BEC 10 Flashcards
what does IRR measure
It measures the interest rate at which the NPV of a projects cashflow is zero
It calculates the rate where the initial investment and the PV of future cash inflows are equal
It is the discount rate at which the net present value is zero
What Net Present Value measure
It is the excess of the present value of cash inflows over cash outflows over the LIFE of the project on a predetermined rate or factor
What is at the capital budgeting process
This process is based on relevant cash flows that will occur if the project is undertaken.
Cashflows are analyzed on an after-ta basis.
depreciation is a tax shield that reduce in come taxes and as a result depreciation is used in the capital budgeting process in determining the tax costs or benefits
How do you figure out the cost of not taking a discount 3/10 net 30
3% / 360 days/
(100% - 3%) * (30days - 10days) = 55.67%
this equals the cost of not taking the discount
What does a positive net present value indicate about its required rate of return
A positive net present value means that at the benchmark rate or RRR the pv of the investment’s future cashflows exceed the initial investment.
This means that the Rate of Return on the investment is greater than the required rate of return
What is a limitation of the profitability index
It relies on forecasts of future information
These forecasts may extending the distant future and may not actually occur
It is based on net present value (includes time value of money)
It measures how profitable an investment is and is consistent with the goal of shareholder wealth maximization
What is capital budgeting
This is used to make long term investment decisions
It is the process for deciding the amount allocated to long-term projects and the acquisition of fixed assets
It would take into consideration the equipment requests of the various departments and other components of the entity
When determining whether or not to make an investment - what do you compare to the Internal Rate of Return
IRR will be compared to a benchmark that is meaningful of rte company - this is frequently the company’s Weighted average cost of capital
It will indicate whether the investment will provide a greater return to its shareholders
If its greater - greater return for investors
If its lower - will reduce it because the return is lower
When is the discount rate (hurdle rate of return) determined in advance
Under the net present value method - the PV of net cash flows is calculated using the hurdle rate of return which is used in advance
In economic order quantity - what is the formula used and assumptions made
economic order quantity
This is the formula used to determine the optimum amount of inventory to purchase with each order to minimize carrying and order costs
It assumes that the cost of carrying a unit in inventory AND the cost of placing an order will remain constant.
It assumes that demand for the period can be estimated
What does the payback period measure
The length of time it requires to recover an investment
Does NOT take into consideration whether or not there are cashflows once the investment has been recovered
What does the discounted payback method measure
It measures the recovery period using discounted future cashflows
It does NOT consider cash flows after the investment has been recovered
What does the the net present value method indicate
It indicates whether or not the return on an investment at least equals a predetermined rate
But doesn’t tell you which investment to make more than one have returns in excess of that threshold
What does IRR indicate
It indicates whether or not the return on an investment at least equals a predetermined rate
But doesn’t tell you which investment to make more than one have returns in excess of that threshold
What does it mean when an investment has a positive net present value at a specified rate of return
This means that the internal rate of return on the investment is greater than the specified rate
What is market capitalization
common stock price per share * common stock shares outstanding
Its only on common stock - not debt - not part of the calculation
Common share represent what
They are ownership interest in a company
They are permanent in nature without a fixed maturity date
They have the LOWEST priority upon liquidation
Debt holders have what
They do NOT have an ownership interest
They do not have a fixed maturity date
Debt generally has a higher priority than common shares in liquidation
A company invests $100,000 in property. The company has a contract to sell it for $120,000 in one year. The bank has a guaranteed interest rate of 10%. What is the net present value of the company’s investment in the property?
Net present value is the difference between the present value of the proceeds from the cash flows generated by an investment, including its sale, and the initial cost of the investment. This investment will generate $120,000 in proceeds at the end of one year. At an interest rate of 10%, the present value would be $120,000/1.10 or $109,091. Compared to the initial investment of $100,000, the net present value is $9,091.
What is the profitability index and when do you use it
It divides net present value by the initial net investment
This can then be used to compare the relative profitability of investments
The idea is that resources are scarce and therefore you need to choose investments with the highest rate of return relative to the amount invested
