Capital Budgeting Measurement Criteria U05a1 Carla Hagood 1. Describe the Net Present Value (NPV) method for determining a capital budgeting project's desirability. What is the acceptance benchmark when using NPV? The NPV determines the monetary increase that can be expected from an investment. It will tell if the return will be above or below the needed amount to complete a project.
• A financial asset is considered to have value if it has the ability to generate positive cash flows. • A financial asset is considered to have value if it is acquired at its market value • A financial asset is considered to have value if it is acquired a its book price. When determing the value of a firm, which of the following statements is true? • The timing of cash flows a firm can generate is very important in determing the value of a firm. All else being equal, cash received sooner is better.
By following the matching principle all of the costs associated with a particular product, not just its wholesale price, is expensed when the item is sold. Requirement 2 - A Generally, the lower of cost or market method is used to value inventory in order to “avoid reporting inventory at an amount greater than the benefits it can provide” (Spiceland, Sepe, & Nelson, 2013, p. 476). According to Spiceland, Sepe, and Nelson (2013) the “change in replacement cost usually is a good indicator of the direction of change in selling price” (p. 477). When the change in replacement cost is negative the LCM method allows companies to apply the conservatism principle. The conservatism principle involves “recognizing expenses and liabilities as soon as possible when there is uncertainty about the outcome, but to only recognize revenues and assets when they are assured of being received” (The conservatism principle).
Liquidity Ratios Liquidity ratios provide information about a firm's ability to meet its short-term financial obligations. The current ratio is the ratio of current assets to current liabilities: Current Ratio | = | Current Assets | | Current Liabilities | | * Interpretation: Current ratio comes from total assets divided by current liabilities. Current assets include cash, accounts and notes receivable (less reserves for bad debts), advances on inventories, merchandise inventories, and marketable securities. This ratio measures the degree to which current assets cover current liabilities. The higher the ratio the more assurance exists that the retirement of current liabilities can be made.
2. Which of the following statements about valuing a firm using the APV approach is most CORRECT? a. The value of operations is calculated by discounting the horizon value, the tax shields, and the free cash flows at the cost of equity. b.
The organization should primarily focus on the incremental cash flow because the incremental cash flow holds a marginal benefit from the project. Depreciation is considered to be an expense item which means that the greater the depreciation, the larger the expense will be to the organization. Therefore, if Caledonia was looking at the project from an accounting profit view, the profit would be much lower than that of the free cash flow. 2. What are the incremental cash flows for the project in years 1 through 5 and how do these cash flows differ from accounting profits or earnings?
Discount rate = 11%. The Net Present Value (NPV) of an investment proposal is equal to the present value of its annual free cash flows less the investment’s initial outlay (Keown, A. J., Martin, J. D., & Petty, J. W. (2014). The rule here is that our company will accept projects with a net present value greater than zero, and decline the ones with a net present value that is less than zero. The greater the net present value, the more appropriate the investment is. Based on that, Corporation B is desirable to Corporation A as it has a greater net present value.
By contrast, the price elasticity of demand tells you “how much” quantity demanded changes when price changes. It shows the responsiveness of a change in quantity demanded to a change in price. [text: E p. 114; MI p. 114] 2. Why do economists use percentages rather than absolute amounts in measuring the responsiveness of consumers to changes in price? There are two basic reasons.
------------------------------------------------- JAN 10 Section B Question 4 (b) Evaluate the argument that managers controlling large companies might follow policies which do not necessarily maximise the profits of the owners. 25 marks Kn Economic theory standardly assumes maximising behaviour on the part of economic agents. Consumers are assumed to maximise utility from consumption subject to their limited income, for example, while workers maximise income subject to the constraint of wanting leisure time. It is assumed that firms pursue profit maximisation, although a number of other maximising behaviours are possible in reality such as revenue maximisation or maximising the volume of sales, and these are sometimes thought likely to be pursued by the managers of large firms. It is also possible that managers do not adopt maximising behaviour at all, perhaps “satisficing” in response to shareholder discipline or that the policy of the firm is the result of complex interactions between various stakeholders.
Profit Maximization is the process that a firm uses to establish where the best output and price levels are, in order to maximize its return. There are two primary methods that can be used to establish profit maximization. One method is the Marginal Revenue minus the Marginal Cost (MR-MC) method. When utilizing this method economists assume that profit would be at its highest when MR and MC are equal, which denotes that for every item made MP=MR-MC. When / if MR is higher than MC then MP would result in a profit for Company A.