How do we determine if we should purchase a project?
bring all expected future earnings into present value terms
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, 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:
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
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
means that the project is expected to add value to the firm and will therefore increase the wealth of the owners.
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).
The present value of an investment's future cash flows divided by the initial cost of the investment is called the:
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)
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
____________ is used more frequently even though ____________ __________ is a better method.
payback, discounted payback
Which one of the following methods of analysis provides the best information on the cost-benefit
aspects of a project?
When the present value of the cash inflows exceeds the initial cost of a project, then the project
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
required rate of return
Which two methods of project analysis are the most biased towards short-term projects?
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
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?
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