B2-M8

Question 1

Net Present Value Method (NPV)

Answer 1

=Discounted cash flows- Initial investment

• positive result means make investment
• discount (hurdle rate) made in advance
• assumes cash flows are reinvested @ same rate
• depreciation (except tax shield) is ignored
• flexible to handle inconsistent rates of return
• does not provide true rate of return

Question 2

Capital budgeting

Answer 2

Process for evaluating and selecting LT investment projects for firm

Question 3

Profitability index

Answer 3

• PV of net future cash inflow/ PV of net initial investment

- used for capital rationing( restriction on the amt of new projects)

Question 4

Pretax cash flow

Answer 4

start with Net income and add back non-cash expenses (depreciation and amortization)

Question 5

Net initial cash outflow

Answer 5

Purchase price of asset + shipping/installation and testing + required increase in working capital