Capital Budgeting Decisions Flashcards

A project generates a level $25,000 per year for 5 years and costs $90,000. At a 10% rate (annuity factor 3.791), the NPV is approximately:

Answer: $4,775

NPV = $25,000 x 3.791 - $90,000 = $94,775 - $90,000 = $4,775.

Sensitivity analysis in capital budgeting primarily examines:

Answer: How NPV changes when one input variable changes

Sensitivity analysis isolates one variable at a time to see its impact on NPV.

Capital rationing occurs when a firm:

Answer: Has limited funds and must choose among acceptable projects

Under capital rationing, budget limits force selection among otherwise acceptable projects.

Under capital rationing, projects are best ranked by:

Answer: Profitability index

The profitability index maximizes value created per dollar of constrained capital.

The discounted payback period differs from regular payback because it:

Answer: Discounts cash flows before accumulating them

Discounted payback applies the time value of money to each cash flow before summing.

Scenario analysis improves on basic sensitivity analysis by:

Answer: Examining combinations of variables under best/base/worst cases

Scenario analysis varies several inputs together to reflect realistic combinations of conditions.

Inflation should be handled in capital budgeting by:

Answer: Discounting nominal cash flows at a nominal rate

Consistency requires nominal cash flows be discounted at a nominal rate (or real with real).