Fin 300 Final Exam notes || with 100% Correct Answers.
Net Present Value(NPV) correct answers NPV uses cash flows instead of earnings. NPV uses all
relevant cash flows of the project. NPV recognizes the magnitude, risk, and timing of cash flows,
consistent with stock price maximization being the primary corporate goal.
NPV directly measures the increase in value to the firm.
NPV=PV(Benefits)-PV(Costs) correct answers DCF valuation,
1. estimate initial costs and future cash flows; how much & when?
2.estimate discount rate appropriate for the risk level of the project
-accept a project is NPV>0
CF correct answers Cash Flow
NI correct answers Net Income
How long does it take to get the initial investment back? correct answers Computation:
1. Estimate the cash flows
2. subtract the future cash flows from the initial cost until the initial investment has been
recovered
-accept if the payback period is less than the cutoff time
Discounted Payback Period correct answers How long does it take to get the initial investment
back based on the present (or discounted) value of each cash flow?
Discounted Payback period computation correct answers 1.Compute the present value of each
cash flow
2.Determine how long it takes to pay back on a discounted basis
3.Compare to a present limit on the required period
, -accept the project if it pays back on a discounted basis within the cutoff time
Advantage of discounted payback correct answers Includes time value of money
Easy to understand
Does not accept negative estimated NPV investments when all future cash flows are positive
Biased towards liquidity
Disadvantage of discounted payback correct answers May reject positive NPV investments
Requires an arbitrary cutoff point
Ignores cash flows beyond the cutoff point
Biased against long-term projects, such as R&D and new products
Average Accounting Return (AAR) correct answers Average Net Income/ Average Book Value.
May reject positive NPV investments, Requires an arbitrary cutoff point. Ignores cash flows
beyond the cutoff point. Biased against long-term projects, such as R&D and new products.
-Accept the project if AAR is greater than a present return
Advantage of AAR correct answers -Easy to calculate
-Needed information is readily available in accounting statements.
Disadvantage of AAR correct answers -Not a true rate of return; time value of money is ignored
-Uses an arbitrary benchmark cutoff rate
-Based on accounting net income and book values, not cash flows and market values
Internal Rate of Return (IRR) correct answers -estimated off cash flows
-independent of interest rates
-return that makes NPV=0
Net Present Value(NPV) correct answers NPV uses cash flows instead of earnings. NPV uses all
relevant cash flows of the project. NPV recognizes the magnitude, risk, and timing of cash flows,
consistent with stock price maximization being the primary corporate goal.
NPV directly measures the increase in value to the firm.
NPV=PV(Benefits)-PV(Costs) correct answers DCF valuation,
1. estimate initial costs and future cash flows; how much & when?
2.estimate discount rate appropriate for the risk level of the project
-accept a project is NPV>0
CF correct answers Cash Flow
NI correct answers Net Income
How long does it take to get the initial investment back? correct answers Computation:
1. Estimate the cash flows
2. subtract the future cash flows from the initial cost until the initial investment has been
recovered
-accept if the payback period is less than the cutoff time
Discounted Payback Period correct answers How long does it take to get the initial investment
back based on the present (or discounted) value of each cash flow?
Discounted Payback period computation correct answers 1.Compute the present value of each
cash flow
2.Determine how long it takes to pay back on a discounted basis
3.Compare to a present limit on the required period
, -accept the project if it pays back on a discounted basis within the cutoff time
Advantage of discounted payback correct answers Includes time value of money
Easy to understand
Does not accept negative estimated NPV investments when all future cash flows are positive
Biased towards liquidity
Disadvantage of discounted payback correct answers May reject positive NPV investments
Requires an arbitrary cutoff point
Ignores cash flows beyond the cutoff point
Biased against long-term projects, such as R&D and new products
Average Accounting Return (AAR) correct answers Average Net Income/ Average Book Value.
May reject positive NPV investments, Requires an arbitrary cutoff point. Ignores cash flows
beyond the cutoff point. Biased against long-term projects, such as R&D and new products.
-Accept the project if AAR is greater than a present return
Advantage of AAR correct answers -Easy to calculate
-Needed information is readily available in accounting statements.
Disadvantage of AAR correct answers -Not a true rate of return; time value of money is ignored
-Uses an arbitrary benchmark cutoff rate
-Based on accounting net income and book values, not cash flows and market values
Internal Rate of Return (IRR) correct answers -estimated off cash flows
-independent of interest rates
-return that makes NPV=0
