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CH. 9

How do we determine if we should purchase a project?

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

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

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:

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

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

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

means that the project is expected to add value to the firm and will therefore increase the wealth of the owners.

positive NPV

preferred capital budgeting technique?

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

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

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

accept AAR if:

AAR> Mgmt's #

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

internal rate of return

Accept if IRR:

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

Which 2 concepts do NOT use the Time value of money?

Payback and AAR

what 3 techniques are the most superior?

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

is equal to the required return when the net present value is equal to zero.

the IRR

Which one of the following methods of analysis provides the best information on the cost-benefit

aspects of a project?

aspects of a project?

Profitability Index

When the present value of the cash inflows exceeds the initial cost of a project, then the project

should be:

should be:

accepted

bc the PI > 1

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:

upon the:

required rate of return

information is so readily available.

AAR

results are easy to communicate and understand.

IRR

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

payback &

discounted payback

discounted payback

CH. 10

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

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

costs that was incurred in the past and cannot be recouped?

sunk cost

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

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

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

relating to a project, what 2 things should be included in the cash flow at time zero?

initial stuff