Lecture 6 Quiz

The incremental cash flow is the difference between the cash flow of the firm with the project, and the cash flow of the firm without the project.

Depreciation is an incremental cash flow. When the company tax rate is zero, if the project increases the depreciation expense of the company by an amount, say $100,000, we need to reduce the cash flow of that project by that amount.

Opportunity cost, side effect and salvage value are incremental cash flow while sunk cost is not an incremental cash flow

To evaluate the NPV of a project, we need to use the incremental cash flow.

A project can be considered as a small company and the method of the cash flow statement preparation for a company can be used to prepare the cash flow for the project.

The discount rate used for a project can be a nominal discount rate or a real discount rate. When the cash flow of a project is nominal, we use a nominal discount rate. When the cash flow of the project is in real terms, we use a real discount rate.

The net cash from operating activities of a project is the profit generated by the project plus its depreciation expense plus the change in working capital in the project.

Interest expense is an incremental cash flow in a project. Interest expense is incorporated via discounting procedure. There is no need for a separate item of interest expense when calculating net cash from operating activities for a project.

Payback period and discounted payback period ignores the time value of money while internal rate of return considers the time value of money.

Discounted payback period is the length of time until the sum of the discounted cash flows is equal to the initial investment. A project is accepted if its discounted payback period is less than a cut-off period specified by the investor.

Payback period is the time it takes to recoup the initial investment. A project is accepted if its payback period is less than a cut-off period specified by the investor.

The internal rate of return of a project is the discount rate that makes the NPV equal to zero. When the discount rate is higher than the internal rate of return, the NPV of the project is negative.

Optimal investment timing means that the decision maker should select the earliest time to invest so that the project has a positive net present value.

Mutually exlusive projects refer to a set of projects for which only one project can be selected for investment.

Equivalent annual cash flow converts the total present value of the costs of an equipment to an annuity. Equipments with different lifespans can be compared based on their equivalent annual cash flows.

Economic rent is any payment to a factor of production in excess of the costs needed to bring that factor into production. In competitive markets, economic rents can be earned if a firm has competitive advantage obtained from e.g., its patents or strategic assets.

Break even analysis explores the maximum adverse change that one variable can experience before the NPV of the project becomes negative.

Monte Carlo simulation provides the whole distribution of the NPV of the project when some variables vary stochastically. Monte Carlo simulation cannot take into account the relationship that exists among variables.

Scenario analysis provides a sense of how the project performs when a particular scenario occurs. The explored scenario can take into account the dependence of one variable on other variables.

Sensitivity analysis helps to identify variables that have strong impact on the NPV of the project