Flashcards in Deck 7 Deck (20):
What capital budgeting method is used for Capital Rationing?
Discounted cash flow methods include:
NPV, IRR, and profitability index
After tax cash flows =
Annual cash inflows after tax plus depreciation tax shield
Internal rate of return method
Computes rate of return where NPV equals zero (focuses on discount rate instead of dollars)
The higher the present value factor, the lower the
Internal rate of return
Present value factor =
Investment / Cash flows
Annual Operating Cash flow (After-tax CF) =
Pretax CF x (1 - tax rate) + (Depreciation x tax rate)
The amount of dollars saved =
Depreciation x tax rate
Discounted Cash flow =
PV of cash outflow - PV of cash inflow
What happens to NPV when the discount rate is increased?
Major advantage of NPV over IRR
NPV allows for differing rates; IRR - can only use a single rate
Profitability Index (PI) =
PVFCF / initial investment (cost); PI > 1 = positive NPV
What happens to discount rate when risk increases?
Increase the discount rate
Financial leverage increases when:
Debt to equity ratio increases
Use of fixed operating costs rather than variable operating costs
Firm uses debt rather than equity to finance the company
Cost of debt is most frequently measured as:
Actual interest rate minus tax savings
What is the least expensive component of a company's capital structure?
Does a company want a low or high WACC?
Lowest possible WACC