Capital Budgeting Methods and Cash Flow Analysis

These flashcards cover key concepts related to capital budgeting methods and cash flow analysis, ensuring a comprehensive review for exam preparation.

What does IRR stand for in capital budgeting?

Internal Rate of Return.

What is the purpose of capital budgeting?

To evaluate the profitability of investments in projects.

Which capital budgeting method measures the time it takes to recover the initial investment?

Payback method.

What do the abbreviations ARR and PI stand for in capital budgeting?

ARR stands for Accounting Rate of Return, and PI stands for Profitability Index.

What is an important consideration when calculating predicted cash flows?

The accuracy of the forecasted cash flows.

What does the term 'incremental cash flow' refer to?

The cash flow generated by a new project that considers the impact on existing projects.

What is cannibalization in the context of cash flow?

When a new project reduces the cash flow generated from existing projects.

What are the two types of cash flow in capital budgeting?

Real cash flow and nominal cash flow.

How does inflation affect capital budgeting decisions?

It alters the real cash flow and can complicate budgeting by requiring assumptions about inflation rates.

What is the formula for the equivalent annual cost in relation to NPV?

It's the present value of annuity calculation used to solve timing problems in NPV.

What happens to cash flows when using straight-line depreciation versus immediate expensing?

Straight-line depreciation spreads the expense over time, while immediate expensing increases profits in year zero.

Why is financial accounting knowledge important for a financial manager?

It's crucial for accurately predicting cash flows essential for investment decisions.

What is the issue with comparing mutually exclusive projects of different lengths in NPV analysis?

The NPV may not allow a meaningful comparison because it does not account for the opportunity to repeat shorter projects.

What is a potential drawback of the NPV method?

It can have timing issues and may not provide meaningful comparisons of projects with different durations.