SS11 R36 Capital Budgeting

Question 1

profitability index

Answer 1

PV of a project’s future CFs divided by initial investment

= 1 + NPV/initial investment

Question 2

Is negative NPV and positive IRR possible?

Answer 2

yes

eg. payback period of 1 year with initial outlay of 100 and CFs of 100, then 5

Question 3

Why are interest costs likely NOT included in the estimate of the incremental cash flows from a project?

Answer 3

costs to finance a project are taken into account already when CFs are discounted at the appropriate cost of capital

interest costs are a part of the cost of debt, which is already included in the cost of capital

Question 4

Where are financing costs recognized in terms of capital budgeting?

Answer 4

financing costs are reflected in the project’s required rate of return

Question 5

What type of cost are cash flows based upon?

Answer 5

cash flows are based on opportunity costs