chapter 10 Flashcards

1
Q

Card M1

A

Card M2

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2
Q

What is the formula for Net Present Value (NPV)?

A

NPV = Σ (CFₜ / (1 + r)ᵗ) – Initial Outlay

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3
Q

What does NPV stand for?

A

Net Present Value

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4
Q

What is the decision rule for NPV?

A

Accept the project if NPV ≥ 0

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5
Q

What is the Payback Period?

A

The time it takes to recover the initial investment from project cash flows

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6
Q

What is the Discounted Payback Period?

A

The time it takes to recover the initial investment using discounted cash flows

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7
Q

What is the decision rule for Payback Period?

A

Accept if PBP ≤ cutoff period

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8
Q

What is the formula for Profitability Index (PI)?

A

PI = PV of inflows / Initial Outlay

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9
Q

What is the decision rule for PI?

A

Accept if PI ≥ 1

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10
Q

What does IRR stand for?

A

Internal Rate of Return

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11
Q

What is IRR?

A

The discount rate that makes NPV = 0

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12
Q

What is the IRR decision rule?

A

Accept the project if IRR ≥ required rate of return

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13
Q

What is MIRR?

A

Modified Internal Rate of Return

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14
Q

Why is MIRR used over IRR?

A

MIRR solves multiple IRR problems and assumes reinvestment at WACC

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15
Q

What is the EAA (Equivalent Annual Annuity)?

A

A method to convert NPV into equal annual amounts over a project’s life

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16
Q

What is the formula to find EAA?

A

EAA = NPV / PVIFA(r,n)

17
Q

What does PVIFA stand for?

A

Present Value Interest Factor of an Annuity

18
Q

What is the primary goal of capital budgeting?

A

To choose projects that increase firm value (positive NPV)

19
Q

What are the main capital budgeting tools?

A

NPV, IRR, MIRR, PI, Payback, DPBP, EAA

20
Q

What is capital rationing?

A

When a firm limits capital spending despite having positive NPV projects

21
Q

What is a crossover point?

A

The discount rate at which two project NPVs are equal

22
Q

What is the formula for calculating DPBP between two years?

A

DPBP = Year X + (Remaining amount / Next year’s discounted CF)

23
Q

What’s the primary weakness of the payback method?

A

Ignores TVM and cash flows after cutoff

24
Q

How is IRR calculated?

A

Trial and error or financial calculator until NPV = 0

25
Q

What causes multiple IRRs?

A

Projects with cash flows that change sign more than once

26
Q

When does IRR conflict with NPV?

A

In mutually exclusive projects or non-normal cash flows

27
Q

What is the required rate of return usually set to?

A

The firm’s WACC

28
Q

What does WACC stand for?

A

Weighted Average Cost of Capital