UO BA 318 Final || Get it Correct.
NPV correct answers - Way to decide if we should invest in a project or not.
- Dollar measure
- How the investment effects the value of a company.
- Going to look at the changes in cash flows (future free & Incremental) that occur from a
project.
When there is excess cash flow they can do two things correct answers - Pay dividends
- Reinvest in projects evaluated by NPV criteria
Interest rate, opportunity cost, discount rate correct answers (r)
When calculating NPV correct answers Ignore all financing activities when making capital
budgeting decisions
Discount rates correct answers Riskiness of future free cash flows
NPV ignores (drawbacks) correct answers Value of managerial flexibility. NPV does not take
option value into account.
You accept the project when correct answers NPV is positive
When NPV is positive.. correct answers - IRR is greater than R
- Increases firm value
- PV of cash inflows are greater than PV of cash outflows
,You reject when correct answers NPV is negative because it decreases firm value. Not what we
want to do.
When choosing between 2 (or multiple) projects correct answers NPV is always going to be best
When you get zero NPV correct answers Indifferent because it does not increase or decrease firm
value.
Other ways to evaluate investment opportunities (Capital Budgeting Decisions) correct answers -
Internal rate of return (IRR)
- Payback period
- Profitability Index
IRR correct answers Discount rate (percentage) that tells you the actual rate of return a project is
expected to earn
Decision rule bases on internal rate of return correct answers - Accept if IRR is greater than the
(required) discount rate.
- Accept if investments internal rate of return exceeds a pre-specified benchmark return;
otherwise reject the investment.
Don't use IRR when (drawbacks) correct answers - Generally inappropriate to use IRR to choose
among projects.
- Choosing between two different projects can create problem as...
- Multiple rates can be appropriate.
Payback period correct answers How long it takes to get the initial investment back
, Decision rule for payback period correct answers Accept if the payback period is less than some
preset benchmark length of payback period.
Issues with Payback correct answers - Payback doesn't correspond to a measure of an
investments effect on the value of the firm
- Payback doesn't discount cash flows
- Benchmark payback period is arbitrary
- Payback ignores distant cash flows, everything past benchmark
Profitability Index (PI) correct answers The present value of an investment's future cash flows
divided by its initial cost. Also called the benefit-cost ratio.
Accept when PI is correct answers Greater than 1
Issues with PI include correct answers - Requires long detailed forecasts of cash flows
- Shouldn't be used to choose between projects
Capital Budgeting correct answers - Decision making process for investment decisions
- Deciding how much and what to invest in
Operating cash flow includes correct answers - Revenues from the project
- Operating costs
- Taxes — include the tax effects of depreciation
- Incremental overhead and administrative costs the project creates
Depreciation correct answers Reduces a firms taxable income
NPV correct answers - Way to decide if we should invest in a project or not.
- Dollar measure
- How the investment effects the value of a company.
- Going to look at the changes in cash flows (future free & Incremental) that occur from a
project.
When there is excess cash flow they can do two things correct answers - Pay dividends
- Reinvest in projects evaluated by NPV criteria
Interest rate, opportunity cost, discount rate correct answers (r)
When calculating NPV correct answers Ignore all financing activities when making capital
budgeting decisions
Discount rates correct answers Riskiness of future free cash flows
NPV ignores (drawbacks) correct answers Value of managerial flexibility. NPV does not take
option value into account.
You accept the project when correct answers NPV is positive
When NPV is positive.. correct answers - IRR is greater than R
- Increases firm value
- PV of cash inflows are greater than PV of cash outflows
,You reject when correct answers NPV is negative because it decreases firm value. Not what we
want to do.
When choosing between 2 (or multiple) projects correct answers NPV is always going to be best
When you get zero NPV correct answers Indifferent because it does not increase or decrease firm
value.
Other ways to evaluate investment opportunities (Capital Budgeting Decisions) correct answers -
Internal rate of return (IRR)
- Payback period
- Profitability Index
IRR correct answers Discount rate (percentage) that tells you the actual rate of return a project is
expected to earn
Decision rule bases on internal rate of return correct answers - Accept if IRR is greater than the
(required) discount rate.
- Accept if investments internal rate of return exceeds a pre-specified benchmark return;
otherwise reject the investment.
Don't use IRR when (drawbacks) correct answers - Generally inappropriate to use IRR to choose
among projects.
- Choosing between two different projects can create problem as...
- Multiple rates can be appropriate.
Payback period correct answers How long it takes to get the initial investment back
, Decision rule for payback period correct answers Accept if the payback period is less than some
preset benchmark length of payback period.
Issues with Payback correct answers - Payback doesn't correspond to a measure of an
investments effect on the value of the firm
- Payback doesn't discount cash flows
- Benchmark payback period is arbitrary
- Payback ignores distant cash flows, everything past benchmark
Profitability Index (PI) correct answers The present value of an investment's future cash flows
divided by its initial cost. Also called the benefit-cost ratio.
Accept when PI is correct answers Greater than 1
Issues with PI include correct answers - Requires long detailed forecasts of cash flows
- Shouldn't be used to choose between projects
Capital Budgeting correct answers - Decision making process for investment decisions
- Deciding how much and what to invest in
Operating cash flow includes correct answers - Revenues from the project
- Operating costs
- Taxes — include the tax effects of depreciation
- Incremental overhead and administrative costs the project creates
Depreciation correct answers Reduces a firms taxable income
