PTD Flashcards
NPV VS PAYBACK PERIOD
his is to provide the information you requested concerning the payback period and net present value approaches to evaluating capital projects.
The payback period approach determines the economic feasibility of a capital project by determining how long it takes for net cash flows from the project to recover the initial cost of the project. For example, a project that costs $60,000 and is expected to generate $20,000 per year in net cash flow would have a three year payback period ($60,000/$20,000).
Typically, a firm will pre-establish a maximum period for recovering the cost of a project. If the payback period of a project is expected to be equal to or less than the pre-established maximum period, the project is considered economically feasible. But, if the payback period is expected to be longer than the pre-established maximum period, the project is not considered economically feasible and would not be pursued. In the above example, if the pre-established payback period is three years or less, the project would be considered economically feasible.
The payback period approach has the advantage of being easy to understand and apply. In addition, it is based on cash flow, which makes it especially useful in evaluating the liquidity of a project. However, this approach has two serious drawbacks. First, it uses nominal cash flows, rather than discounted cash flows. Therefore, it ignores the time value of money. A variation, the discounted payback period approach, would overcome this disadvantage. The second drawback is that it measures cash flows only for the period of time needed to recover the initial investment, not for the entire life of the project. Therefore, this approach does not measure total project profitability.
The net present value approach assesses projects by comparing the present value of the expected cash flows of the project with the initial cash investment in the project. Specifically, the expected cash flows from a project are discounted to present value using an appropriate discount rate, frequently the firm?s cost of capital. If the present value of expected cash flows is equal to or greater than the investment in the project, which would create a net present value that is zero or positive, the project would be considered economically feasible. If the net present value is negative, the project would not be economically feasible.
The determination of net present value of a project is based on cash flows discounted to present value. Therefore, unlike the payback period method, it recognizes the time value of money. Also, unlike the payback period method, it considers the entire life and expected results of a project. However, because it applies a discount rate to cash flows over the life of the project, it implicitly assumes that when those cash flows are received they can be reinvested at the discount rate used, which may not occur.
The foregoing describes the basic nature of the payback period and the net present value methods of evaluating capital projects, and the primary advantages and disadvantages of each. If you would like additional information, please let me know.
I.M. Candidate
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ERM
Enterprise risk management concerns the identification and management of events and circumstances that may impact the ability of an entity to achieve its objectives. A number of recent corporate frauds, including Enron Corp., WorldCom, Adelphia Communications, Tyco International, Global Crossing, and Qwest Communications scandals have increased concern with, and attention to, enterprise risk management.
A number of risks should be considered as a part of enterprise risk management. These risks include damage to the organization’s reputation, business interruption due to disaster (e.g., flood) or human events (e.g., a labor strike), liability to third parties, distribution or supply chain failure, risk related to the market environment, to regulatory or legislative changes, due to market competition or failure to attract or retain key staff or management, technology failure, failure of a disaster recovery plan, and loss of data.
A number of benefits can be realized by organizations to effectively implement systems for managing enterprise-level risks. These benefits include aligning the organization’s risk appetite and strategy such that the organization chooses to assume an appropriate level of risk, rather than assuming an unknown or inappropriately low or high level of risk. Assessment of an organization’s risk appetite and strategy also enables the development of mechanisms to better manage risk. Risk management also creates the possibility for improving organizational responses to risk. For example, organizations may choose to avoid, reduce, share, or to accept, risks. Better management of enterprise-level risks also reduces the likelihood of operational surprises and losses.
Enterprise level risk management enables organizations to better identify potential risk events and to establish responses, thereby reducing surprises in the associated costs and losses. Risk management also enables the ability to manage multiple and cross enterprise risks. For example, Ensenada Products has divisions both in the United States and Mexico. The risks related to political instability along the U.S. Mexican border, coupled with increased risks of drug cartel actions in Mexico must be assessed jointly to determine whether and how they pose risks and threats to Ensenada’s operations. The assessment of enterprise-level risks can also lead to the identification of opportunities to enhance an organization’s business prospects. For example, assessing the risks related to online sales and activities may give rise to the realization that additional opportunities exist in online markets that have not been previously considered. Finally, enterprise-level risk assessment can lead to improved capital deployment. Specifically, risk information can allow management to better assess its capital needs and to improve capital allocations among competing projects and alternatives.
In short, enterprise-level risk assessment promises a number of important insights and advantages to Ensenada Products. I look forward to exploring these opportunities further with you.
Sincerely,
Alex Poindexter
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The optimal capitalization for an organization usually can be determined by the
Maximum degree of financial leverage.
Maximum degree of total leverage.
Lowest total weighted-average cost of capital.
Intersection of the marginal cost of capital and the marginal efficiency of investment.
Lowest total weighted-average cost of capital.
