# Finance Exam 3

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### CH. 9 How do we determine if we should purchase a project?

bring all expected future earnings into present value terms

### capital budgeting decisions generally have:

long term effects on a firm

### computing the value of a ￼project based upon the present value of the project's anticipated cash flows?

discounted cash flow valuation

payback period

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

discounted payback period

### A project's average net income divided by its average book value is referred to as the project's average:

accounting return

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

internal rate of return

### computing payback period: 2 steps

1) estimate cash flows

2) Subtract the future cash flows from the initial cost until the initial investment has been recovered

### accept a project under payback AND discounted payback IF:

Payback < Mgmt's #

### How long it takes you to get the initial cost back after you bring all of the cash flows to the present value.

discounted payback period

### computing discounted payback period: 2 steps

1) Estimate the present value of the cash flows

2)Subtract the future cash flows from the initial cost until the initial investment has been recovered

### The difference between the market value of a project and its cost

net present value

positive NPV

NPV

### measures the benefit per unit cost of a project, based on the time value of money. It is very useful in situations where you have multiple projects of hugely different costs and/or limited capital (capital rationing).

Profitability index

PI

### A PI >1 means:

the firm is increasing in value

### a measure of the average accounting profit compared to some measure of average accounting value of a project. The AAR is then compared to a required return by the company.

Average Accounting Return (AA)

### AAR=

Average Net Income/Average Book Value

AAR> Mgmt's #

### it is the return that will yield a NPV = \$0.

internal rate of return

IRR > Rate%

### differentiates itself from IRR in that the reinvestment rate for the cash flows is determined by the evaluator. It is the interest rate that compares the future value of the cash flows with the cost of the project.

modified internal rate of return

Payback and AAR

NVP, IRR, MIRR

### 2 advantages of the payback method

liquidity bias and ease of use

### ____________ is used more frequently even though ____________ __________ is a better method.

payback, discounted payback

the IRR

### Which one of the following methods of analysis provides the best information on the cost-benefit ￼aspects of a project?

Profitability Index

accepted

bc the PI > 1

### competing projects which both require the total use of the same limited resource

mutually exclusive projects

### The final decision on which one of two mutually exclusive projects to accept ultimately depends ￼upon the:

required rate of return

AAR

IRR

### Which two methods of project analysis are the most biased towards short-term projects?

payback &
discounted payback

### CH. 10 allows us to analyze each project in isolation from the firm simply by focusing on incremental cash flows

stand alone principal

### 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 the projects:

incremental cash flows

sunk cost

opportunity cost

### financial statements showing projected values for future time periods

pro forma financial statements

### D = (Initial cost - salvage) / number of years Very few assets are depreciated

straight line depreciation

### The tax savings generated as a result of a firm's depreciation expense is called the:

depreciation tax shield

### what should be included in the analysis of a project?

opportunity and erosion costs

initial stuff

Example: