Finance 3320 Final Exam Review
CH. 11
Lesson #1 Capital Budgeting decisions are critical in defining a company’s business.
Lesson #2 Very large investments are frequently the result of many smaller investment decisions that define a business strategy.
Lesson #3 Successful investment choices lead to the development of managerial expertise and capabilities that influence the firm’s choice of future investments.
Typical Budgeting Process- Phase 1: the firm’s management identifies promising investment opportunities. Phase 2: once an investment opportunity has been identified, its value-creating potential, what some refer to as its “value proposition” is evaluated. Good investments are in are in markets with less competition. Revenue enhancement investment- entering a new market Cost-reduction investment- installing more efficient equipment, Mandatory investment- government regulated, safety material. NPV = PV of inflows – Cost= Net gain in wealth.. If projects are independent, accept if the project NPV > 0. If projects are mutually exclusive, accept projects with the highest positive NPV, those that add the most value. In this example, accept S if mutually exclusive (NPVS > NPVL), and accept both if independent.
[pic] [pic]
[pic] [pic]
Quiz
Internal rate of return, IRR, will increase as the required rate of return of a project is increased? False. If the project’s payback period is greater than or equal to zero, the project should always be accepted? False. When several sign reversals in the cash flow stream occur, the IRR equation can have more that one positive IRR? True. A new forklift under consideration by Home Warehouse requires an initial investment of 100,000 and produces annual cash flows of 50,000, 40,000, and 30,000. Which will not change if the required rate of return is increased from 10 to 12 percent? Internal rate of return. A machine cost 1,000 and has a 3 year life span and salvage value of 100. It will generate after-tax annual cash flow of 600/year,
Lesson #1 Capital Budgeting decisions are critical in defining a company’s business.
Lesson #2 Very large investments are frequently the result of many smaller investment decisions that define a business strategy.
Lesson #3 Successful investment choices lead to the development of managerial expertise and capabilities that influence the firm’s choice of future investments.
Typical Budgeting Process- Phase 1: the firm’s management identifies promising investment opportunities. Phase 2: once an investment opportunity has been identified, its value-creating potential, what some refer to as its “value proposition” is evaluated. Good investments are in are in markets with less competition. Revenue enhancement investment- entering a new market Cost-reduction investment- installing more efficient equipment, Mandatory investment- government regulated, safety material. NPV = PV of inflows – Cost= Net gain in wealth.. If projects are independent, accept if the project NPV > 0. If projects are mutually exclusive, accept projects with the highest positive NPV, those that add the most value. In this example, accept S if mutually exclusive (NPVS > NPVL), and accept both if independent.
[pic] [pic]
[pic] [pic]
Quiz
Internal rate of return, IRR, will increase as the required rate of return of a project is increased? False. If the project’s payback period is greater than or equal to zero, the project should always be accepted? False. When several sign reversals in the cash flow stream occur, the IRR equation can have more that one positive IRR? True. A new forklift under consideration by Home Warehouse requires an initial investment of 100,000 and produces annual cash flows of 50,000, 40,000, and 30,000. Which will not change if the required rate of return is increased from 10 to 12 percent? Internal rate of return. A machine cost 1,000 and has a 3 year life span and salvage value of 100. It will generate after-tax annual cash flow of 600/year,