1) The regular payback method is deficient in that it does not take account of cash flows
beyond the payback period. The discounted payback method corrects this fault.
2) The interest and dividends paid by a corporation are considered to be deductible
operating expenses, hence they decrease the firm’s tax liability.
3) The component costs of capital are market-determined variables in the sense that
they are based on investors’ required returns.
4) Profitability ratios show the combined effects of liquidity, asset management, and
debt management on operating results.
5) Since the focus of capital budgeting is on cash flows rather than on net income,
changes in noncash balance sheet accounts such as inventory are not included in a
capital budgeting analysis.
6) Two important issues in corporate governance are (1) the rules that cover the board’s
ability to fire the CEO and (2) the rules that cover the CEO’s ability to remove members
of the board.
7) A reverse split reduces the number of shares outstanding.
8) We can identify the cash costs and cash inflows to a company that will result from a
project. These could be called “direct inflows and outflows,” and the net difference is
the direct net cash flow. If there are other costs and benefits that do not flow from or to
the firm, but to other parties, these are called externalities, and they need not be
considered as a part of the capital budgeting analysis.
9) There is an inverse relationship between bonds’ quality ratings and their required
rates of return. Thus, the required return is lowest for AAA-rated bonds, and required
returns increase as the ratings get lower.