Corporate Finance Review Exam Questions and Answers Latest Update

Capital Budgeting Process - ANSWER-Identifying & evaluating firm capital projects where cash flow to the firm will be received over a period longer than 1 year Categories of Capital Budgeting Projects - ANSWER-1. Replacement Projects to Maintain the Business: made without detailed analysis, should existing operations continue 2. Replacement projects for cost reduction: should you replace obsolete equipment, fairly detailed analysis 3. Expansion projects: complex analysis, require explicit forecast of future demand 4. New product or market development: complex analysis, large uncertainty involved 5. Mandatory projects: required by government agency/insurance company, generate little to no rev 6. "Other" projects: not analyzed easily through this process, "pet project" like corp perks or high risk endeavor Five Key Principles of Budgeting Process - ANSWER-1. decisions based on cash flows (incremental), not accounting income 2. cash flows are based on opportunity costs 3. timing of cash flows: CF earlier worth more 4. cash flows analyzed on after-tax basis: value based on CF going to keep 5. financing costs reflected in project's required rate of return: projects expected to return more than cost of capital needed to fund them Sunk Costs - ANSWER-costs that can't be avoided even if project isn't undertaken; not affected by accept/reject decision so not included in the analysis ex/ consulting fee Externalities - ANSWER-effects of the acceptance of a project on other cash flows negative: cannibalization, when a new project takes sales from an existing project positive: doing the project would have a positive effect on sales of a firm's other line of project lines