Ch. 8 and 9 Decision Rules and Capital Budgeting

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Terms in this set (...)

What is the Net Present Value Rule?
An investment should be accepted if the NPV is positive and rejected if NPV is negative. If 0, then indifferent.
If a project has an NPV of $1,000, what does that mean?
$1,000 in value is added to the corporation as a result of undertaking the project.
What is the Payback Period and Payback Rule?
How long it takes to recover the initial sum invested in a project. Accept project if they pay back within a pre-specified period of time.
Why is the payback period an accounting breakeven measure?
Because it indicates how long it takes to recover cash flow equal to the initial investment.
Advantage of IRR over NPV
We don't need to know the required rate of return to use IRR. NPV cannot be calculated without a required rate of return.
What does a Profitability Index PI measure?
The value/benefit created per dollar invested. Accept if PI>=1
Profitability Index PI rule says
PI of 1.1 means for every dollar invested, $1.10 in value or $.10 in NPV resutls
Most commonly used capital budgeting procedures
IRR and NPV
IRR used/preferred because
provides a percentage measure which may be preferred to the NPV's dollar measure. Accept if IRR>required rate
Payback used/preferred because
Simple
Operating Cash Flow
EBIT/operating income - taxes + depreciation
Net Income
EBIT/operating income - taxes
EBIT/operating income
Change in revenue - change in expenses - depreciation
Woven Goods is considering adding a new line of baskets to its product line-up. Which of the following are relevant cash flows for this project?
I. increased revenue from existing goods if these baskets are added to the lineup
II. revenue from the new line of baskets
III. money spent to date investigating the availability of woven baskets
IV. cost of expanding the showroom to make space for the new baskets
I. increased revenue from existing goods if these baskets are added to the lineup
II. revenue from the new line of baskets
IV. cost of expanding the showroom to make space for the new baskets
What indicates a project has a required return that exceeds its internal (or actual) rate of return?
A negative NPV
What is IRR
The discount rate that causes the net present value of a project to equal zero
A proposed project will increase a firm's accounts receivables
is a cash outflow at time zero and a cash inflow at the end of the project
Which of the following investment decision rules can choose among mutually exclusive investments?
NPV
The change in a firm's future cash flows that results from adding a new project
incremental cash flows