In most capital budgeting decisions, the emphasis should be on reported earnings rather th
In most capital budgeting decisions, the emphasis should be on reported earnings rather than cash flows. It is not unusual for a corporate president, who deals with security analysts, to be as sensitive to after-tax income as to cash flow.. The payback method is basic to understand and places a heavy emphasis on liquidity. The payback method is not really a theoretically correct approach. The internal rate of return is the interest rate that equates the cash outflows of an investment with the subsequent inflows. The selection of a mutually exclusive project means that all other projects with a positive net present value may also be selected. Cash flow is used for a net present value analysis, and earnings are used for an IRR and payback analysis. It is more likely for financial managers to focus on cash flow and corporate executives to focus on earnings of the company. Multiple Choice In a general sense, "cash flow" can be said to equal operating income less taxes plus depreciation operating income less taxes c operating income before depreciation and taxes plus depreciation operating income after taxes minus depreciation A bask assumption in financial theory is that most investors and managers are nsk seekers. if we are risk-averse, a risky investment with an 8% return will be preferred over a 10% rsk-free investment. The expected value is a weighted average of the outcomes multiplied by their probabilities of occurrence. The cost of capital is assumed to contain no risk for the firm. 14 A common stock with a beta of 1.0 is said to be of equal risk with the market. As the time horizon becomes shorter, more uncertainty enters the forecast. One of several reasons that companies might choose to issue bonds b to shift their capital structure from more equity ownership to more borrowing. Par value and face value on a bond generally are the same. When a company is obligated contractually to pay interest on debt, it must pay the interest even if 4 shows no profit for the year, or else it may go bankrupt. Bonds may be recalled only if there is a specific call provision m the bond The fact that interest payments on debt are fixed is both an advantage and a drawback. Long-term bond prices are more volatile than short-term bond prices, given an equal percentage change in the interest rate.