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