of old asset the difference between the old assets sale proceeds and any applicable taxes or tax refunds related to its sale
Tax of a sale on an old asset depends on the relationship between its sale price and book value and on existing government tax rules
3 possible tax situations More than its book valuefor its book valueLess than its book value
Recaptured depreciation Above book value and below its initial purchase price
Risk (in capital budgeting) the uncertainty surrounding the cash flows that a project will generate or the degree of variability of cash flows.
Break-even cash inflow The minimum level of cash inflow necessary for a project to be acceptable.
Simulation Statistics-based behavior approach that applied predetermined probability distributions to estimate risky outcomes.
Risk-adjusted discount rate The rate of return that must be earned on a given project to compensate the firm’s owners adequately(maintain or improve the firm’s share price).
Total risk Nondiversifiable risk + diversifiable risk
Annualized net present value approach (ANPV) An approach to evaluating unequal-lived projects that converts the net present value of unequal-lived, mutually exclusive projects into an equivalent annual amount, that can be used to select the best project
Real options (strategic options) Opportunities that are embedded in capital projects that enable managers to alter their cash flows and risk in a way that affects project acceptability(NPV)
Abandonment option Abandon or terminate a project prior to the end of its planned life. Increases NPV
Flexibility option Design the production process to accept multiple inputs, to use flexible production technology to create a variety of outputs, by reconfiguring the same plant and equipment. increases NPV
Growth option Develop follow on projects, expand markets, expand or retool plants, and son on that would not be possible without implementation of the project that is being evaluated. Increases NPV
Timing options Determine when various actions with respect to a given project are taken, recognizes the firms opportunity to delay acceptance of a project for one or more periods, to accelerate or slow the process of implementing a project in response to new information or to shut down a project temporarily in response to changing product market conditions or competition.
NPV strategic NPV traditional+value of real options
Net present value approach An approach to capital rationing that is based on the use of present values to determine the group of projects that will maximize owners wealth

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