Chapter 8 Flashcards

1
Q

Chapter 8 focuses on making what decisions?

A

Investment

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2
Q

A specific decision making process that involves whether or not to proceed with a project

A

Capital Budgeting

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3
Q

Capital Budgeting involves what and what measurements?

A

Quantitative and Qualitative

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4
Q

Capital budgeting works by knowing the initial cost and estimating the future what?

A

Costs and Benefits

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5
Q

1 Define the decision and related issues
2 determine criteria to evaluate alternatives
3 generate alternatives
4 analyze and assess alternatives
5 decide and implement

A

The Decision Making Framework

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6
Q

1 payback method
2 net present value
3 internal rate of supportive return (IRR)

A

The 3 Capital Budgeting Techniques

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7
Q

1 for projects with up front investment and smooth or annual cash flows
2 a more general estimation of payback when net cash flows are uneven

A

The 2 Versions of the Payback Method

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8
Q

Initial Investment / Annual Net Cash Inflow

A

The Payback Period Formula

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9
Q

The payback method ignores the what of money? Although this is okay for SMALL investments

A

Time Value

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10
Q

Year Net Cash Flow Cumulative Cash Flow
0 (100) (100)
1. (10). (110)
2. 5 (105)
3. 12. (93)
4. 18. (75)
5. 22. (53)
6. 27. (26)
7. 33. 7
8. 35. 42

A

Payback Method with Uneven Cash Flow Table

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11
Q

1 easy calculation
2 quick measure of risk

A

Strengths of the Payback Method

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12
Q

1 no time value consideration
2 no consideration of cash flows expected to occur beyond payback period

A

Weaknesses of the Payback Method

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13
Q

The goal of the net present value method is to determine what?

A

The net value added to a firm by the project

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14
Q

The cost of capital in the net present value method formula includes what?

A

Discount Rates

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15
Q

The risk associated with uncommon territory for the organization is called what?

A

The Hurdle Rate

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16
Q

A firm should accept any project with a net present value greater than or equal to 0

A

Net Present Value Rule

17
Q

— Co + [ C1 / (1 + r) ]

— Co = Initial Cash Outflow Today
Ct = Initial Cash Outflow Today
r = Disc. Or Hurdle Rate as Decimal

A

The NPV Formula

18
Q

1 accounts for time value
2 reasonably assumes any interim cash flow from project are reinvested at firm’s cost of capital

A

The Strengths of the NPV Method

19
Q

1 challenges in determining realistic cash flow estimate and estimating an appropriate hurdle rate

A

The Weaknesses of the NRV Method

20
Q

A measurement similar to the yield to maturity measure of bonds which tells us what particular discount rate will result in a zero NPV project

A

Internal Rate of Return Technique

21
Q

A firm should accept any project with an internal rate of return greater than or equal to a pre specified hurdle rate

A

IRR Rule

22
Q

1 Take time value into account
2 provide results as a return measure rather than simple dollar measure

A

The Strengths of the IRR Method

23
Q

1 if there is a unusual cash flow pattern (negative to positive) with lots of sign changes than there would be more than one internal rate of return
2 assumed re-invented at IRR which may not be realistic but there is a modified IRR which we will not be tested on

A

Weaknesses of the IRR Model

24
Q

1 the profitability index
2 equivalent annual costs and project lengths
3 mutually exclusive projects and capital rationing

A

The 3 Capital Budgeting Extensions

25
Q

There is no difference between benefits and costs expressed as a dollar amount in NPV method and taken as a ratio

A

The Profitability Index

26
Q

Present Value of Net Cash Flow / Initial Investment

A

Profitability Index Formula

27
Q

Implies choosing one means we don’t take on the other

A

Mutually Exclusive Projects

28
Q

IRR is not as what as NPV because it assumes any project that exceeds the discount or hurdle rate will be taken on

A

Helpful

29
Q

A firm puts a limit on the amount of its investments

A

Capital Rationing

30
Q

1 investment decisions are a crucial function for almost any manager
2 time value of money are foundational for effective decisions
3 managers goal is to add value and this is largley done by positive net present value projects

A

Relevance for Managers of Investment Decisions