Capital budgeting, Financial Mgmt Flashcards
As used in capital budgeting analysis, the internal rate of return uses which of the following items in its computation?
1 - Net Incremental Investment
2 - Incremental Average Operating Income
3 - Net Annual Cash Flows
- Yes
- NO
- Yes
Which of the following events would decrease the internal rate of return of a proposed asset purchase?
a. Decrease tax credits on the asset.
b. Use accelerated, instead of straight-line depreciation. c. Shorten the payback period.
d. Decrease related working capital requirements.
The internal rate of return is computed as follows:
Investment / Cash Flows = Present Value Factor
The higher the present value factor, the lower the computed rate (internal rate of return). Increases to the investment or decreases to the cash flows serve to increase the present value factor.
Choice “a” is correct. A decrease in tax credits associated with an asset would increase the initial investment. That increase would cause the present value factor to increase and would result in a decline in internal rate of return.
As a company becomes more conservative with respect to working capital policy, it would tend to have a (n) ?
Working capital policy is deemed to be more conservative as an increasing portion of an organization’s long-term assets, permanent current assets, and temporary current assets are funded by long-term financing.
An increase in the ratio of current assets to non- current assets would be indicative of an increasingly conservative working capital policy. With no other information, an increase in current assets would indicate that a growing percentage of current assets are financed by non current liabilities and that, nominally, the absolute amount of working capital and the current ratio is improving.
Why would a firm generally choose to finance temporary assets with short-term debt?
Matching the maturities of assets and liabilities reduces risk.
Matching the maturities of current assets with liabilities as they come due is designed to ensure liquidity and reduce risk of cash shortages. Temporary assets (such as inventories, generally, and seasonal inventories, specifically) might be financed with short term debt such that the earnings from the sales of those temporary assets could be used to liquidate the related obligations as they come due and ensure that cash is available to meet cash flow requirements.
Matching cash inflows with cash outflows are more influential in determining a firm’s ability to repay debt rather than the length of the obligation
Which one of the following factors might cause a firm to increase the debt in its financial structure?
a. A decrease in the times interest earned ratio.
b. An increase in the price/earnings ratio.
c. Increased economic uncertainty.
d. An increase in the corporate income tax rate.
Choice “d” is correct. An increase in the corporate income tax rate might cause a firm to increase the debt in its financial structure because interest is tax deductible, while dividends are not tax deductible.
A firm that designs its cost structure to include a higher degree of operating fixed costs than variable costs by electing to pay salaries instead of commissions, is magnifying the impact of each additional sales dollar using the concept of:
a. Fixed leverage.
b. Financial leverage.
c. Operating leverage.
d. Combined leverage.
Choice “c” is correct. Operating leverage is defined as the degree to which a firm uses fixed operating costs, as opposed to variable operating costs. A firm that has high operating leverage has high fixed operating costs and relatively low variable operating costs and uses this cost structure to magnify the financial results of each additional dollar in sales.
Materials requirements planning (MRP)
Materials requirements planning (MRP) is an inventory management technique that projects and plans inventory levels in order to control the usage of raw materials in the production process. MRP primarily applies to work in process and raw materials.