This Answer is Correct
The optimal capitalization for an organization would be determined by the lowest total weighted-average cost of capital. The weighted-average cost of capital determines the average cost of a corporation’s capital by weighting each component, both debt and equity. The lowest total weighted-average cost of capital usually would be the optimal capitalization and would maximize the value of the firm’s stock.
A country’s currency conversion value has recently changed from 1.5 to the U.S. dollar to 1.7 to the U.S. dollar. Which one of the following statements about the country is correct?
Its exports are less expensive for the United States.
Its currency has appreciated.
Its imports of U.S. goods are more affordable.
Its purchase of the U.S. dollar will cost less.
Its exports are less expensive for the United States.
This Answer is Correct
If the currency exchange rate between the U.S. dollar and a foreign currency changes from $1.00 = 1.50 foreign currency units (FCU) to $1.00 = 1.70 FCU, the dollar has appreciated relative to the foreign currency (or the foreign currency has weakened relative to the U.S. dollar). Therefore, U.S. dollars will buy more of that country’s goods/services; the exports of that country are less expensive to the U.S. market.
Which of the following is considered an application input control? Run control total. Edit check. Report distribution log. Exception report.
Edit check.
An edit check is an application input control. Therefore, this is the best answer to this question
Virgil Corp. uses a standard cost system. In May, Virgil purchased and used 17,500 pounds of materials at a cost of $70,000. The materials usage variance was $2,500 unfavorable, and the standard materials allowed for May production was 17,000 pounds. What was the materials price variance for May? $17,500 favorable. $17,500 unfavorable. $15,000 favorable. $15,000 unfavorable.
$17,500 favorable.
This answer is correct. Using the model suggested in the study text to perform the calculations:
Units Price/Unit Total
Standard Costs 17,000 lbs. x Std. Price =
Actual Costs 17,500 lbs. x $4.00* = $70,000
Differences (500) lbs.
*Actual Price = $70,000/17,500 lbs. = $4.00
Usage variance = ($2,500) = Difference in Units x Std. Price
= (500) x Std. Price
Std. Price = ($2,500) / (500) = $5.00 per unit
Substituting the standard price into the previous calculation, we now have:
Units Price/Unit Total
Standard Costs 17,000 lbs. x $5.00 = $85,000
Actual Costs 17,500 lbs. x $4.00* = $70,000
Differences (500) lbs. $1.00 $15,000
Price variance = Difference in Price x Actual Quantity Used =
$1.00 x 17,500 = 17,500 favorable various
Check: Usage Variance + Price Variance = Total Difference in Costs
($2,500) + $17,500 = $15,000
The profitability index is a variation on which of the following capital budgeting models? Internal rate of return. Economic value-added. Net present value. Discounted payback.
Net present value
This answer is correct. The profitability index is calculated as the ratio of the net present value of the project to its initial cost.
Which one of the following is most likely the U.S. share of worldwide exports? 50%. 15%. 10%. 2%.
10%
The U.S. exports about 10% of worldwide exports.
For a given level of tax collections, prices, and interest rates, a decrease in governmental purchases will result in a(n)
(This question is CIA adapted)
Increase in aggregate demand.
Increase in aggregate supply.
Decrease in aggregate demand.
Decrease in aggregate supply.
Decrease in aggregate demand
The government represents one segment of the economy that demands goods and services. If government spending decreases, aggregate demand decreases.
Which one of the following is central to determining the nature of market structure in a free-market economy?
The size of the market.
The nature of the good or service provided by the market.
The extent of competition in the market.
Whether the market provides goods or, alternatively, services.
The extent of competition in the market.
This Answer is Correct
The extent of competition in the market is central to determining the nature of market structure. Perfect competition occupies one end of a conceptual market structure continuum and perfect monopoly—the absence of competition–occupies the other end.
s SWOT analysis concerned with external environment, internal characteristics, or both? External Environment Internal Characteristics Yes Yes Yes No No Yes No No
YES YES
This Answer is Correct
SWOT is concerned with both the external environment of an entity (the opportunities and threats) and its internal characteristics (strengths and weaknesses).
When erroneous data are detected by computer program controls, such data may be excluded from processing and printed on an error report. The error report should most probably be reviewed and followed up by the Supervisor of computer operations. Systems analyst. Control group. Computer programmer.
Control group
This Answer is Correct
This answer is correct because the control group is responsible for providing a continuous review function by supervising and monitoring input, operations, and the distribution of output (i.e., a continuous internal audit function).
Which of the following could be used to hedge a net receivable denominated in British pounds by a U.S. company?
Purchase a currency put option in British pounds.
Purchase a currency call option in British pounds.
Purchase a forward contract to buy British pounds.
Purchase a forward contract to buy U.S. dollars.
Purchase a currency put option in British pounds.
This Answer is Correct
(Correct!) A currency put option would enable the U.S. company to lock in the price at which it could sell (put) the British pounds when received.
