Finance - Exam #3

What is the difference between scenario analysis and sensitivity analysis?

Scenario analysis considers a combination of factors for each scenario while sensitivity analysis focuses on only one variable at a time.

Incremental cash flows come about as a(n) _________ consequence of taking a project under consideration.

- Direct

A project's net present value (NPV) is computed:

- Discounting the cash inflows from the project and subtracting the investment (if conventional).

Side effects from investing in a projects refer to cash flows from:

- Erosion effects - Beneficial spillover effects

Interest expenses incurred on debt financing are _______ when computing cash flows from a project.

- Ignored

Synergy will ________ the sales of existing products.

- Increase

The NPV will increase if:

- One or more cash inflows is increased or received sooner - The investment is smaller - The discount rate is smaller, everything else equal

Investment in net working capital arises when:

- Cash is kept for unexpected expenditures - Credit sales are made - Inventory is purchased

An increase in depreciation expense will __________ cash flows from operations.

- Increase

The stand alone principle assumes that the evaluation of a project may be based on the project's _________ cash flows.

- Incremental

Sunk Costs

- A cost that has already been incurred & cannot be recouped & therefore should no be considered in an investment decision. - The firm will have to pay this cost no matter what.

Depreciation (Straight Line & MARCS)

- Accounting depreciation is a noncash deduction

Cash flows should always be considered on a(n) ________ basis.

- After-tax

AAR

- An investments average net income divided by its average book value. - Average accounting return

What is the relationship between depreciation, income, taxes and investment cash flows?

- As depreciation expense increases, net income and taxes will decrease, while investment cash flows will increase.

IRR

- Internal Rate of Return - Most important alternative to NPV - The discount rate that makes the net present value of an investment zero. - Based on the IRR rule, an investment is acceptable if the IRR exceeds the required return. It should be rejected otherwise. - The IRR on an investment is the required return that results in a zero NPV when it is used as the discount rate.

Which technique will provide the most consistent correct result?

- Net Present Value

Accounts receivable and accounts payable are included in project cash flow estimation as part of changes in:

- Net working capital

What are methods of calculating the MIRR of a project?

- Reinvestment approach - Discounting approach - Combination approach

One of the most important steps in estimating cash flow is to determine the _________ cash flows.

- Relevant

Opportunity cost are classified as ________ costs in project analysis.

- Relevant

To investigate the impact on NPV of a change in one variable, you would employ:

- Sensitivity analysis

What should and should not be included in the analysis of a project?

- Should: Depreciation, opportunity cost, erosion & net working capital - Should no include: Financing expense & sunk cost

What is the depreciation tax shield if EBIT is $600, depreciation is $1,800, and the tax rate is 30%?

- Tax Shield = $1800 x .3 = $540

Payback Period

- The amount of time required for an investment to generate cash flows sufficient to recover its initial costs. - Based on the payback rule, an investment is acceptable if its calculated payback period is less than some prespecified number of years.

Incremental Cash Flows

- The difference between a firm's future cash flows with a project & those without a project. - The incremental cash flows for project evaluation consist of any and all changes in the firm's future cash flows that are a direct consequence of taking the project.

NPV

- The difference between an investments market value and its cost. - A measure of how much value is created or added today by undertaking an investment. - Given our goal of creating value for the stockholders, the capital budgeting process can be viewed as a search for investments with positive net present values.

When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus ________ raised to the nth power.

- The discount rate

Opportunity Costs

- The most valuable alternative that is given up if a particular investment is undertaken. - We give up the valuable opportunity to do something else with it.

Capital rationing exists when a company has identified positive NPV projects but can't find:

- The necessary financing

Profitability Index

- The present value of the future cash flows divided by the initial investment. - So, if a project costs $200 and the present value of its future cash flows is $220, the profitability index value would be $220/200 = 1.10. - Disadvantage: May lead to incorrect decisions in comparison of mutually exclusive investments. - Measures "bang for the buck".

While performing sensitivity analysis, we recompute NPV several times by changing one input variable at a time. True or False?

- True

In a competitive market, positive NPV projects are:

- Uncommon

In order to analyze the risk of a project's NPV estimate, we should establish _____________ for each important estimate variable.

- Upper & lower bounds

Opportunity costs are:

- benefits lost due to taking on a particular project.

A positive NPV exists when the market value of a project exceeds its cost. Unfortunately, most of the time the market value of a project:

- cannot be observed

Sunk cost are costs that:

- have already occurred and are not affected by accepting/rejecting a project.

Net working capital =

Current assets - current liabilities

Accelerated Cost Recovery System (ACRS):

Depreciation method under U.S. tax law allowing for the accelerated write-off of property under various classifications.