BFIN 300 Final Review Questions with Correct
Verified Answers
Capital Budgeting Decision
What long term investment should we make?
-process of determining the nature of the firm's operations for years to come
Allocating Capital decisions
What services to offer?
What markets to compete in?
What new products to introduce?
Corporate Finance
Relationship between business decisions and the value of stock in the business
Net Present Value (NPV)
the difference between an investment's market value and its cost
-What investment is worth more than it costs?
-Account of time value of money helps identify NPV
Formula of NPV
NPV = PV of Cash Flows - Initial Investment
What is your role as an investor, treasurer, CEO or CFO?
To determine which investment has a positive net present value (shareholder value)
-done through capital budgeting process
,+ NPV, -NPV, 0 NPV
+ NPV = accept (binary decision investment)
- NPV = reject
0 NPV = agnostic
5 Capital Budgeting Methods
1) Payback Period Rule
2) Discounted Payback Period
3) Average Accounting Return
4) Internal Rate of Return
5) Profitability Index
Payback Period Rule
the amount of time required for an investment to pay itself (original cost)
Discounted Payback Period
Amount of time for discounted cash flow to equal 0
Discounted Cash Flow
What you are losing by not investing (in a given period)
Average Accounting Return
Average net income/average book value
-> average annual profit/ initial investment
Internal rate of return
, Discount rate that makes the NPV of a particular investment 0
Profitability Index
Present value of investment future cash flows divided by its initial cost (1+ = accept, below 1 =
reject)
Internal Rate of Return (IRR)
the single rate of return that summarizes the merits of a specific project.
-depends ONLY on the cash flows of the SPECIFIC project!
IRR formula
IRR = (It's value to you at the end of the term - initial investment you paid)/ Initial investment
you paid
-PERCENTAGE
Formula for calculating IRR without discount rate
NPV = (Initial investment) + [Value at the end of term/(1 + R)]
NPV = ($100) + [$110/(1+R)]
1 + R = $110/$100 = 1.1
R = 10%
IRR advantages
-closely related to NPV
-Leads to identical Decisions
IRR disadvantages
Verified Answers
Capital Budgeting Decision
What long term investment should we make?
-process of determining the nature of the firm's operations for years to come
Allocating Capital decisions
What services to offer?
What markets to compete in?
What new products to introduce?
Corporate Finance
Relationship between business decisions and the value of stock in the business
Net Present Value (NPV)
the difference between an investment's market value and its cost
-What investment is worth more than it costs?
-Account of time value of money helps identify NPV
Formula of NPV
NPV = PV of Cash Flows - Initial Investment
What is your role as an investor, treasurer, CEO or CFO?
To determine which investment has a positive net present value (shareholder value)
-done through capital budgeting process
,+ NPV, -NPV, 0 NPV
+ NPV = accept (binary decision investment)
- NPV = reject
0 NPV = agnostic
5 Capital Budgeting Methods
1) Payback Period Rule
2) Discounted Payback Period
3) Average Accounting Return
4) Internal Rate of Return
5) Profitability Index
Payback Period Rule
the amount of time required for an investment to pay itself (original cost)
Discounted Payback Period
Amount of time for discounted cash flow to equal 0
Discounted Cash Flow
What you are losing by not investing (in a given period)
Average Accounting Return
Average net income/average book value
-> average annual profit/ initial investment
Internal rate of return
, Discount rate that makes the NPV of a particular investment 0
Profitability Index
Present value of investment future cash flows divided by its initial cost (1+ = accept, below 1 =
reject)
Internal Rate of Return (IRR)
the single rate of return that summarizes the merits of a specific project.
-depends ONLY on the cash flows of the SPECIFIC project!
IRR formula
IRR = (It's value to you at the end of the term - initial investment you paid)/ Initial investment
you paid
-PERCENTAGE
Formula for calculating IRR without discount rate
NPV = (Initial investment) + [Value at the end of term/(1 + R)]
NPV = ($100) + [$110/(1+R)]
1 + R = $110/$100 = 1.1
R = 10%
IRR advantages
-closely related to NPV
-Leads to identical Decisions
IRR disadvantages
