Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

ACF100 > week 17 > Flashcards

week 17 Flashcards

1
Q

what are good decision criteria

A

have all cash flows been considered
has the time value of money been taken into account
has risk been adjusted for
does the decision rule enable you to rank projects
does the decision rule provide information on whether it will create value for the firm

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

what is the payback period

A

how long it takes to recover the initial cost of the project

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

how do you calculate payback period

A

estimate cash flows
initial cost - future cash flows until initial investment is recovered
accept if payback period is less than a pre-set max

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

should we use payback as the primary decision rule

A

biggest drawback is that the issue is the impact of investment on stock value, not how long it takes to recover money

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

what are the pros of payback

A

easy to understand
adjusts for uncertainty in later cash flows
biased towards liquidity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

what are the cons of payback

A

ignores time value of money
requires an arbitary cut-off point and ignores cash flows beyond the cut-off date
biased against long term project such as R&D and new projects

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

what is average accounting return (AAR)

A

money made or lost over a given period

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

how do you calculate AAR

A

average net income / average book value

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

what is book value

A

the balance sheet value of assets, liabilities and equity, usually based on cost

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

what is market value

A

true value, the price at which assets, liablities or equity can be bought or sold

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

what is net income

A

revenue - expenses for the period

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

should we use AAR as primary decision criteria

A

AAR treats near and distant future as the same, no discounting or meaningful economic rate of return

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

what are the pros of AAR

A

easy to calculate
required info is usually easy to obtain

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

what are the cons of AAR

A

not a true rate of return, ignores time value of money
uses an arbitary benchmark cut off rate
based on accounting net income and book values, not cash flows and market values

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

what is net present value (NPV)

A

the difference between the present value of cash inflows of a project and its cost

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

how do you calculate NPV

A

sum of Ct / (1+r)^t

17
Q

what is the NPV decision rule

A

NPV > 0, accept project as it adds value to the firm and increases owner wealth
direct measure of how well the project will increase shareholder wealth
accepting NPV < 0, will destroy firm value

18
Q

what does positive NPV mean

A

return of capital - pay back cost
return on capital - get a return payment
value for shareholders - net gain of wealth

19
Q

should we use NPV as the primary decision criteria

A

yes

20
Q

what is an independent project

A

cash flows of one project are unaffected by acceptance of another
accept all projects which meet minimum acceptance criteria

21
Q

what is a mutually exclusive project

A

the acceptance of one project precludes accepting the other
choose best project by ranking the alternatives

22
Q

how do you use the NPV decision rule

A

minimum acceptance criteria - only take projects with positive NPV
ranking criteria - choose the project with the highest NPV

23
Q

what is the profitability index

A

a company has limited financial resources and cannot finance all available projects
helps select project combinations and alternatives
helps identify which combination of projects maximises NPV from investment

24
Q

what is capital rationing

A

firms have limited resources and cannot undertake positive NPV projects
soft rationing - limited resources are temporary and usually self imposed
hard rationing - capital will bever be available for this project

25
Q

how do you calculate PI

A

NPV / investment
or
value created / resource consumed
larger PI measure, greater value of the project given required investment
rank projects incorrectly where they are mutually exclusive

26
Q

what is internal rate of return (IRR)

A

alternative to NPV
widely used
based on estimated cash flows
independent rates of interest
similar to YTM
its is a discount rate the sets NPV = 0

27
Q

how do you calculate IRR

A

sum of Ct / (1+IRR)^t = 0

28
Q

what is the IRR decision rule

A

accept the project if IRR is greater than required return
ranking criteria - select alternative with highest IRR

29
Q

what are the pros of IRR

A

often preferred by exectutives, it is intuitively appealing
eacy to communicate vlaue of a project
if IRR is high enough, may not need to estimate required return

30
Q

what are the cons of IRR

A

can produce multiple answers
cannot rank mutually exclusive projects
reinvestment assumption flawed

31
Q

when do you use NPV vs IRR

A

conventional cash flows, independent - NPV
conventional cash flows, mutually exclusive - conflict
non-conventional, independent - IRR
non conventional, mutually exclusive - IRR, conflict

32
Q

what is value additivity

A

when the value of a whole group of assets exactly equals the sum of values of individual assets that make a group of assets

33
Q

why do NPV profiles cross

A

size differences - smaller project free up funds sooner than investment, higher opportunity cost more valuable the funds so high discount rate favours small projects
timing differences - project with faster payback provides more cash flow in early years of reinvestment
discount rate is high, early cash flow especially good

34
Q

what is the scale problem

A

NPV focuses on increase in nominal value
IRR focuses on rate of return
ultimately interested in creating higher value for shareholders, use NPV to choose between projects

35
Q

what are the conflicts between NPV and IRR

A

always use NPV if there is a conflict
IRR is unreliable if it is non-conventional cash flows or mutually exclusive projects
IRR can sometimes have practical advantages

36
Q

should we only use NPV

A

difficulty of NPV is coming up with reliable cash flows estimates
determining appropriate discount rate can be hard
should consider AAR and payback to make final decision

ACF100 (26 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions