Capital Budget 2.

Question 1

What is discounted cash flow?

Answer 1

Discounted cash flow is a technique that uses time value of money concepts to measure the present value of cash inflows and cash outflows expected from a capital budget project.

Question 2

What is the objective of discounted cash flow?

Answer 2

The objective of discounted cash flow is to focus decision makers on relevant cash flows appropriately discounted to the present value.

Question 3

What are 2 types of DCF methods?

Answer 3

1. Net Present Value

2. Internal Rate of Return

Question 4

What are 3 factors of DCF?

Answer 4

1. Dollar amount of initial investment
2. the dollar amount of future cash inflows and cash outflows
3. the rate of return desired for projects

Question 5

What is the rate of return?

Answer 5

Compensation for all risk assumed.

Question 6

What are 3 different approaches to assign the rate of return for DCF?

Answer 6

1. Assign rate based on WACC
2. Assign target rate
3. Assign rate base on risk

Question 7

What are the advantages of DCF?

Answer 7

One advantage of DCF is the consideration of time value of money.

Question 8

What are the limitations of DCF?

Answer 8

DCF frequently uses a single interest rate over time and this is unrealistic because interest rates or risk may fluctuate.

Question 9

What DCF method allows for the rate of return to change?

Answer 9

Net present value is the discount rate that allows the rate of return to change.

Question 10

What DCF method uses an unchanging rate of return?

Answer 10

Internal rate of return does not allow the rate of return to change.