finance ch 9 10 11

Straight line depreciation*

(Initial cost - salvage) / number of years

4 different approaches OCF

EBIT+ Dep - Taxes NI+Dep Sales- Costs - Taxes (Sales- Costs)(1- Tax Rate) +Dep *Tax

What is the first step in the Net Present Value (NPV) process?

Estimate the future cash flows.

Profitability Index

Net Present Value / Investment Required) measures the benefit per unit cost based on TVM CPT NPV with CFO divide by CFO

When reviewing a graph of data from sensitivity analysis, the ____________ the line, the ____________ the sensitivity of the estimated Net Present Value.

Steeper, greater.

The Payback Period Rule states that a company will accept a project if:

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

The Internal Rate of Return (IRR) represents which

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

Which one of the following will be used in the computation of the best-case analysis of a proposed project?

The lowest variable cost per unit that can reasonably be expected

MACRS

The standard method of depreciation for federal income tax purposes is called the Modified Accelerated Cost Recovery System, or MACRS. Essentially, a MACRS depreciation schedule will begin with a declining balance method, then switch to a straight line schedule to finish the schedule.

what is IRR unreliable with

Unreliable with: Non-conventional cash flows Mutually exclusive projects

Scenario Analysis

WORST CASE BEST CASE what happens to the NPV under different cash flow scenarios

Relevant cash flows

cash flows that should be included in a capital budgeting analysis are those that will only occur if the project is accepted also known as incremental cash flows

Sensitivity analysis determines the:

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

forecasting risk

how sensitive is our NPV to changes in the cash flow estimates; the more sensitive, the greater the forecasting risk

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

likely to occur.

types of cash flows

sunk costs- costs that have accrued in the past oppurtunity costs- costs of lost options

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

disadvantages of payback

-Ignores the time value of money -Requires an arbitrary cutoff point -Ignores cash flows beyond the cutoff date -Biased against long-term projects, such as research and development, and new projects

IRR disadvantages

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

Advantages of Payback Period

-easy to understand -biased toward liquidity

Steps to finding net present value

1. estimate the expected future cash flows 2. estimate the required return for projects of this risk level 3. find the present value of the cash flows and subtract the initial investment to arrive at the net present value

What are non-conventional cash flows?

A combination of cash outflows and inflows.

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

Identifying the appropriate discount rate to use.

Independent versus Mutually Exclusive Projects***

Independent - The cash flows of one project are unaffected by the acceptance of the other Mutually Exclusive - The acceptance of one project precludes accepting the other.

Payback Period

Length of time until initial investment is recovered Accept if payback < some specified target Doesn't account for time value of money Ignores cash flows after payback investment required/ annual net cash inflow

Why is NPV the dominant method

Meets all desirable criteria Considers all CFs Considers TVM Adjusts for risk Can rank mutually exclusive projects Directly related to increase in VF

NPV>0

accept the project project is expected to add value to the firm will increase the wealth of owners

Fixed costs:

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

Book Value Equation*

book value= initial cost - accumulated depreciation acquisition cost -( acquisitions cost * four yr depreciation percentages) = book value equation

Net Working Capital

current assets - current liabilities

The main focus of sensitivity analysis is to:

determine the one variable that has the highest level of risk.

taxes and financing costs

dont include interest as it is already factored into the discount rate

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

five

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 values for costs.

Forecasting risk is defined as the possibility that:

incorrect decisions will be made due to erroneous cash flow projections.

IRR advantages

most important alternative to NPV widely used in practice intuitively appealing preffered by executives considers all cash flows considers TVM

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

sensitivity

what happens when we change one variable at a time

sensitivity analysis

Combining scenario analysis with sensitivity analysis can yield a crude form of _____ analysis. really just an expanded sensitivity and scenario analysis

simulation

Internal Rate of Return

the discount rate that makes the NPV of an investment zero ndependent of interest rates *accept if IRR is greater than the required return rate * calculator: cash flows as usual then press IRR

Net Present Value

the sum of the present values of expected future cash flows from an investment accept if >0

Variable costs can be defined as the costs that:

vary directly with sales.