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Flashcards in BEC Homework 3.1 Deck (26):

In a equipment replacing decision which of the cost does not affect decision making process

Original fair market value of the old equipment


Strength of a pay back method

It is easy to understand. The pay back method takes the total investment in a project and divides by annual cash flows to determine the number of years it will take to gain a return of the initial investment.
Pay back and bailout pay back do not consider the time value of the money. It neglects total project profitablity


If the net present value of a capital budgeting project is positive

It would indicate that the rate of return for the project is greater than the discount percentage rate used in the net present value computation. NPV can be used if there is different hurdle rates for different years of the project. Initial cost is one of the most important caluculations of NPV. The method of funding the project has no effect on NPV model.Adding working capital requirements and salvage value affet cash flow


Internal rate of return formulae

Net incremental investment/Net annual cash flows=Present value factor. The IRR method is less reliable than the NPV technique when there are several alternating period of cash inflows and net cash outflows differ significantly. The IRR is strictly a percentage of return while NPV is an absolute measure.. The higher the present value factor the lower the computed rate of return


The capital budgeting model that's is generally considered the best model for long range decision making

is the discounted cash flow model


PV cash savings /inflows

PV net cash outflows


If they ask pretax cash flow

Add to net income all non-cash tax expense


In making capital budgeting decisions which ones are the financial or the qualitative factor

Increase in manufacturing flexibility
Improved product delivery and service
Reduction in new product development time

Less scrap and rework are considered as non-qualitative or non-financial factor.


A depreciation tax shield is

reduction in income taxes. Depreciation tax shield is caused by the tax deductibility of the depreciation expense not by the face that depreciation does not affect cash flows


Profitablity index is a variation of

net present value. The profitability index is the ratio of present value of the net future cash inflows to the present value of net initial investment. The profitability index is also referred to as excess present value index or simply the present value index. Companies hope the ratio will be over 1.0 present value of net future cash inflows/ present value of net initial investment. It is used for capital rationing. Ranking and selction of investments is made in decending order. Limited capital resources are applied in the order of index until resources are either exhausted or investment required by the next project exceeds remaining resources


Weighted average capital

Typically a company will use its own weighted average cost of capital as the hurdle rate for computing NPV. A positive NPV would not likely give any indication of the relationship between required rate of return and WACC. The required rate of return and WACC are equal


What input would be most beneficial to consider when management is developing capitol budget

Profit center equipment request. Current product sales prices and costs representing operating data most relevant to operating rather than capital budgeting. Wage trends represent operating data most relevant to operating than capital budgeting


In evaluating costs for decision making the company would consider each costs except

Variable costs. Variable costs change in level of output but may not change purely in response to different select alternatives. Although variable cost are frequently relevant they are not always relevant.


Incremental costs

represent the change in cost associated with different alternatives and are considered synonymous with relevant.


Diiferential costs

represent change in costs associated with two separate course of action and are considerd synonymous with relevant



Discounted cash flows -Initial investment. It assumes that positive cash flows are reinvested at hurdle rates thereby considering compounding. It uses cash basis not accrual basis. NPV measures dollars not years. . The discount rate or hurdle rate is determined in advance for the NPV. Advanced determination of management required return is integral .
If in the question it is given in the question cash inflow from the project will be $4000 a year for the next six years. The present value factor to be taken from all of the choices below
present value of $1 to be received after 6 years
Present value of an ordinary annuity of $1 per period for six periods
Present value of an ordinary annuity due of $1 per period of six periods
Future value of $1 at the end of six periods is
Present value of an ordinary annuity of $1 per period for six periods. Take the one without dollar sign



The internal rate of return is equal to the discount rate at which Cash flows discounted at what percent. It is the rate that provides a zero to the net present value. It is a time adjusted rate of return from investment


Pay pack period

Initial cost / Increase in Annual net after tax cash inflow. It doesn't take into calculation depreciation or salvage value. The pay back method typically ignores the time value of the money and computes the number of years it will take take for the investment to pay back


the common disadvantage of all capital budgeting models

is they rely on forecasting future data. Capital financing relates to longer periods of time that are subject to greater level of uncertainty than other short term budgeting decisions


Accounting rate of return

ARR is based on GAAP rate of return and is based on GAAP income and not cash flows and does not considers time value of money


Discounted pay back period don't take into account

salvage value


What methodology used to develop fair value of common shares

Discounted cash flow method


Price earning methods

require future earnings


Price sales methods

require estimation of future sales


Economic value added

is a residual income measure that compares income with requested return on investment. Positive amount indicates that objectives have been met and negative indicates it has not


Machine replacement decisions

sunk cost is original cost of the new machine