FIN 6100 Exam 3
What is the solution to the NPV method? - CORRECT ANSWER-Profitability Index.
Allows ranking of projects.
Takes the PV of all future cash flows and divides it by the cost of the project.
What is Economic Value Added used to do? - CORRECT ANSWER-evaluate the
effectiveness of employees and operating units.
Are you generating more worth than we are paying you?
What is the difference between after-tax and tax shield? - CORRECT ANSWER-After-
Tax: cash flows left over after paying taxes.
Tax Shield: expenses that save you from having to pay as much in taxes.
If you are expecting positive cash flows, do you want to use MACRS or straight line
depreciation? - CORRECT ANSWER-MARCS.
if you are expecting a loss, use straight line. often used for new businesses with
uncertain income.
What are side effects? - CORRECT ANSWER-Things that otherwise wouldn't have
happened because you took on a project.
Cannibalization/shifting revenue
What are the 3 types of expenditures? - CORRECT ANSWER-Depreciable
non-depreciable
expenditures on net working capital
what are three methods for evaluating a project? - CORRECT ANSWER-1. scenario
analysis
2. sensitivity analysis
3. breakeven analysis
What are decision rules? - CORRECT ANSWER-methods that we use in the evaluation
of projects to see what we want to invest in
5 types of decision rules - CORRECT ANSWER-1. Payback Period
2. Discounted Payback Period
, 3. IRR
4. NPV
5. Profitability index
Pros and Cons of the Payback period method
(2, 4) - CORRECT ANSWER-Pros:
- focus on recovering funds quickly
- easy to understand/teach
Cons:
- short term focus at the expense of long term profit
- ignores timing and the magnitude of later cash flows.
- ignores risk
- doesn't allow ranking
What does it mean if the IRR is larger than the WACC? - CORRECT ANSWER-that we
are earning more than what it costs us. Making profit.
Pros and Cons of IRR (3, 2) - CORRECT ANSWER-Pros:
- incorporates risk of cash flows.
- accounts for timing of cash flows
- allows for ranking based on return.
Cons:
- does not show magnitude of earnings.
- cannot have more than 1 neg. cash flow.
What is the best and worst method for project selection? - CORRECT ANSWER-Best:
NPV
Worst: payback period
Pros and Cons of the NPV method (4, 1) - CORRECT ANSWER-pros:
- adjusted for timing of cash flows
- considers all cash flows
- can handle multiple neg. cash flows
- considers magnitude
always accept the same projects whether using IRR or NPV
Cons:
- doesn't allow for ranking.
What is cash flow? - CORRECT ANSWER-the cash available to return to investors and
other sources of financing.
What is the solution to the NPV method? - CORRECT ANSWER-Profitability Index.
Allows ranking of projects.
Takes the PV of all future cash flows and divides it by the cost of the project.
What is Economic Value Added used to do? - CORRECT ANSWER-evaluate the
effectiveness of employees and operating units.
Are you generating more worth than we are paying you?
What is the difference between after-tax and tax shield? - CORRECT ANSWER-After-
Tax: cash flows left over after paying taxes.
Tax Shield: expenses that save you from having to pay as much in taxes.
If you are expecting positive cash flows, do you want to use MACRS or straight line
depreciation? - CORRECT ANSWER-MARCS.
if you are expecting a loss, use straight line. often used for new businesses with
uncertain income.
What are side effects? - CORRECT ANSWER-Things that otherwise wouldn't have
happened because you took on a project.
Cannibalization/shifting revenue
What are the 3 types of expenditures? - CORRECT ANSWER-Depreciable
non-depreciable
expenditures on net working capital
what are three methods for evaluating a project? - CORRECT ANSWER-1. scenario
analysis
2. sensitivity analysis
3. breakeven analysis
What are decision rules? - CORRECT ANSWER-methods that we use in the evaluation
of projects to see what we want to invest in
5 types of decision rules - CORRECT ANSWER-1. Payback Period
2. Discounted Payback Period
, 3. IRR
4. NPV
5. Profitability index
Pros and Cons of the Payback period method
(2, 4) - CORRECT ANSWER-Pros:
- focus on recovering funds quickly
- easy to understand/teach
Cons:
- short term focus at the expense of long term profit
- ignores timing and the magnitude of later cash flows.
- ignores risk
- doesn't allow ranking
What does it mean if the IRR is larger than the WACC? - CORRECT ANSWER-that we
are earning more than what it costs us. Making profit.
Pros and Cons of IRR (3, 2) - CORRECT ANSWER-Pros:
- incorporates risk of cash flows.
- accounts for timing of cash flows
- allows for ranking based on return.
Cons:
- does not show magnitude of earnings.
- cannot have more than 1 neg. cash flow.
What is the best and worst method for project selection? - CORRECT ANSWER-Best:
NPV
Worst: payback period
Pros and Cons of the NPV method (4, 1) - CORRECT ANSWER-pros:
- adjusted for timing of cash flows
- considers all cash flows
- can handle multiple neg. cash flows
- considers magnitude
always accept the same projects whether using IRR or NPV
Cons:
- doesn't allow for ranking.
What is cash flow? - CORRECT ANSWER-the cash available to return to investors and
other sources of financing.
