Exam 4 (Chapters 8 and 10) Flashcards
the process of planning and managing firms long term financial investments
Capital Budgeting
What are the 4 different types of Projects?
- Expansion
- Improvements of efficiency
- Recalls or Replacements
- Government Mandated
What are the 3 Capital Budgeting Methods?
Payback, NPV, and IRR
Time required for an investment to generate cash flows, to recover initial costs
Payback
what is another terms for Payback?
“Get your bait back” method
What are the advantages of payback?
Easiest
Adjust cash flows
Biased towards liquidity
What are the disadvantages of payback?
Ignores TVM
Requires an arbitrary cutoff point
Ignores cash flows beyond cutoff date
Biased against long term projects
what is the rule regarding payback?
accept on the project if the payback is less than the project cutoff
the difference between a projects market value and its cost
NPV
What is the rule of NPV?
accept projects with a positive NPV
reject projects with a negative NPV
what are the advantages of NPV?
Most reliable capital budgeting method
Provides a direct measure of investor contributions
DOES consider TVM
What are the disadvantages of NPV?
the growth rate is arbitrary
the discount rate (interest rate) that makes NPV of an investment zero
Internal Rate of Return (IRR)
the point at which you make nothing
Break even point
What is the rule of IRR?
accept project if the IRR that we calculate is the same or greater than the return investors require
What are the advantages of IRR?
investors prefer to speak %
what are the disadvantages of IRR?
often lead to inaccurate investment decisions
if you take on one investment, you cannot take on any other
mutually exclusive projects