chapter 9,10,11 finance exam
disadvantages of the payback period
-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
advantages of IRR
-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 -Provides indication of risk
disadvantages of IRR
-can produce multiple answers -cannot rank mutually exclusive projects -reinvestment assumption flawed
Accept project if NPV _____ 0
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What are non-conventional cash flows?
A combination of cash outflows and inflows.
Decision rule
Accept if the payback period is less than some preset limit
What is the first step in the Net Present Value (NPV) process?
Estimate the future cash flows.
According the video, one of the biggest challenges for the Net Present Value method is:
Identifying the appropriate discount rate to use.
Whenever there is a conflict between NPV and another decision rule always use the
NPV
profitability index decision rule
P1 > 1.0 then accept
Which type of analysis identifies the variable, or variables, that are most critical to the success of a particular project?
Sensitivity
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 of the following
The discount rate that makes the net present value equal to zero.
All of the following are useful for understanding Profitability Index, except:
The initial investment is included when calculating the present value of the future cash flows
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
All of the following are disadvantages of the Payback Period, except:
The method incorporates the time value of money.
simulation analysis
a combination of scenario and sensitivity analysis
simulation analysis
an expanded sensitivity and scenario analysis
Fixed costs:
are constant over the short-run regardless of the quantity of output produced.
the greater the volatility in NPV in relation to a specific variable, the larger the forecasting risk
associated with that variable
the payback period is a
break even type measure
sensitivity analysis
change one variable at a time
NPV= PV inflows-
cost
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.
Advantaged of Payback period
easy to understand, biased towards liquidity
best-case scenario
high revenues, low costs
forecasting risk
how sensitive is our NPV to changes in the cash flow estimates; the more sensitive, the greater the forecasting risk
Forecasting risk is defined as the possibility that:
incorrect decisions will be made due to erroneous cash flow projections.
The base case values used in scenario analysis are the values considered to be the most:
likely to occur.
worst-case scenario
low revenues, high costs
base case
most likely event
NPV=
net gain in shareholder wealth
what happens when we change
one variable at a time
if the NPV is __________ accept the project
positive
Monte Carlo simulation can estimate thousands of
possible outcomes based on conditional probability distributions and constraints for each the variables
The acceptance of one project ___________ accepting the other.
precludes
Profitability Index Formula
present value of net cash inflows / initial investment
Based upon the following graph, which variable should Simmons Corporation be most concerned about?
price (highest)
NPV=0 means
projects inflows are exactly sufficient to repay the invested capital and provide the required rate of return
For IRR accept the project if the IRR is greater than the
required return
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 _____ analysis.
simulation
The cash flows of one project are ___________ by the acceptance of the other.
unaffected
Variable costs can be defined as the costs that:
vary directly with sales
scenario analysis
what happens to the NPV under different cash flow scenarios
this is a subset of scenario analysis
where we are looking at the effect of specific variables on NPV
scenario analysis
worst, base, best case
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.
The IRR is the discount rate that makes NPV equal to ________________.
zero