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Questions and Answers
Which of the following best describes the purpose of computing Equivalent Annual Cost (EAC)?
What is the reason for computing EAC?
In what type of firms does the termination of a major founder(s) result in the termination of the firm?
Which type of entity typically has limited liability to the amount of capital conferred?
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What does EBITDA represent?
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For what type of cash flows can the Net Present Value be computed?
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What do fixed costs exclude?
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What does the current ratio measure?
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What does the payback period count?
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What is the formula for calculating net working capital?
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What is contribution margin per unit?
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What is the internal rate of return (IRR)?
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What is the purpose of incremental cash flow analysis?
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What does real cash flow differ from nominal cash flow in terms of?
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What is the internal rate of return (IRR)?
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What is the method to tackle the scale problem of cash flows?
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What is the method that cannot tackle the timing problem of cash flow?
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What is the relationship between discounted payback period and payback period?
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Study Notes
Equivalent Annual Cost (EAC)
- EAC serves as a method to compare the annual cost of different projects or investments with varying lifespans.
- Computing EAC helps in making decisions for projects by converting costs into an equivalent annual amount.
Termination of Founders Impact
- In certain firms, especially sole proprietorships or partnerships, the termination of a major founder leads to the termination of the firm.
- This often occurs in closely-held family businesses or firms heavily reliant on a founder's leadership.
Limited Liability
- Limited liability is typically associated with corporations and limited liability companies (LLCs), where owners are not personally liable beyond their investment.
EBITDA
- EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, representing a firm's operational profitability by focusing on earnings from core business functions.
Net Present Value (NPV)
- NPV can be computed for cash flows that occur at different times, evaluating the profitability of an investment by discounting future cash flows to present value.
Fixed Costs
- Fixed costs exclude variable costs and are expenses that remain constant regardless of production levels in the short term.
Current Ratio
- The current ratio measures a company’s ability to pay its short-term liabilities with its short-term assets, indicating liquidity and financial health.
Payback Period
- The payback period counts the time required for an investment to generate cash flows sufficient to recover its initial cost.
Net Working Capital Formula
- Net working capital is calculated as current assets minus current liabilities, reflecting liquidity and operational efficiency.
Contribution Margin per Unit
- Contribution margin per unit represents the revenue remaining after variable costs have been subtracted, contributing to covering fixed costs and profit generation.
Internal Rate of Return (IRR)
- IRR is the discount rate at which the net present value of an investment's cash flows equals zero, indicating the expected annual return.
Incremental Cash Flow Analysis
- Incremental cash flow analysis is used to evaluate the additional cash flows generated by a project, aiding in decision-making for capital investments.
Real vs. Nominal Cash Flow
- Real cash flow adjusts for inflation, providing a more accurate measure of purchasing power over time compared to nominal cash flow, which reflects current market values.
Scale Problem of Cash Flows
- The scale problem can be tackled using techniques such as the Internal Rate of Return (IRR), which adjusts for investment size and cash flow magnitude.
Timing Problem of Cash Flow
- The payback method does not effectively address the timing problem of cash flows, as it ignores cash flows beyond the payback period.
Discounted Payback vs. Payback Period
- The discounted payback period accounts for the time value of money, whereas the payback period ignores it, potentially leading to different conclusions in investment analysis.
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Description
This quiz will test your knowledge on various financial concepts such as Equivalent Annual Cost (EAC) and the reasons why it is computed. You will also be asked about the termination of a firm's life in relation to proprietorship and limited partnership. Sharpen your financial skills and take this quiz now!
