Capital Budgeting Flashcards
Why is capital budgeting the most important responsibility to a financial manager
Capital budgeting decisions often involves the purchase of costly long term assets with lives of many years
The principals underlying the capital budgeting process also apply to other corporate decisions
What are the capital budgeting process
1- idea generation (most important step) (idea could come from external or internal entities)
2- analyzing the project proposal (reject/accept project according to its incremental cash flows)
3- create the firm wide capital budget (prioritize profitable projects according to the timings of its cash flows, funds available and the company’s overall strategic plan.
4- monitoring decisions and conducting a post audit (actual vs estimated results) (identify errors in estimates)
What are the projects that cannot be assessed using the capital budgeting process and NPV
Pet projects(projects independent of your actual work) and very risky projects
What are the costs that are presented with the cash flows and what does the required rate of return reflect
Externalities, opportunity cost and taxes
While the required rate of return include the financing costs and a risk adjustment premium
What distinguishes conventional and unconventional cash flows
The signs change only once
What is project sequencing
Carrying a project today which will result in a project opportunity in a year from today, IF the project was profitable
IRR assumptions
Pv(outflows)=pv(inflows)
NPV=0
What is represented on the x and y axis of an NPV profile
Y-axis is the NPV
X-axis is the cost of capital
Why do two projects intersect in the NPV profile
Because of the difference in the cash flow timings
When does the irr produce conflicting results with the NPV
When assessing mutually exclusive projects
Reasons why irr and NPV might have conflicting results
Cash flow timing difference
The project size
Can a project have no IRR and still be profitable
Yes
Calculating a perpetual cash inflows we use
CF divided by the required rate of return
If a project is sold at the end of the period we add the cash inflow to the last cash flow of the project
Yes
