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BUSA523 - Corporate Finance > Unit 4: Capital Budgeting > Flashcards

Unit 4: Capital Budgeting Flashcards

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1
Q

True or false

Sunk costs can be changes by the decision to accept or reject a project

A

False

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2
Q

True or false

NPV is negative for discount rates below the internal rate of return (IRR)

A

False

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3
Q

What are Multiple rates of return?

A

One potential problem in using the IRR method if more than one discount rate makes the NPV of an investment zero.

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4
Q

While computing the project operating cash flow it is assumed that there is no _____ expense.

A

interest.

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5
Q

True or false

(Regular) payback period methods adjust for uncertainty of later cash flows.

A

true

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6
Q

True or false

NPV is negative for discount rates above the internal rate of return (IRR).

A

True

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7
Q

The Internal Rate of Return (IRR) is sometimes called the ____ _____ _____ or ____ _____

A

Discounted Cash Flow (DCF)

or

DCF return

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8
Q

True or false

Cash flows from financing costs are considered (relevent/not relevant) cash flows.

A

not relevant.

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9
Q

True or false

NPV is positive for discount rates below the internal rate of return (IRR).

A

True

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10
Q

In capital budgeting decisions, cash flows should always be considered on an ____-__ basis.

A

After-tax

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11
Q

What is a Sunk Cost?

A

A sunk cost is a cost we have already paid or have already incurred the liablity to pay.

Such a cost cannot be changed by the project’s accept/reject decision.

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12
Q

Accounrding to the basic IRR rule, we should (accept/reject) a project if the IRR is less than the required return.

A

reject

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13
Q
A
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14
Q

True or false

(Regular) payback period methods are biased toward liquidity.

A

True

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15
Q

What is Capital rationing?

A

The situation that exists if a firm has positive NPV projects but cannot find the necesary financing.

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16
Q

True or false

Cash flows from beneficial spillover effects are considered (relevent/not relevant) cash flows.

A

relevant.

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17
Q

True or false

Costs that are already paid or have been incurred as a liability are sunk costs.

A

True

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18
Q

True or false

Deciding how a firm will manage its short-term operating activites is a part of Capital Budgeting.

A

False

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19
Q

What is the benefit/cost ratio?

A

The Profitability index of an investment project.

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20
Q

The internal rate of return of a project is a function of the _______ of the project.

A

Cash Flows

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21
Q

True or false

Operating Cash Flow (OCF) can be calculated by subtracting costs and taxes from total sales.

OCF = Sales - Costs - Taxes

A

True

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22
Q

Evaluating an investment by discounting its future cash flows is called _____ _____ _____ valuation.

A

Discounted cash flow

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23
Q

True or false

Sales revenue lost due to new competitors entering the market is an example of an opportunity cost

A

False

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24
Q

True or false

New Working Capital is needed to purchase raw materials

A

True

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25
Q

What is the impact on the depreciation tax shield if the tax rate increases?

A

It will increase

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26
Q

If a Net Present Value of an investment is negative the investment should be <accepted>?</accepted>

A

rejected

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27
Q

The amount of time required for an investment to generate cash flows to recover its initial cost is called its ____ _____

A

Payback period

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28
Q

True or false

NPV is equal to zero when the discount rate equals the internal rate of return (IRR).

A

True

29
Q

____ ____ ____ is a measure of how much value is created or added today by undertaking an investment

A

Net Present Value

30
Q

What is the Net Present Value rule?

A

An investment should be accepted if the NPV is positive and rejected if the NPV is negative.

31
Q

True or false

Deciding which fixed assets to buy is a part of Capital Budgeting.

A

True

32
Q

Financial Statements projecting future years’ operations are known as ___ ____ financial statements.

A

Pro forma

33
Q

What does NPV stand for?

A

Net Present Value

34
Q

The capital budgeting method used to find the length of time required for an investment’s discounted cash flows to equal its initial cost is called the ______ _____ ______ method

A

Discounted payback period

35
Q

True or false

Cash flows from erosion effects are considered (relevent/not relevant) cash flows.

A

relevant.

36
Q

Which of the following are examples of sunk costs

  • The salvage value of equipment
  • The cost of new equipment
  • The test marketing expenses of a new product
  • The direct labour cost of a new project
A
  • The test marketing expenses of a new product
  • The direct labour cost of a new project
37
Q

A Conventional Cash Flow is….

A

When the first cash flow is negative (a typical investment) and all other cash flows are positive (there are no years of negative cash flows).

