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Financial Management > Chapter 11 > Flashcards

Chapter 11 Flashcards

1
Q

refers to long term assets used in production

A

capital

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2
Q

plan that outlines projected expenditures during some future period

A

budget

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3
Q

summary of planned investment in long term assets

A

capital budget

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4
Q

process of planning expenditures on assets with cash flows that are expected to extend beyond 1 year

A

capital budgeting

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5
Q

capital budgeting uses same concepts used in

A

security valuation

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6
Q

stocks and bond exist in the security markets, and investors select from the available set
investors have no influence on the cash flows produced by their investments

A

security valuation

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7
Q

firms, create capital budgeting projects
corporations have major influence on projects’ results

A

capital budgeting

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8
Q

similarities of stock valuation and capital budgeting

A
  1. forecast set of cash flows
  2. find the present value of those flows
  3. pv of the inflows > investment’s cost
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9
Q

criteria for deciding to accept or reject projects

A
  1. Net present value
  2. Internal Rate of return
  3. modified internal rate of return
  4. regular payback
  5. discounted payback
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10
Q

a method of ranking investment proposals using the npv, which is equal ro the pv of future net cash flows, discounted at the cost of capital

A

NPV

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11
Q

tells how much a project contributes to shareholder wealth

A

NPV

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12
Q

high discount rate will lead to __ NPV

A

lower

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13
Q

larger NPV = ____ project adds

A

more value

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14
Q

NPV FORMULA

A

NPV = CF0 + CFN / (1+r )^N

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15
Q

types of decision rules

A
  1. independent projects
  2. mutually exclusive projects
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16
Q

projects whose cash flows are note affected by one another

A

independent project

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17
Q

independent projects

A

NPV > 0 => Accept

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18
Q

projects where if one project is accepted, the other must be rejected

A

Mutually exclusive projects

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19
Q

mutually exclusive projects accept

A
  • highest positive NPV
  • if no project is positive - reject all
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20
Q

it is the discount rate that forces the pv of inflows to equl the cost. (npv = 0)

A

internal rate of return

21
Q

if IRR>cost of fund

A

difference will be a bonus to a stockholders and cause stock price to rise

22
Q

independent projects accept

A

IRR > WACC

23
Q

mutually exclusive project accept

A

project with highest IRR

24
Q

a graph showing the relationship between a project’s NPV and fhe firm’s cost of capital

A

NPV Profiles

25
Q

npv profiles x and y axes

A

x axis - discount rate
y axis - NPV

26
Q

the rate of return at which rhe NPVs of two projects are equal

A

crossover rate

27
Q

useful in capital budgeting analysis because it tells the investing company about the cost of capital at which both of the mutually exclusive projects are equally good

A

npv profiles

28
Q

limitations of IRR

A
  1. unconventional cash flows
  2. reinvestment assumption
    (npv calculation is based on the assumption that cash inflows can be reinvested at the projects risk adjusted wacc
29
Q

assumes that positive cash flows are reinvested at the firm’s cost of capital and that negative cash flows are financed at the firm’s financing cost

A

MIRR

30
Q

MIRR FORMULA

A

[nth root of FV (reinvestment rate)/ -PV (finance cost)] - 1

31
Q

evaluating true ratw of return

A

MIRR > IRR

32
Q

choosing among competing projects

A

NPV > IRR and MIRR

33
Q

the length of time required for an investment’s net revenues to cover its cost

A

payback period

34
Q

payback formula

A

no. of years prior to full recovery + (unrecovered cost at start of year/CF during full recovery)

assumes unifoem CF

35
Q

payback note

A

shorter the payback, better the project

36
Q

advantages of payback period

A
  • easy to understand
  • adjust for uncerrainy of later CF
  • biased towards liquidity
37
Q

disadvantages if payback period

A
  • ignores time value of money
  • requires an arbitrary cutoff point
  • ignores cf beyond the cutoff date
  • biased against long term projects, such as research and development, and new projects
38
Q

the length of time required for an investment’s cash flows, discounted at the investment’s cost of capital, to cover its costs

A

discounted payback

39
Q

it is used as part of capital budgeting to determine which projects to take on

A

discounted payback

40
Q

more accurate because discounted payback period factors in the

A

time value of money

41
Q

accept/reject decisions, large, sophisticated firms

A

all five measures

42
Q

provides direct measure of value the project adds to shareholder wealth

A

NPV

43
Q

measure profitability

A

IRR and MIRR

44
Q

contain information concerninf project’s safety margin

A

percentage rate of return

45
Q

is better indicator to know projects’ rates if return

A

MIRR

46
Q

provide indications if project’s liquidity and risk

A

payback and discounted payback

47
Q

means relatively illiquid and riskier than one with a shorter payback

A

long payback

48
Q

it is the best single criterion, but all of the methods provide useful information and all are easy to calculate, thus all are used along with judgement and common sense

A

NET PRESENT VALUE

Financial Management (5 decks)

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