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Flashcards in Capital Budgeting Module Deck (81):
1

Capital _________ is the process of selecting a company's long-term capital assets.

budgeting

2

A company must determine which long-term _____________ to undertake to maximize owner wealth.

investments

3

A _______ expenditure (CAPEX) is one where the returns are expected beyond the period of 12 months.

capital

4

What does CAPEX stand for?

Capital expenditure

5

Capital Expenditure (CAPEX) is meant as a ________ investment and hence returns are expected to be long-lasting.

long-term

6

The main reasons behind CAPEX are to expand, replace or renew _____ assets and commitment of funds for other activities that are expected to reap future gains.

fixed

7

Fixed assets usually need to be replaced or renewed at some point for example outdated equipment or those needing repair. Expansion of fixed assets occurs during company ______. Other activities may be investment in research and development of new products, advertising etc.

growth

8

The CAPEX process is undertaken to determine the suitability and selection of projects and consists of the following five steps: producing a proposal, review and analysis, decision making, implementation and _________.

follow-up

9

___________ is a crucial step in the CAPEX process, to actually roll-out the project.

Implementation

10

What are the five steps of the CAPEX process?

1) Producing a proposal
2) Review and analysis
3) Decision making
4) Implementation
5) Follow-up

11

The two best known types of CAPEX projects are the ___________ and mutually exclusive projects.

independent

12

What are the two known types of CAPEX projects?

Independent and Mutually exclusive projects

13

Independent projects have no correlation to each other and can be selected individually without impairing the chances of another project. However, mutually exclusive projects ________ with each other, with only one needing to be selected.

compete

14

CAPEX budgeting decisions can be taken on the _____________ or ranking approach.

accept-reject

15

The ranking approach to CAPEX budgeting compares the investment options by some predetermined measure, for example, ___________.

rate of return

16

The accept-reject approach to CAPEX budgeting merely examines a projects ________.

suitability

17

CAPEX ____________ are routinely examined by the cash flow pattern.

expenditures

18

Cash flow patterns allow financial managers to examine the in and outflows of funds for a particular investment. Cash flows may be __________, unconventional, a mixed stream or annuity.

conventional

19

The inflows of cash from an _______ are in equal amounts over a regular period.

annuity

20

It is called a nonconventional cash flow pattern because the initial outflow is then not followed by a ________ stream of inflows.

consistent

21

It is called a mixed stream if the pattern is not an annuity, in other words, the cash inflows are for _______ amounts of money.

varying

22

The relevant cash flows must be examined to assess the _____ budgeting alternatives.

CAPEX

Explanation:

These are the cash flows that matter and assist in determining the suitability and profitability of a project. These cash flows include incremental flows (additional in or out flows that result from a project), the initial investment and operating cash inflows (after-tax cash inflows resulting from a project).

23

When examining a replacement CAPEX decision, the incremental tax flows must take into account the cost of the ____ investment, after-tax inflows from the new replacement asset and the after-tax inflow from the liquidation of the old asset.

initial

24

The asset to be replaced must be liquidated and a value obtained in order to directly _______ the operating cash inflows of the old and new asset.

compare

25

The _________ cost of a new asset and the after-tax proceeds of the old asset are the two types of cash flows to examine in calculating the initial investment of CAPEX.

installed

Explanation:

It is not just the cost of the asset that is required but also the cost of installation of that asset to give a true cost of the asset.

26

Where the original purchase price of Asset A is $125,000, the book value of that asset is $100,000 and upon sale of that asset the price obtained was $110,000; then the difference in the sale price and book value is called recaptured ____________.

depreciation

27

Recaptured depreciation is treated as _________ income and taxed as such.

ordinary

28

In order to make the right CAPEX decisions, capital _________ techniques should be implemented by financial managers.

budgeting

29

Capital budgeting techniques are used to analyze the various project proposals using methods like _________ rate of return.

internal

30

Unsophisticated capital budgeting techniques do not consider the ____ value of money.

time

31

Unsophisticated capital budgeting techniques do not calculate the time value by _________ cash flows to determine present value.

discounting

32

The average rates of ______ and payback period are examples of unsophisticated capital budgeting techniques.

return

Explanation:

These are the two common techniques.

33

To calculate the average rate of return, average profit after taxes for the duration of the projects life is divided by the average _________.

investment

Explanation:

Average Profit (After taxes for the duration of the projects) / Average Investment = Rate of Return

34

The average investment is calculated by halving the ____ investment.

initial

35

When applying the average rate of return technique, the project is accepted where the minimum average rate of return is ________.

exceeded

36

Companies set their own acceptable average rate of return, so if the calculation for a project is greater than that figure, then it will be accepted. However, if the company also uses a _______________ rank, then the project with the better average rate of return will be selected.

profitability

37

The payback period method of capital budgeting calculates the amount of ____ necessary for a project investment to recoup its initial investment.

time

38

The payback period method calculates the cash ______ over time.

inflows

39

In making a decision using the payback period method, a project is accepted where the payback period is less than the _________ payback period as stated by a company.

maximum

40

Where the payback period is less than the maximum allowable, the initial investment is recouped within a ________ acceptable to the company.

timeframe

41

As a capital budgeting technique, the payback period is more ________ than the average rate of return.

accurate

42

The payback period is more accurate as it considers real cash flows rather than accounting profits and because it indirectly considers the ________ of money through the timing of cash flows.

time value

43

The three main sophisticated capital budgeting techniques are the net present value (NPV), profitability index (PI) and ________ rate of return.

internal

Explanation:

These are the 3 most popular techniques that take into account time value of money.

