BEC 10

Question 1

what does IRR measure

Answer 1

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

Question 2

What Net Present Value measure

Answer 2

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

Question 3

What is at the capital budgeting process

Answer 3

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

Question 4

How do you figure out the cost of not taking a discount 3/10 net 30

Answer 4

3% / 360 days/
(100% - 3%) * (30days - 10days) = 55.67%

this equals the cost of not taking the discount

Question 5

What does a positive net present value indicate about its required rate of return

Answer 5

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

Question 6

What is a limitation of the profitability index

Answer 6

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

Question 7

What is capital budgeting

Answer 7

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

Question 8

When determining whether or not to make an investment - what do you compare to the Internal Rate of Return

Answer 8

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

Question 9

When is the discount rate (hurdle rate of return) determined in advance

Answer 9

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

Question 10

In economic order quantity - what is the formula used and assumptions made

Answer 10

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

Question 11

What does the payback period measure

Answer 11

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

Question 12

What does the discounted payback method measure

Answer 12

It measures the recovery period using discounted future cashflows

It does NOT consider cash flows after the investment has been recovered

Question 13

What does the the net present value method indicate

Answer 13

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

Question 14

What does IRR indicate

Answer 14

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

Question 15

What does it mean when an investment has a positive net present value at a specified rate of return

Answer 15

This means that the internal rate of return on the investment is greater than the specified rate

Question 16

What is market capitalization

Answer 16

common stock price per share * common stock shares outstanding

Its only on common stock - not debt - not part of the calculation

Question 17

Common share represent what

Answer 17

They are ownership interest in a company

They are permanent in nature without a fixed maturity date

They have the LOWEST priority upon liquidation

Question 18

Debt holders have what

Answer 18

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

Question 19

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?

Answer 19

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.

Question 20

What is the profitability index and when do you use it

Answer 20

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