Chapter 12 Flashcards
What are the 5 types of capital budgeting decision?
- Plant expansion
- Equipment selection
- Lease or buy
- equipment replacement
- Cost reduction
What is the time value of money?
A dollar today is worth more than a dollar a year from now
What is the equation for the payback method?
Payback period = investment required / Annual net cash inflow
How do you calculate payback period for an uneven cash flow?
Subtract cash inflow from initial investment until all is recovered
What are the strengths of the payback method?
- serves as a screening tool
- identifies investments that will recoup investment quickly
- identifies products that recoup initial investment quickly
What are the weaknesses of the payback method?
- ignore the time value of money
- ignores cash flow after the payback period
- short payback period does not always mean a more desirable investment
What are the three main types of cash flow under NPV?
- initial cash outlay (outflow)
- annual cash flow (both)
- salvage and final cash flow
What are the two approaches to NPV?
- Total cost approach
- Least cost approach
What is the table layout for NPV?
year | cash flow | Annuity | PV
What is the equation for profitability index?
PI = present value of cash inflow / required investment
What is the Internal rate of return?
The discount rate that results in NPV = 0
How do you solve for IRR?
- PV factor = investment / Annual cash inflow
- Use PV factor and PV annuity table to solve for IRR
What is the formula for simple rate of return?
simple rate of return = annual incremental NOI / initial investment
