44 terms

# 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
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:
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
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?
Profitability Index
When the present value of the cash inflows exceeds the initial cost of a project, then the project
should be:
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
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
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
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
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