# Exam3_FC2 - The flashcards are formatted for printing...

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Payback Period Capital Investment Evaluation Method

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The ideal method should include all cash flows that occur during the life of the project, consider the time value of money, and incorporate the required rate of return on the project. How long will it take for the project to generate enough cash to pay for itself?
1. Payback period 2. Net present value 3. Profitability index 4. Internal rate Payback Period

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of return
Firm cutoffs are subjective and do not consider the time value of money, the required rate of return, or all of the project’s cash flows. Methods to decide if a capital investment project should be accepted or rejected:

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Accept; Reject Net Present Value
The total present value of the annual net cash flows minus the initial outlay (benefit – cost). If NPV is ____, accept; if NPV is ____, reject.

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Internal Rate of Return Greater than or Equal to 1; Less than 1
If PI is ____, accept; if PI is ____, reject. The return on the firm’s invested capital; simply the rate of return that the firm earns on its capital budgeting projects.

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Internal Rate of Return Internal Rate of Return
The rate of return that makes the present value of the cash flows equal to the initial outlay. What’s the discount rate that will make the benefit equal to the cost?

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Greater than or Equal to the RoR; Less than the RoR Internal Rate of Return
Looks very similar to our yield to maturity formula for bonds. If IRR is ____, accept; if IRR is ____, reject.

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1. Size disparity 2. Time disparity 3. Unequal lives Internal Rate of Return
A good decision-making tool as long as cash flows are conventional; there’s a problem if there are multiple sign changes in the cash flow stream because you could get multiple ones. Problems with project ranking:

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Time Disparity Size Disparity
There’s the same number of years, but the mutually exclusive projects have unequal size; assumes you reinvest at the internal rate of return, which isn’t true, creating the disparity. The big cash flows occur at different times in mutually exclusive projects.

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Equivalent Annual Annuity Unequal Lives
When the firm is planning to expand and we have to select among two machines that differ in terms of economic life and capacity. Simply annualize the net present value over the project’s life; assume that each project will be replaced an infinite number of times in the future.

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Payback Period Equivalent Annual Annuity
annuity; spreads the NPV over the life of the project. The number of years it

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Exam3_FC2 - The flashcards are formatted for printing...

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