Finance Exam (9,10,11)
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
