Finance 3504

What is the total number of inputs that change while doing sensitivity analysis?

1

What are the advantages of the payback period method for management?

1. The payback period method is easy to use 2. the payback period method is ideal for short projects 3. it allows lower level managers to make small decisions effectively

What are the weaknesses of the payback method?

1. Time value of money principles are ignored 2. Cash flows received after the payback period are ignored 3. the cutoff date is arbitrary

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

1. beneficial spillover effects 2. erosion effects

What are considered to be relevant cash flows?

1. cash flows from erosion effects 2. cash flows from beneficial spillover effects 3. cash flows from opportunity costs

Investment in networking capital arises when _____.

1. inventory is purchases 2. cash is kept for unexpected expenditures 3. credit sales are made

What are the weaknesses of the discounted payback period?

1. loss of simplicity as compared to the payback method 2. exclusion of some cash flows 3. arbitrary cutoff date

Identify the three main sources of cash flows over the life of a typical project:

1. net cash flows from sales and expenses over the life of a project 2. net cash flows from salvage value at the end of the project 3. cash outflows from investment in plant and equipment at the inception of the project

When evaluating cost-cutting proposals, how are operating cash flows affected?

1. there is an additional depreciation deduction 2. the decrease in costs increases operating income

The three attributes of NPV are that it:

1. uses all the cash flows of a project 2. uses cash flows 3. discounts the cash flows properly

Opportunity cost

Cost of capital

OCF=

EBIT-TAX+DEPR

FCF=

EBIT-TAX+DEPR-Change in NWC-CX

How to calculate fixed costs?

TC=VC+TC

Marginal or incremental revenue

The change in revenue when there is a small change in output

How to calculate total variable cost?

VC=Q*Cost/unit

According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:

a target average accounting return

The decision making process for accepting and rejecting projects

capital budgeting

inflation

cost of capital already includes inflation

Variable costs

cost that change when the quantity of output changes

Fixed costs

cost that do not change when the quantity of output changes during a particular time period

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

direct

The profitability index is calculated by dividing the PV of the ____ cash flows by the initial investments

future

Salvage value

if you resell, what it will be worth

Why can the payback period lead to incorrect decisions if it is used to literally?

ignores cash flows after the cutoff date

Sensitivity analysis

investigation of what happens to NPV when only one variable is changed

When cash flows are conventional, NPV is ____ if the discount rate is above the IRR

negative

The difference between a firm's current assets and its current liabilities is known as ____

net working capital

Using your personal savings to invest in your business is considered to have an ____ because you are giving up the use of these funds for other investments or uses, such as, a vacation or paying off a debt

opportunity cost

What capital budgeting method allows lower management to make smaller, everyday financial decisions effectively?

payback method

What method differs from NPV because it evaluates a project by determining the time needed to recoup the initial investment

payback method

For a project with normal cash flows, the NPV is ____ if the required return is less than the IRR, and it is ____ if the required return is greater than the IRR.

positive, negative

In capital budgeting, the net ____ determines the value of a project to the company

present value

Erosion will _____ the sales of existing products

reduce

Opportunity costs are classified as _____ costs in project analysis

relevant

The first step in estimating cash flow is to determine the ______ cash flows

relevant

IRR must be compared to the ____ in order to determine the acceptability of a project.

required return

If the IRR is greater than _____ _____, we should accept the project.

required return

NPV accounts for the size of the project and eliminates the effects of _____.

scale

When using ____ all of the variables except one are frozen in order to determine how sensitive the NPV estimate is to changes in that particular variable

sensitivity analysis

According to the _____ principle, once the incremental cash flows from a project have been identified, the project can be viewed as a "minifirm."

stand-alone

Operating cash flow is a function of:

taxes, EBIT, depreciation

Once cash flows have been estimated, which investment criteria can be applied to them?

NPV, payback period, IRR

What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%?

NPV=-$95+(107/1.06)=$5.94

Marginal or incremental cost

the change in costs that occurs when there is a small change in output

Scenario analysis

the determination of what happens to NPV estimates when we ask what if questions. Best case/worst case/base case

NPV

the difference between an investment's market value and its cost. how much value is created or added today by undertaking an investment

Among the 3 main sources of cash flow, which source of cash flow is the most important and also the most difficult to forecast?

the operating cash flows from net sales over the life of the project

Accounting break-even

the sales level that results in zero project net income

What is the relationship between variable costs and output?

total variable costs are directly related to the level of output

True or false: two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing

true

In a competitive market, positive NPV projects are:

uncommon

The IRR is the discount rate that makes the NPV of a project equal to ___

zero

Simulation analysis

a combination of scenario and sensitivity analysis.

How to calculate break even?

(FC+D)/(P-v)

What is a sunk cost?

a cost incurred in the past that is irrelevant to the capital investment decision process

When cash flows are conventional, NPV is ___

1. Positive for discount rates below the IRR 2. equal to zero when the discount rate equals the IRR 3. negative for discount rates above the IRR

According to the top-down approach, what is the operating cash flow if sales are $200,000, total cash costs are $190,636, and the tax bill is $1,144?

200,000-190,636-1144= 8,220

What is the PI for a project with an initial cash outflow of $30 and a subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12%?

=((80/1.12)+(20/1.12^2))/30=2.91

Overhead cost

CEO salary, other expenses to a company that won't change because of a project

Externalities

Cannebalization (erosion)

Sunk costs

R&D- inmaterial, marketing cost. Should do NPV analysis before spending

A project should be _____ when its NPV is greater than zero

accepted

If a project's payback period is less than or equal to a particular cutoff date, the payback period rule suggests...

accepting

How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the project's lifetime

an increase in the size of the first cash inflow will decrease the payback period, all else held constant

One of the weaknesses of the payback period is that the cutoff date is a(n) ____ standard.

arbitrary

Opportunity costs are ____.

benefits lost due to taking on a particular project