44

What are the three main sophisticated capital budgeting techniques?

1) Net present value (NPV)
2) Profitability Index (PI)
3) Internal rate of return

Explanation:

These are the 3 most popular techniques that take into account time value of money.

45

_____ is calculated by subtracting the initial investment from the present value of cash inflows.

NPV (Net present value)

46

What does IRR stand for?

Internal Rate of Return (IRR)

47

What does NPV stand for?

Net present value (NPV)

48

What does PI stand for?

Profitability Index (PI)

49

If NPV is greater than ____, then a project should be accepted.

zero

Explanation:

This is because above the $0 level, the cost of capital will be less than the return from the project.

50

The PI is calculated by taking the present value of cash inflows and dividing it by the initial __________.

investment

Explanation:

Present value of cash inflows/initial investment = PI (Profitability Index)

51

Projects with a PI (Profitability Index) lower than 1 should be ________.

rejected

52

Where the PI (Profitability Index) is 1 or more, then the ____ will exceed $0.

NPV (Net Present Value)

53

The IRR (Internal rate of return) is the ________ rate that results in a net present value (NPV) of zero for a series of future cash flows.

discount

Explanation:

This is the definition for IRR, which ensures that the present value of cash inflows equals the initial investment.

54

A financial manager should accept a project where the IRR (Internal rate of return) is greater than the cost of _______.

capital

55

Where the IRR(Internal rate of return) is greater than the cost of capital, the company will be making a rate of return higher than the initial investment and hence increase _______ to the company's owners.

wealth

56

Ranking of projects will be critical when the projects are mutually _________.

exclusive

Explanation:

This is because one project has to be chosen at the expense of another; hence ranking will help financial managers make the better choice.

57

_________ can conflict when using the NPV and IRR method because of intermediate cash flows.

Rankings

58

___________ cash flows are treated differently by the 2 methods. In NPV (Net present value), the assumption is that it is reinvested at the cost of capital, whereas in IRR the assumption is it is reinvested at a rate equal to the projects IRR (Internal rate of return).

Intermediate

59

Where a company has unlimited funds, then capital budgeting is straightforward; however, most companies have to apply capital ________ because it has a limited pool of funds and a variety of competing projects to choose from.

rationing

60

__________ has to take place because the reality is that companies do not have a bottomless pit of money to undertake any project it likes.

Rationing

61

When capital rationing, a company can use an ________ opportunities schedule (IOS) to graph the internal rate of return of the competing projects in descending order against the total dollar investment.

investment

62

The ______ limit will dictate which projects are acceptable within dollar constraints but cannot determine which one will maximize owner wealth.

budget

63

What does IOS stand for?

Investment opportunities schedule (IOS)

64

Using the ____ approach to capitol rationing will ensure that the projects selected will maximize owner wealth.

NPV (Net present value)

Explanation:

This approach determines the mixture of opportunities with the greatest overall present value.

65

_______ risk can be determined by the scenario and sensitivity analysis, statistical analysis, decision trees and simulation.

Project

66

How can Project risk be determined?

Scenario and sensitivity analysis, statistical analysis, decision trees and simulation.

67

Sensitivity analysis is a _________ approach using a specified variable with several possible values to determine the effect on return. The scenario analysis is similarly a behavioral approach but has a wider scope.

behavioral

68

Risk can be assessed via the statistical concepts of expected value and _______ deviation and building a table of possible results.

standard

69

Standard deviation is the measure of ________ around the expected outcome.

variability

70

Expected value is the weighted average of possible results from a particular project multiplied by their probability of _________.

occurrence

71

__________ uses a variety of random variables as inputs for analyzing risk.

Simulation

72

The simulation approach is a _________ orientated behavioral method of analyzing risk.

statistically

73

When conducting a capital budgeting exercise using NPV, we need to either adjust the discount rate or cash inflow to reflect ____.

risk

74

_______ rate = (risk adjusted discount rate RADR). This is one of the two main methods of building in risk to the calculation for NPV in capital budgeting.

Discount

75

When adjusting the cash inflows for risk assessment, this process is called certainty ___________.

equivalents

76

Certainty equivalents (CEs) represent the portion of estimated cash inflows which investors are happy to definitely receive as opposed to cash inflows that are _________.

possible

77

Expected cash inflows are converted to CEs and then __________ using the risk free rate.

discounted

78

What does CE stand for?

Certainty equivalents (CE)

79

The risk-free rate is a rate of return on a practically ________ investment, for example, US Treasury bills.

risk-free

80

The _____________ discount rate (RADR) is the rate of return that must be earned on a particular project in order to maintain or improve the company's share price.

risk-adjusted

81

The discount rate of Risk-adjusted discount rate (RADR) is determined by adding the expected risk premium to the __________ rate to calculate the present value of a risky investment.

risk-free