FINA 4330 Ch 8 & 9
OCF =
EBIT + Depreciation - Taxes
Disadvantage of Profitability Index
It cannot rank mutually exclusive projects
The Tax Shield Approach
OCF = (Sales - Costs) x (1-TC) + Depreciation x TC
The Tax Shield Approach to OCF
OCF = (Sales - costs)(1 - T) + Deprec*T
average return =
Revenue - Costs (Net Income) / Investment Period
Net Salvage Cash Flow
SP - (SP-BV)(T) Where: SP = Selling Price BV = Book Value T = Corporate tax rate
What is crossover rate?
The discount rate at which we are indifferent between two investments
Specifying variables in the Excel NPV function differs from the manner in which they are entered in a financial calculator in which of the following ways?
The range of cash flows specified in Excel begins with Cashflow 1, not Cashflow 0. The discount rate in Excel is entered as a decimal, or as a percentage with a percent sign. With the Excel NPV function, Cashflow 0 must be handled outside the NPV function. The Excel NPV function is actually a PV function.
What is the first step when calculating the crossover rate?
To calculate the cashflow differences between each project
Stand-alone principle
allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flows
The goals of risk analysis in capital budgeting include:
assessing the degree of financing risk identifying critical components
AAR =
average net income/average book value *** OR *** average return during period/average investment
hard rationing
capital will never be available for this project
The Average Accounting Return (AAR) Rule states that a company will accept a project that has an average account return that:
exceeds a pre-determined target average accounting return
The profitability index is calculated by dividing the PV of the _________ cash inflows by the initial investment.
future
Book Value
initial cost - accumulated depreciation
The combination approach for calculating the Modified Internal Rate of Return (MIRR) differs because:
negative cash flows are discounted back and positive cash flows are compounded forward
cash flow from assets
operating cash flow - net capital spending - change in net working capital
Relevant Cash Flows
opportunity costs, side effects/erosion, net working capital, tax effects
The __________ is best suited for decisions on relatively small, minor projects while ______ is more appropriate for large complex projects.
payback period; NPV
According to the basic IRR rule, we should:
reject a project if the IRR is less than the required return
After-Tax Salvage
salvage - T(salvage - book value)
The MIRR assumes that cash flows will be reinvested at
the cost of capital
soft rationing
the limited resources are temporary, often self-imposed
The depreciation tax shield is
the tax savings that results from the depreciation deduction