BEC Unit 2 Module 9

Question 1

Internal Rate of Return

Answer 1

Rate used to arrive at a NPV of 0

• -Focuses decision makers on percentages
• -IRR > Hurdle Rate = Accept
• -Sometimes called time-adjusted rate of return
• • Investment / Cash Flows
• • Less reliable than the NPV when there are several alternating periods of net cash inflows and outflows

Question 2

Payback Period

Answer 2

Net initial investment / Average incremental cash flow

• -Ignores cash flows at end of payback period (disadvantage)
• -Uneven cash flows, use the cumulative approach (logical approah)
• -Ignores time value of money
• -Emphasizes liquidity and risk

Question 3

Finance Lease

Answer 3

Finance an asset with debt and meets ONE of the OWNES requirements

Question 4

Operating Lease

Answer 4

Does NOT meet ANY of the OWNES requirements

Question 5

Investment Decision

Answer 5

Discount after-tax operating cash inflows at the firm’s WACC

Question 6

Financing Decision

Answer 6

Discount cash-flows at the after-tax cost of debt
Lowest NPV of cost
Option#1: Buy asset
–Purchase cost or present value of lease payments
–Tax savings from depreciation
–Scrap proceeds
Option#2: Lease asset
–Lease payments (outflow)
–Tax savings on lease payments (offsets outflow)

Question 7

After-tax lease payment formula

Answer 7

Lease payment x (1 - T)