Chapter 11 Flashcards
The process of making decisions regarding long-term investments is called what?
Capital Budgeting
When using the Capital Budgeting Process, what are the two types of decisions you can use.
Screening Decisions
“Does the project meet the minimum objectives first?”
Preference Decisions
-where you rank projects
The technique of Capital Budgeting decisions focus on ___
Incremental Cash Inflows
and
Incremental Cash Outflows
3 typical things included in Cash Outflows
Initial Investments
Increased Working Capital
Incremental Operating Costs
-repairs and maintenance
4 typical things included in Cash Inflows
Incremental Revenues
Release of Working Capital
Reduction in Costs
Salvage Value
Payback Period formula? What is its weakness?
Net Initial Investment / Annual Cash Flow
- ONLY use if “annual cash flows” are equal
- Depreciation excluded from cash flows
WEAKNESS
-does not consider time value of money
What is ARR? Give its formula.
Simple Rate of Return Method (ARR)
Average Annual Income / Net Initial Investment
When should a project be acceptable using ARR?
Accept Project IF:
ARR >(or equal to) minimum required rate of return
1 Advantage of using ARR and 1 Disadvantage?
Advantage
-easy for managers to understand and calculate
Disadvantage
-does not consider Time Value of Money
What are 2 other names the Discount Rate is called?
Cost of Capital
Minimum Acceptable Rate of return
2 Assumptions of NPV
- Cash Flows immediately reinvested at Discount Rate/Cost of Capital/Minimum Acceptable Rate of Return
- cash flows occur at year end
Profitability Index
NPV / Net Investment Required
What makes the NPV equal 0?
Internal Rate of Return (IRR)
-interest rate that makes NPV zero
Is Depreciation included in the Annual Cash Flow when using the Discount Payback Method (meaning depreciation costs decreases the cash flow)
No
Is Depreciation included in the Average Annual Income when using the Simple Rate of Return Method(meaning depreciation costs decreases the NI)
Yes
