Long-Term Capital Investments Flashcards

A company is evaluating two mutually exclusive projects with different useful lives. Which technique is MOST appropriate for comparing them?

Answer: Equivalent annual annuity (EAA)

The equivalent annual annuity converts NPVs to annual terms, enabling valid comparison of projects with unequal lives.

Which component is NOT included in the incremental cash flows used in capital budgeting analysis?

Answer: Sunk costs

Sunk costs are past expenditures that cannot be recovered and are irrelevant to future capital budgeting decisions.

A project has an NPV of $0 when discounted at 12%. What does this indicate?

Answer: The project exactly meets the required rate of return

An NPV of zero means the project earns exactly the required rate of return (hurdle rate), making it marginally acceptable.

The Modified Internal Rate of Return (MIRR) differs from IRR primarily because MIRR:

Answer: Assumes reinvestment at the cost of capital rather than the IRR

MIRR corrects the IRR's reinvestment rate assumption by assuming intermediate cash flows are reinvested at the firm's cost of capital.

In capital budgeting, the terminal cash flow typically includes:

Answer: After-tax salvage value and recovery of net working capital

Terminal cash flows include after-tax proceeds from asset disposal and return of net working capital invested at the project's start.

Which type of real option gives management the right to abandon a project if conditions deteriorate significantly?

Answer: Abandonment option

The abandonment option allows management to exit a project early and recover salvage value, limiting downside losses.

A treasury professional is analyzing a project with uneven cash flows. Which capital budgeting method requires trial-and-error or financial calculator iteration to solve?

Answer: Internal rate of return

IRR requires finding the discount rate that sets NPV to zero, which typically requires iterative calculation for uneven cash flows.