FIN 320 Final Exam

Sensitivity Analysis

What happens to NPV when we change one variable at a time

Scenario Analysis

What happens to the NPV under different cash flow scenarios?

NPV vs. IRR?

Whenever there is a conflict between NPV and another decision rule, you should always use NPV. NPV and IRR will generally give us the same decision

Scenario analysis is defined as the:

determination of changes in NPV estimates when what-if questions are posed

The internal rate of return is defined as the :

discount rate which causes the net present value of a project to equal zero.

Which one of the following methods of project analysis is defined as computing the value of a project based upon the present value of the project's anticipated cash flows?

discounted cash flow valuation

Which one of the following best describes pro forma financial statements? - financial statements expressed in a foreign currency - financial statements where the assets are expressed as a percentage of total assets and costs are expressed as a percentage of sales - financial statements showing projected values for future time periods - financial statements expressed in real dollars, given a stated base year - financial statements where all accounts are expressed as a percentage of last year's values

financial statements showing projected values for future time periods

Which one of the following will decrease the net present value of a project? - increasing the value of each of the project's discounted cash inflows - moving each of the cash inflows to an earlier time period - decreasing the required discount rate - increasing the project's initial cost at time zero - increasing the amount of the final cash inflow

increasing the project's initial cost at time zero

The stand-alone principle advocates that project analysis should be based solely on which one of the following costs?

incremental

The additional cash flows that occur if a project is accepted is called:

incremental cash flows

The difference between a firm's future cash flows if it accepts a project and the firm's future cash flows if it does not accept the project is referred to as the project's:

incremental cash flows

The operating cash flow for a project should exclude which one of the following? - taxes - variable costs - fixed costs - interest expense - depreciation tax shield

interest expense

Net present value:

is the best method of analyzing mutually exclusive projects

Payback Period

- How long does it take to get the initial cost back? - Accept if the payback period is less than some preset limit

Net Present Value (NPV)

- The difference between the market value of a project and its cost. - How much value is created from undertaking an investment? If the NPV is positive, accept the project.

Internal Rate of Return (IRR)

- The most important alternative to NPV. The return that makes the NPV=0 - It is based entirely on the estimated cash flows and is independent of interest rates found elsewhere. - Accept the project if the IRR is greater than the required return

Forecasting risk

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

Which of the following is an example of a sunk cost?

1,200 paid to a repair machine last year

What evaluation tools could we use? Answer by ranking them from best to least effective.

1. NPV 2 .IRR 3. Payback 4. MIRR 5. Modified Payback 6. Average Accounting Return 7. Profitability Index

You are considering a project with an initial cost of $8,600. What is the payback period for this project if the cash inflows are $2,100, $3,140, $3,800, and $4,500 a year over the next four years, respectively?

2.88 years

You are considering two independent projects. Project A has an initial cost of $125,000 and cash inflows of $46,000, $79,000, and $51,000 for years 1 to 3, respectively. Project B costs $135,000 with expected cash inflows for years 1 to 3 of $50,000, $30,000, and $100,000, respectively. The required return for both projects is 16 percent. Based on IRR, you should:

Accept Project A and reject Project B.

JBI Inc has analyzed two mutually exclusive projects. Project A has an NPV of $81,406, a payback of 1.5 years. Project B has an NPV of $82,909, a payback of 2.1 years. The required return for A is 11.5% and for B is 12%. Which should be chosen?

Accept Project B only. Because they are mutually exclusive, only 1 can occur and B has the higher NPV.

Fixed costs:

Are constant over the short-run regardless of the quantity of output produced

Average Accounting Return

Average Net Income/Average Book Value

The IRR that causes the net present value of the differences between two project's cash flows to equal zero is called the:

Crossover Point

The length of time a firm must wait to recover, in present value terms, the money it has in invested in a project is referred to as the:

Discounted Payback Period

Which one of the following best describes the pro forma financial statements?

Financial statements showing projected values for future time periods.

In actual practice, managers most frequently use which two types of investment criteria?

IRR and NPV

Profitability Index

Measures the benefit per unit cost, based on the time value of money. - A 1.1 profitability index means $.10 of additional value off every $1. - Useful in situations where we have limited capital

Sunk Cost

Money that is already spent and cannot be recovered

If a firm accepts Project A it will not be feasible to also accept Project B because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be:

Mutually Exclusive

You are viewing a graph that plots the NPV's of a project to various discount rates that could be applied to the projects cash flows. What is the name given to this graph?

NPV Profile

Include in initial cash flow? Prototype developed before project? Consulting done before a project?

No! Sunk Cost

The length of time a firm must wait to recoup the money it has invested in a project is called the:

Payback period (not in present value terms)

You are considering two mutually exclusive projects. Both projects have an initial cost of $52,000. Project A produces cash inflows of $25,300, $37,100, and $22,000 for years 1 through 3, respectively. Project B produces cash inflows of $43,600, $19,800 and $10,400 for years 1 through 3, respectively. The required rate of return is 14.2 percent for Project A and 13.9 percent for Project B. Which project should you accept and why?

Project A because it has the larger NPV.

Kawliga Electronics has a required payback period of three years for all of its projects. Currently, the firm is analyzing two independent projects. Project A has an expected payback period of 2.8 years and a net present value of $6,800. Project B has an expected payback period of 3.1 years with a net present value of $28,400. Which projects should be accepted based on the payback decision rule?

Project A only

Modified IRR (Benefits)

Single answer and specific rates for borrowing and reinvestment

A project has a net present value of zero. Which one of the following best describes this project? - The project has a zero percent rate of return. - The project requires no initial cash investment. - The project has no cash flows - The summation of all of the project's cash flows is zero. - The project's cash inflows equal its cash outflows in current dollar terms.

The project's cash inflows equal its cash outflows in current dollar terms

A proposed project has an initial cost of $38,000 and cash inflows of $12,300, $24,200, and $16,100 for years 1 through 3, respectively. The required rate of return is 16.8 percent. Based on IRR, should this project be accepted? Why or why not?

Yes the IRR exceeds the required return by .58 percent.

Include in initial cash flow? Cost of equipment used in project

Yes!

Include in initial cash flow? Working capital needed for project

Yes!

Mutually Exclusive

You can only choose one project

Which one of the following is the best example of two mutually exclusive projects?

You own a piece of land that can accommodate one building--you have to decide between a hospital and car dealership.

The stand-alone principle

allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flows

incremental cash flows

cash flows included in a capital budgeting analysis that will only occur/not occur if the project is accepted

By definition, which one of the following must equal zero at the accounting break-even point?

net income

When is IRR unreliable?

non-conventional cash flows and mutually exclusive projects

The option that is foregone so that an asset can be utilized by a specific project is referred to as which one of the following?

opportunity cost

The length of time a firm must wait to recoup (recover) the money it has invested in a project is called the:

payback period

The present value of an investment's future cash flows divided by the initial cost of the investment is called the:

profitability index

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

sensitivity

The fact that a proposed project is analyzed based on the project's incremental cash flows is the assumption behind which one of the following principles?

stand-alone principle -Allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flows

Which one of the following costs was incurred in the past and should not be considered when evaluating a project?

sunk

Which one of the following best describes the concept of erosion?

the cash flows of a new project that come at the expense of a firm's existing cash flows

Variable costs can be defined as the costs that:

vary directly with sales