FINA 4330 Ch 8 & 9

OCF =

EBIT + Depreciation - Taxes

Disadvantage of Profitability Index

It cannot rank mutually exclusive projects

The Tax Shield Approach

OCF = (Sales - Costs) x (1-TC) + Depreciation x TC

The Tax Shield Approach to OCF

OCF = (Sales - costs)(1 - T) + Deprec*T

average return =

Revenue - Costs (Net Income) / Investment Period

Net Salvage Cash Flow

SP - (SP-BV)(T) Where: SP = Selling Price BV = Book Value T = Corporate tax rate

What is crossover rate?

The discount rate at which we are indifferent between two investments

Specifying variables in the Excel NPV function differs from the manner in which they are entered in a financial calculator in which of the following ways?

The range of cash flows specified in Excel begins with Cashflow 1, not Cashflow 0. The discount rate in Excel is entered as a decimal, or as a percentage with a percent sign. With the Excel NPV function, Cashflow 0 must be handled outside the NPV function. The Excel NPV function is actually a PV function.

What is the first step when calculating the crossover rate?

To calculate the cashflow differences between each project

Stand-alone principle

allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flows

The goals of risk analysis in capital budgeting include:

assessing the degree of financing risk identifying critical components

AAR =

average net income/average book value *** OR *** average return during period/average investment

hard rationing

capital will never be available for this project

The Average Accounting Return (AAR) Rule states that a company will accept a project that has an average account return that:

exceeds a pre-determined target average accounting return

The profitability index is calculated by dividing the PV of the _________ cash inflows by the initial investment.

future

Book Value

initial cost - accumulated depreciation

The combination approach for calculating the Modified Internal Rate of Return (MIRR) differs because:

negative cash flows are discounted back and positive cash flows are compounded forward

cash flow from assets

operating cash flow - net capital spending - change in net working capital

Relevant Cash Flows

opportunity costs, side effects/erosion, net working capital, tax effects

The __________ is best suited for decisions on relatively small, minor projects while ______ is more appropriate for large complex projects.

payback period; NPV

According to the basic IRR rule, we should:

reject a project if the IRR is less than the required return

After-Tax Salvage

salvage - T(salvage - book value)

The MIRR assumes that cash flows will be reinvested at

the cost of capital

soft rationing

the limited resources are temporary, often self-imposed

The depreciation tax shield is

the tax savings that results from the depreciation deduction