38
Q

A company is considering a $105 000 investment for new equipment. The discounted Operating Cash Flows are $98500 and the value of the tax shield on CCA is $35 000. What is the NPV of this project?

A

$28 500

You add the CCA Tax Shield to the NPV.

39
Q

True or false

New Working Capital is needed to purchase plant and equipment.

A

False

40
Q

What is the Average Accounting Return (AAR)?

A

Average Accounting Return (AAR) is

An investment’s average net income divided by its average book value.

Average Net Income / Average Book Value = AAR

41
Q

True or false

(Regular) payback period methods adjust any risks associated with projects.

A

false

42
Q

If a Net Present Value of an investment is positive the investment should be <accepted>?</accepted>

A

accepted

43
Q

True or false

Operating Cash Flow (OCF) can be calculated by adding depreciation costs to EBIT

OCF = EBIT + Depreciation

A

True

44
Q

Interest expenses incurred on debt financing are (ignored/treated as cash outflows) when analyzing a proposed investment.

A

Ignored

45
Q
A
46
Q

The Equivalent Annual Costs (EAC) approach is most useful when comparing project with unequal (lives / cash flows)

A

Lives

47
Q

Net present value (NPV) is (positive/negative) if the requried return is greater than the IRR?

(use the picture to understand the concept)

A

negative

48
Q

The ______ ______ method considers the time value of money yet its usage is far less frequent than the regular payback method.

A

Discounted Payback

49
Q

True or false

Cash flows from sunk costs are considered (relevent/not relevant) cash flows.

A

not relevant.

50
Q

What does DCF stand for?

A

Discounted Cash Flow

51
Q

True or false

New Working Capital is needed to cover the amount of accounts receivable

A

True

52
Q

True or false

NPV is positive for discount rates above the internal rate of return (IRR).

A

False

53
Q

True or false

A firm’s investment in a project’s Net Working Capital closely resembles a loan.

A

True

54
Q

Net present value (NPV) is (positive/negative) if the requried return is less than the IRR?

(use the picture to understand the concept)

A

positive

55
Q

True or false

New Working Capital is needed to cover the amount of accounts payable

A

False

56
Q

What is the Profitability Index (PI)?

A

The present value of an investment’s future cash flows divided by its initial cost; also called benefit/cost ratio.

57
Q

The formula for calculating the present value of the tax shield on Capital Cost Allowance (CCA) applies when ____

A

The CCA asset class will remain open when the project is completed.

e.g. There is Undepreciated Capital Cost (UCC) still on the books.

58
Q

What is the Net Present Value Profile?

A

A graphical representation of the relationship between an investment’s NPV and the various discount rates.

59
Q

What order should the steps to determine the discounted payback period

  • Add the discounted cash flows
  • Accept if the discounted payback perido is less than a prescribed # of years.
  • Determine the discounted payback period
  • Discount the cash flows using the discount rate
A
  1. Discount the cash flows using the discount rate
  2. Add the discounted cash flows
  3. Determine the discounted payback period
  4. Accept if the discounted payback perido is less than a prescribed # of years.
60
Q

What is Discounted Cash Flow (DCF) valuation?

A

The process of valuing an investment by discounting future cash flows

61
Q

The difference between a firm’s future cash flows with a project and without the project is called _____ cash flows.

A

Incremental

62
Q

This picture is an example of a(n)…..

A

NPV Profile.

The NPV is plotted on the Y (vertical) axis

Various return rates is plotted on the X (horizontal) axis

The Internal Rate of Return (IRR) is the return rate where NPV is zero.

63
Q

What is the stand-alone principle?

A

Evaluation of a project based on the project’s incremental cash flows.

64
Q

What is Net Present Value (NPV)?

A

The difference between an investment’s market value and it’s cost.

NPV = Market Value - Cost

65
Q

The IRR of a project is the discount rate that makes the project’s NPV equal to ____.

A

Zero

66
Q

True or false

(Regular) payback period methods adjust for time value of money

A

false

67
Q

What are the 3 core beliefs of the basic net present value (NPV) investment rule?

A
  • Accept a project if its NPV is greater than zero
  • Reject a project if its NPV is less than zero
  • Indifferent to a project it its NPV is equal to zero
68
Q

The portion of cash flows of a new project that come at the expense of a firm’s existing operations is called ______.

A

Erosion

BUSA523 - Corporate Finance (9 decks)

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