Finc Mgmt A2 - Financial and Risk Analysis Flashcards
Advantages of IRR over ARR:
- emphasis on CFs
- use of TVM
Payback Period is the
of Years it takes in Cash Inflows to recover the entire Cash outflow
If income tax is ignored, how would depreciation be handled under the ARR, IRR, and PB methods?
Include in ARR but exclude in IRR and PB
Profitability Index =
(PV of Future CF aka Initial investment + NPV) / Initial Investment
Rates used in NPV include
cost of capital, hurdle rate, and req. rate of return
Q6
[PLACEHOLDER]
Internal Rate of Return =
[PLACEHOLDER]
If mgmt believes too many proposals are being rejected, the hurdle rate would be
lower
If mgmt believes bank loans are riskier than capital investments, then the hurdle rate would be
different for each of the methods
If mgmt believes capital investment proposals involve average risk, then the hurdle rate would be
average
If mgmt wants to factor risk into the consideration of projects, then the hurdle rate would be
high
Annual Compound Interest Formula =
A = P (1 + (r/n))^nt
Where:
A = Accrued Amount (principal + interest) P = Principal Amount I = Interest Amount r = Annual Nominal Interest Rate % t = Time Involved in years n = number of compounding periods per unit t; at the END of each period
Chose projects with the _____ profitability index first
highest
ARR =
Incremental Accounting Income / Initial Investment OR Net Cost Savings / Initial Investment
*factors depreciation in
The use of resource markets outside of the firm involve
opportunity costs
Opportunity are _____ costs
implicit
Accounting profit =
Revenue - Explicit Costs
IRR should be used with which TVM table?
PV of an Annuity of $1
NPV should be used with which TVM table?
PV of $1
Discounted breakeven period is
the point where discounted cumulative cash inflows = discounted total cash outflows
NPV =
PV of future cash inflows - Initial Investments
Positive NPV indicates that the IRR _____ the hurdle rate
exceeds
Ordinary Annuity aka Annuity in Arrears is
payable at the end of each period
Annuity Due aka Annuity in Advance is
payable at the beginning of each period
Discounted Payback period should be used with which TVM table?
PV of $1
When you expect a series of equal payments for a fixed amount of time, the NPV should be used with the
PV of an ordinary annuity of $1
The discounted, net-of-tax amount related to disposal of an asset =
Proceeds from sale - (Sales price less tax basis x tax rate x PV of $1)
As interest rates get higher, the PV factors for the same # of periods becomes
smaller
For NPV, the use of an accelerated depreciation method instead of the straight-line method has the effect of
increasing the PV of the depreciation tax shield
A multiperiod project has a positive NPV, thus the required rate of return is
less than the project’s IRR
The NPV of a proposed investment is negative, therefore the discount rate must be
greater than the project’s IRR
When the risks of the individual components of a project’s cash flows are different, an acceptable procedure to evaluate these cash flows is to
discount each cash flow using a discount rate that reflects the degree of risk
If a project has differing required rates of return over it’s life, i.e., 8% the first 3 years and 12% the second 3 years, the analyst should
compute NPV using both rates for the applicable years and accept the project if NPV is at least zero
The method that recognizes TVM by discounting the after tax CF over the life of a project, using the company’s minimum desired rate of return is
NPV method
The method that determines the discount rate at which the PV of the projected future CF exactly equals the initial cost of the investment is
IRR method
The method that determines the length of time required to recover the inital cash outlay of a capital project computed as the initial investment divided by annual cash flow is
Payback Period
The method that uses non-discounted measures and is computed as (Net CF - Depreciation) / Investment is
ARR method
If NPV is positive, it would indicate that the rate of return is _______ than the discount percentage rate used in the NPV computation
greater
The recommended technique for evaluating projects when capital is rationed and there are no mutually exclusive projects from which to choose is to rank the projects by
Profitability index
A projects NPV, ignoring income tax considerations, is normally affected by the
proceeds from the sale of the asset to be replaced
Capital budgeting methods are often divided into what 2 classes?
project screening and project ranking
Example of project ranking method
Profitability Index
Examples of project screening methods
Payback method, Time adjusted rate of return, and the ARR method
The capital budgeting model that is generally considered the best model for long-range decision making is the
discounted CF model
The payback reciprocal can be used to approximate a project’s
IRR if CF pattern is relatively stable
- If the cash flow pattern is relatively stable, the payback reciprocal number serves as a good approximation of a present value of an annuity table factor. Using the payback number and a PV of an Annuity table, it becomes a relatively simple matter to look up an interest rate corresponding to the appropriate number of years’ life of a project. This interest rate will be a close approximation of the internal rate of return.
The Profitability Index is a variation on the which capital budgeting model?
NPV
Contribution Margin =
(Revenue - VC) / Revenue
A measure of project risk is provided by the capital budgeting technique of
payback
PV of $1 =
Future CF / (1+Req. rate of return)^n
Profitability Index =
NPV / Investment Required
Payback method:
- does not adjust for TVM
- formula = Initial Investment / Annual CF
- Ignores profitability
- is the length of time required to recover the initial investment
- Does not consider equip replacement
ARR =
Increase in Income / Required Investment
Payback period =
Initial Investment / Annual Cash Flow
If you ______ discount rate, NPV would decrease
increase
IRR > Required Rate of return, then
NPV > 0
In capital budgeting, the Profitability Index is best used to
select projects when capital budgeting funds are limited
Capital budgeting techniques would ______ likely be used to evaluate the adoption of a new method of allocating non-traceable costs to product lines
least
If a firm identifies (or creates) an investment opportunity with a present value ________ its cost, then the value of the firm and the price of its common stock will ________.
greater than; increase
When evaluating capital budgeting analysis techniques, the payback period emphasizes
liquidity
IRR is less reliable than NPV when
there are net cash inflows of sizable amounts early in the project
Real $ =
Actual $ / (1+Inflation rate)^n
