FINANCE QUIZ

It is recommended that at a minimum, we might want to investigate _________ scenarios in all, including the base case.

5

Capital Budgeting

Analysis of potential projects Long-term decisions Large expenditures Difficult/impossible to reverse Determines firm's strategic direction

What is used in the computation of the best-case analysis of a proposed project?

D. the lowest variable cost per unit that can reasonably be expected

First step in calculating the NPV

Estimate the expected future cash flows

FORMULA for Profitability Index

Find NPV on calc, add initial cost, divide by initial cost

Independent Project vs Mutually Exclusive

For independent, the cash flows of one project are unaffected by the acceptance of the other, and the acceptance of one project precludes/excludes accepting the other.

one of the biggest challenges for the Net Present Value method is

Identifying the appropriate discount rate to use

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. also vise versa

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

TRUE

IRR (internal rate of return)

The discount rate that makes the NPV=0....Most important alternative to NPV, Independent of interest rates, accept project if IRR is greater than required return

Formula for Sensitivity of operating cash flows

(((Expected units sold(Selling Price-Variable Costs))-Fixed Costs)(1-Tax Rate)))+ Tax Rate(Necessary Cost/years))) Then add given amount to given category Take base oc-new oc /// base vs -new oc

IRR advantages

Preferred by executives Intuitively appealing Easy to communicate the value of a project If the IRR is high enough, may not need to estimate a required return Considers all cash flows Considers time value of money

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

Sensitivity Analysis

Which type of analysis identifies the variable, or variables, that are most critical to the success of a particular project?

Sensitivity Analysis

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

Simulation

When reading a graph on sensitivity analysis, the steeper the line the greater the sensitivity of NPV

Vise Versa

NPV Positive

accept project, will add value, will increase owners wealth, direct measure of how well project will meet goal of increasing shareholders wealth, net gain in shareholders wealth

fixed costs

are constant over the short-run regardless of the quantity of output produced.

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.

The base case values used in scenario analysis are the values considered to be the most:

likely to occur

Profitability Index

measures the benefit per unit cost, based on the time value of money, accept project if >0

Variable Costs are costs that

vary directly with sales

Formula for BEST/WORST CASE

((Sales*(1+-%)-Costs(1+-%))(1-Tax Rate)))+ ((Tax Rate)(Necessary Cost/years)

All of the following are disadvantages of the Payback Period (ADVANTAGES)

-Cash flows that extend beyond the cutoff date are not considered. -The method ignores the time value of money. -All projects are considered based upon cash flows alone. -The company must select a specified number of years to compare projects. -Requires arbitrary cutoff point (EASY TO UNDERSTAND, BIASED TOWARDS LIQUIDITY)

All of the following are useful for understanding Profitability Index, except: -A profitability index greater than 1 equals a positive NPV. -A profitability index less than 1 equals a negative NPV. -The initial investment is included when calculating the present value of the future cash flows. -The denominator for the profitability index is the cost of the project. -The initial investment is excluded when calculating the present value of the future cash flows.

-The initial investment is included when calculating the present value of the future cash flows.

IRR disadvantages

-can produce multiple answers -cannot rank mutually exclusive projects -reinvestment assumption flawed -unreliable in mutually exclusive projects

To get the worst case scenario, we assign the least favorable value to each item. This means to assign low values for items like units sold and price per unit and

High Value for Costs