Unit 4: Capital Budgeting Flashcards by Keith McDonnell

True or false

Sunk costs can be changes by the decision to accept or reject a project

False

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True or false

NPV is negative for discount rates below the internal rate of return (IRR)

False

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What are Multiple rates of return?

One potential problem in using the IRR method if more than one discount rate makes the NPV of an investment zero.

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While computing the project operating cash flow it is assumed that there is no _____ expense.

interest.

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True or false

(Regular) payback period methods adjust for uncertainty of later cash flows.

true

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True or false

NPV is negative for discount rates above the internal rate of return (IRR).

True

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The Internal Rate of Return (IRR) is sometimes called the ____ _____ _____ or ____ _____

Discounted Cash Flow (DCF)

DCF return

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True or false

Cash flows from financing costs are considered (relevent/not relevant) cash flows.

not relevant.

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True or false

NPV is positive for discount rates below the internal rate of return (IRR).

True

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In capital budgeting decisions, cash flows should always be considered on an ____-__ basis.

After-tax

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What is a Sunk Cost?

A sunk cost is a cost we have already paid or have already incurred the liablity to pay.

Such a cost cannot be changed by the project’s accept/reject decision.

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Accounrding to the basic IRR rule, we should (accept/reject) a project if the IRR is less than the required return.

reject

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True or false

(Regular) payback period methods are biased toward liquidity.

True

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What is Capital rationing?

The situation that exists if a firm has positive NPV projects but cannot find the necesary financing.

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True or false

Cash flows from beneficial spillover effects are considered (relevent/not relevant) cash flows.

relevant.

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True or false

Costs that are already paid or have been incurred as a liability are sunk costs.

True

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True or false

Deciding how a firm will manage its short-term operating activites is a part of Capital Budgeting.

False

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What is the benefit/cost ratio?

The Profitability index of an investment project.

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The internal rate of return of a project is a function of the _______ of the project.

Cash Flows

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True or false

Operating Cash Flow (OCF) can be calculated by subtracting costs and taxes from total sales.

OCF = Sales - Costs - Taxes

True

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Evaluating an investment by discounting its future cash flows is called _____ _____ _____ valuation.

Discounted cash flow

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True or false

Sales revenue lost due to new competitors entering the market is an example of an opportunity cost

False

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True or false

New Working Capital is needed to purchase raw materials

True

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What is the impact on the depreciation tax shield if the tax rate increases?

It will increase

If a Net Present Value of an investment is negative the investment should be ?

rejected

The amount of time required for an investment to generate cash flows to recover its initial cost is called its ____ \_\_\_\_\_

Payback period

True or false NPV is equal to zero when the discount rate equals the internal rate of return (IRR).

True

\_\_\_\_ ____ \_\_\_\_ is a measure of how much value is created or added today by undertaking an investment

Net Present Value

What is the *Net Present Value rule*?

An investment should be accepted if the NPV is positive and rejected if the NPV is negative.

True or false Deciding which fixed assets to buy is a part of **Capital Budgeting**.

True

Financial Statements projecting future years' operations are known as ___ \_\_\_\_ financial statements.

Pro forma

What does NPV stand for?

Net Present Value

The capital budgeting method used to find the length of time required for an investment's discounted cash flows to equal its initial cost is called the ______ \_\_\_\_\_ ______ method

Discounted payback period

True or false Cash flows from erosion effects are considered (**relevent/not relevant**) cash flows.

relevant.

Which of the following are examples of sunk costs * The salvage value of equipment * The cost of new equipment * The test marketing expenses of a new product * The direct labour cost of a new project

* The test marketing expenses of a new product * The direct labour cost of a new project

A **Conventional Cash Flow** is....

When the first cash flow is negative (a typical investment) and all other cash flows are positive (there are no years of negative cash flows).

A company is considering a $105 000 investment for new equipment. The discounted Operating Cash Flows are $98500 and the value of the tax shield on CCA is $35 000. What is the NPV of this project?

$28 500 You add the CCA Tax Shield to the NPV.

True or false New Working Capital is needed to purchase plant and equipment.

False

What is the **Average Accounting Return (AAR)?**

Average Accounting Return (AAR) is An investment's average net income divided by its average book value. Average Net Income / Average Book Value = AAR

True or false (Regular) payback period methods adjust any risks associated with projects.

false

If a Net Present Value of an investment is positive the investment should be ?

accepted

True or false Operating Cash Flow (OCF) can be calculated by adding depreciation costs to EBIT OCF = EBIT + Depreciation

True

Interest expenses incurred on debt financing are (ignored/treated as cash outflows) when analyzing a proposed investment.

Ignored

The Equivalent Annual Costs (EAC) approach is most useful when comparing project with unequal (**lives** / **cash flows**)

Lives

Net present value (NPV) is (**positive/negative**) if the requried return is greater than the IRR? (use the picture to understand the concept)

negative

The ______ \_\_\_\_\_\_ method considers the time value of money yet its usage is far less frequent than the regular payback method.

Discounted Payback

True or false Cash flows from sunk costs are considered (**relevent/not relevant**) cash flows.

not relevant.

What does DCF stand for?

Discounted Cash Flow

True or false New Working Capital is needed to cover the amount of accounts receivable

True

True or false NPV is positive for discount rates above the internal rate of return (IRR).

False

True or false A firm's investment in a project's Net Working Capital closely resembles a loan.

True

Net present value (NPV) is (**positive/negative**) if the requried return is less than the IRR? (use the picture to understand the concept)

positive

True or false New Working Capital is needed to cover the amount of accounts payable

False

What is the **Profitability Index (PI)?**

The present value of an investment's future cash flows divided by its initial cost; also called benefit/cost ratio.

The formula for calculating the present value of the tax shield on Capital Cost Allowance (CCA) applies when \_\_\_\_

The CCA asset class will remain open when the project is completed. e.g. There is Undepreciated Capital Cost (UCC) still on the books.

What is the **Net Present Value Profile?**

A graphical representation of the relationship between an investment's NPV and the various discount rates.

What order should the steps to determine the discounted payback period * Add the discounted cash flows * Accept if the discounted payback perido is less than a prescribed # of years. * Determine the discounted payback period * Discount the cash flows using the discount rate

1. Discount the cash flows using the discount rate 2. Add the discounted cash flows 3. Determine the discounted payback period 4. Accept if the discounted payback perido is less than a prescribed # of years.

What is Discounted Cash Flow (DCF) valuation?

The process of valuing an investment by discounting future cash flows

The difference between a firm's future cash flows with a project and without the project is called _____ cash flows.

Incremental

This picture is an example of a(n).....

NPV Profile. The NPV is plotted on the Y (vertical) axis Various return rates is plotted on the X (horizontal) axis The Internal Rate of Return (IRR) is the return rate where NPV is zero.

What is the **stand-alone principle**?

Evaluation of a project based on the project's incremental cash flows.

What is Net Present Value (NPV)?

The difference between an investment's market value and it's cost. NPV = Market Value - Cost

The IRR of a project is the discount rate that makes the project's NPV equal to \_\_\_\_.

Zero

True or false (Regular) payback period methods adjust for time value of money

false

What are the 3 core beliefs of the basic net present value (NPV) investment rule?

* Accept a project if its NPV is greater than zero * Reject a project if its NPV is less than zero * Indifferent to a project it its NPV is equal to zero

The portion of cash flows of a new project that come at the expense of a firm's existing operations is called \_\_\_\_\_\_.

Erosion

Unit 4: Capital Budgeting Flashcards

(68 cards)