Finance Exam (9,10,11)

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Operating Cash Flow (OCF)

((Sales - costs) x (1-T)) + (T x Depreciation)

What are the disadvantage of the payback period

- Ignores the time value of money - requires an arbitrary cutoff point - ignores cash flows beyond the cutoff date

IRR Advantages

- Preferred by executives - Intuitively appealing - Easy to communicate the value of a project - Considers all cash flows - Considers the time value of money

IRR disadvantages

-can produce multiple answers -cannot rank mutually exclusive projects

Advantages of Payback period

-easy to understand -biased toward liquidity

What is the equation for Book Value

= (initial cost - accumulated depreciation)

What is equation to calculate Depreciation

= (initial cost - salvage value) / number of years

What is the equation for Profitability Index

=PV of cash flows (not investment)/ Initial investment

What are non-conventional cash flows

A combination of cash outflows and inflows

opportunity cost

Cost of lost options... the most desirable alternative given up as the result of a decision

When should you accept a projects payback period

IF the payback periods less than some prest limit accept it

One of the biggest challenges when calculating NPV is?

Identifying the appropriate discount rate to use

Relevant cash flows are also called

Incremental cash flows: cash flows that should be included in a capital budgeting analysis are those that will occur or not occur if the project is accepted.

Depreciation

Is a non-cash expense, consequently it is only relevant because it affects taxes

What should you consider NPV or IRR when deciding when to chose to a project

NPV is the dominate method

What type of analysis identifies the variable/es that are most critical to the success of a particular project

Sensitivity

mutally exclusive

The acceptance of one project preludes accepting the other

The payback period rule states that a company will accept a project if

The calculated payback is less then a pre-specified number of years

Definition of an Independent Project

The cash flows of one project are unaffected by the acceptance of the other

The Internal Rate of Return is known as

The discount rate that makes the net present value equal to zero

If a substantial percentage of the scenarios look bad, the degree of forecasting risk is high and further investigation is in order... True or False

True

Monte Carlo Simulation

can estimate thousands of possible outcomes based on conditional probability distributions and constraints for each of the variables

Sunk Costs

costs that have accrued in the past

Sensitivity analysis determines the?

degree to which the net present value reacts to changes in a single variable.

The main focus of sensitivity analysis is to

determine the one variable that has the highest level of risk

What is the first step in the Net Present Value process

estimate the future cash flows

best-case scenario

high revenues, low costs

When should you accept the profitability index

if PI > 1 you accept

When should you accept NPV

if it is positive of NPV > 0

When should you accept IRR

if the IRR is greater than the required return you can accept the project

Forecasting risk is defined as the possibility that:

incorrect decisions will be made due to erroneous cash flow projections

worst-case scenario

low revenues, high costs

When is IRR unreliable?

non-conventional cash flows and mutually exclusive projects

An analysis of the change in a project's NPV when a single variable is changed is called _____ analysis.

sensitivity

Combining scenario analysis with sensitivity analysis can yield a crude form of ....

simulation analysis

The base case values used in scenario analysis are the ones considered...

the most likely to occur

When you assign the lowest anticipated sales price and the highest anticipated costs to a project, you are analyzing the project under the condition known as:

worst-case scenario analysis


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