Capital budgeting analysis consists of three distinct stages. The first stage is:
a. Discounted Cash Flows
b. Simulation
c. Decision Analysis
d. Net Present Value
Answer = c: Decision analysis is a process whereby you evaluate your options, variables and other attributes associated with the decision. You need to define this framework before you start estimating costs and benefits which in turn feeds your economic analysis (Net Present Value).
The ability to postpone, delay, alter or abandon a project adds value to the project. This value is referred to as:
Relevant cash flows
Attribute value
Net Present Value
Option Pricing
Answer = d: Option pricing gives an investment better capacity for change and since so many investments have changing requirements once launched, the opportunity to pursue another option increases the value of the investment.
The time value of money is important for three reasons. These three reasons are:
Inflation, uncertainty, and opportunity costs.
Answer = a: Three fundamental reasons behind the need for discounting (accounting for the time value of money) are: 1) Adjusting for the impacts of inflation or loss in purchasing power over time, 2) Risk and uncertainty over time, and 3) Lost opportunities to invest the money if you had access to the funds today.
Which of the following is relevant in determining the cash flows of a project?
Sunk costs
