Chapter 8

Question 1

Chapter 8 focuses on making what decisions?

Answer 1

Investment

Question 2

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

Answer 2

Capital Budgeting

Question 3

Capital Budgeting involves what and what measurements?

Answer 3

Quantitative and Qualitative

Question 4

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

Answer 4

Costs and Benefits

Question 5

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

Answer 5

The Decision Making Framework

Question 6

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

Answer 6

The 3 Capital Budgeting Techniques

Question 7

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

Answer 7

The 2 Versions of the Payback Method

Question 8

Initial Investment / Annual Net Cash Inflow

Answer 8

The Payback Period Formula

Question 9

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

Answer 9

Time Value

Question 10

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

Answer 10

Payback Method with Uneven Cash Flow Table

Question 11

1 easy calculation
2 quick measure of risk

Answer 11

Strengths of the Payback Method

Question 12

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

Answer 12

Weaknesses of the Payback Method

Question 13

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

Answer 13

The net value added to a firm by the project

Question 14

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

Answer 14

Discount Rates

Question 15

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

Answer 15

The Hurdle Rate

Question 16

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

Answer 16

Net Present Value Rule

Question 17

— Co + [ C1 / (1 + r) ]

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

Answer 17

The NPV Formula

Question 18

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

Answer 18

The Strengths of the NPV Method

Question 19

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

Answer 19

The Weaknesses of the NRV Method

Question 20

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

Answer 20

Internal Rate of Return Technique

Question 21

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

Answer 21

IRR Rule

Question 22

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

Answer 22

The Strengths of the IRR Method

Question 23

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

Answer 23

Weaknesses of the IRR Model

Question 24

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

Answer 24

The 3 Capital Budgeting Extensions

Question 25

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

Answer 25

The Profitability Index

Question 26

Present Value of Net Cash Flow / Initial Investment

Answer 26

Profitability Index Formula

Question 27

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

Answer 27

Mutually Exclusive Projects

Question 28

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

Answer 28

Helpful

Question 29

A firm puts a limit on the amount of its investments

Answer 29

Capital Rationing

Question 30

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

Answer 30

Relevance for Managers of Investment Decisions