Unit 4 Flashcards

1
Q

Net Present Value (for project)

A

Difference between MV and Cost (not final answer)

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2
Q

Strengths of NPV

A
  1. Uses cash flows, which are better than earnings
  2. Other approaches ignore cash flows beyond a certain date
  3. fully incorporates the time value of money
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3
Q

Payback period

A
  1. Average time a project starts making a profit
  2. Must be LESS than target period to ACCEPT
  3. Must be MORE than target period to REJECT
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4
Q

Shortfalls of payback period

A
  1. TVM is ignored
  2. Biased against long term projects
  3. Requires arbitrary cutoff point
  4. Ignores CF beyond cutoff point
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5
Q

Advantages of payback period

A
  1. Easy to understand
  2. Adjusts for uncertainty for later
  3. Biased towards liquidity
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6
Q

Average Accounting Return

A
  1. Investment’s average net income by its average book value
  2. Must be MORE than target period to ACCEPT
  3. Must be LESS than target period to REJECT
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7
Q

Advantages of AAR

A
  1. Easy to calculate
  2. Needed information is easily available
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8
Q

Disadvantages of AAR

A
  1. Not a true rate of return (TVM ignored)
  2. Uses arbitrary benchmark cuttoff rate
  3. Based on book values and not CF and MV
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9
Q

Depreciation and tax

A

Relevant cash flow = wear and tear tax shield = (Wear and tear × tax rate)

W&T is a non-cash expense, so only relevant because it affects taxes

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10
Q

Recoupment and salvage value

A

If salvage value is different from tax value of asset, there’s a tax effect

Tax value = initial cost - accumulated W&T

After tax salvage = salvage - T(salvage - tax value)

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11
Q

Qualitative factors

A
  1. Reliability of machine purchased
  2. Machine life span
  3. Suppliers reliability
  4. Environmental aspects
  5. Social aspects (job losses)
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