week 3 - reading materials - chapter 4 Flashcards
why cash flow matters more than profit (which are the limits of the profit) in valuying a business?
Because profit is based on accounting concepts
what is capital budgeting? when a project is worth pursuing?
It is the process by which a company determines whether projects (such as investing in R&D, opening a new branch, replacing a machine) are worth pursuing. A project is worth pursuing if it increases the value of the company
which costs we need to consider when we value a project?
This includes the cash paid to the supplier of the asset plus any other costs involved in making the project operational.
when should we accept a project based on the NPV method?
if its >= 0
which appraisal valuation method should be used for mutually exclusive projects and why?
NPV should be used, in fact IRR doesn’t consider the scale of a project. [a firm prefers to make 30% on a million dollar project than 60% on a 1000 dollar project]
which appraisal valuation method should be used if we have variable discount rates?
NPV, since IRR cannot handle variable rates.
which appraisal valuation method should be used if we have unconvetional cash flows?
the NPV is the best solution
what does the NPV and the IRR assumes?
NPV assumes that all cash flows can be reinvested at the firm’s cost of capital. IRR assumes that the annual cash flows can be reinvested at the project internal rate of return
what does the process of capital rationing refers to?
it refers to allocating scarce resources among competing, economicallt desirables projects, not all which can be undertaken
what is the opportunity cost of capital?
it’s the return shareholders could obtain for the same level of risk by investing their capital elsewhere.
what resocurces can be considered scarce in a company?
skilled labour, management time, working capital requirements.
