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Chapter 8
Chapter 8
Chapter 9
Chapter 9
Chapter 9
100
Most firms measure values in what type of term?
Net Present Value 
100
List 3 weaknesses of the Payback Rule
1. It ignores the time value of money


2. It ignores the cash flows after the payback period

3. It lacks a decision criterion grounded in economics

100
List 3 types of Initial Outlay Cash Flows
1. Purchase Equipment


2. Initial Development Costs

3. Increase in Net Working Capital (Increase Inventories, Raw Materials, etc.)

100
What is the incremental effect of a project on a firm's available cash?
Free Cash Flow
100
What allows corporations to take losses during a current year and offset them against gains in nearby years?
Tax Loss Carryforwards/Tax Loss Carrybacks
200
What is the logic of the Decision Rule?
When making an investment decision, take the alternative with the highest NPV, which is equivalent to receiving its NPV in cash today
200
Which rules tells you to take any investment opportunity where IRR exceeds the opportunity cost of capital?
The Internal Rate of Return Rule
200
List 4 types of Ongoing Cash Flows
1. Incremental Revenues


2. Incremental Costs

3. Taxes

4. Change in Net Working Capital (change in inventories, raw materials, accounts receivable and payable)

200
What is Trade Credit?
The difference between receivables and payables is the net amount of the firm's capital that is consumed as a result of these credit transactions
200
What is a capital budgeting tool that determines how the NPV varies as a single underlying assumption is changed?
Sensitivity Analysis
300
What does the NPV Decision Rule imply?
Accept positive NPV projects and Reject negative NPV projects
300
List 2 weaknesses in IRR
1. In most cases, IRR agrees with NPV for stand alone projects if all negative cash flows precede positive cash flows


2. In other cases, the IRR may disagree with NPV

300
List 3 types of Terminal Cash Flows
1. Sale of Equipment (Net of any taxes)


2. Shutdown Costs

3. Decrease in Net Working Capital (Decrease in inventories, raw materials, etc)

300
How do you compute a project's NPV?
One must discount its free cash flow at the appropriate cost of capital
300
What is a Break-Even Analysis?
The level of parameter for which an investment has an NPV of zero
400
What is the Payback Rule?
It is based on the notion that an opportunity that pays back the initial investment quickly is the best idea
400
What should you do if you have mutually exclusive projects? Which one do you choose?
You can't just pick the project with a positive NPV, the projects must be ranked and the best one chosen. Pick the project with the highest NPV
400
What is the tax rate a firm will pay on an incremental dollar of pre-tax income?

The Marginal Corporate Tax Rate

400
List 4 "other effects" on Incremental Free Cash Flows
1. Opportunity Costs


2. Project Externalities (Cannibalization)

3. Sunk Costs (Fixed overhead expenses or Past R&D)

4. Adjusting Free Cash Flow (time of CF and Accelerated depreciation)

400
What is EBIT Break-Even?
The level of a particular parameter for which a project's EBIT is zero
500
What is the Payback Period?
The amount of time it takes to pay back the initial investment. 


Accept if the payback period is less than required, Reject if it is greater

500
What is the Bottom Line on IRR?
- Picking the investment opportunity with the largest IRR can lead to a mistake


- In general, it is dangerous to use the IRR in choosing between projects

- Always rely on NPV

500
__________ expenses do not correspond to actual cash outflows
Depreciation
500
What is Liquidation or Salvage Value?
When an asset is liquidated, any capital gain is taxed as income
500
What is a capital budgeting tool that determines how the NPV varies as a number of underlying assumptions are changed simultaneously?
A Scenario Analysis