Financial Analysis & Decision Making Flashcards

In a make-or-buy decision, which costs are most relevant to the analysis?

Answer: Incremental (differential) costs and opportunity costs

Only incremental costs that differ between alternatives and opportunity costs of foregone options are relevant to make-or-buy decisions.

A project has an IRR of 14% and the company's WACC is 11%. The strategic manager should:

Answer: Accept the project because IRR exceeds WACC

When IRR exceeds WACC (the hurdle rate), the project generates returns above its cost of capital and should be accepted.

Which financial statement best reveals whether a profitable company is generating or consuming cash?

Answer: Statement of Cash Flows

A company can show accounting profit yet burn cash due to working capital changes; the cash flow statement reveals actual cash generation.

Economic Value Added (EVA) is best defined as:

Answer: NOPAT minus the dollar cost of all capital employed

EVA = NOPAT − (WACC × Invested Capital); it measures the economic profit after accounting for the full cost of capital.

A company's operating leverage is high when:

Answer: Fixed costs represent the majority of total costs

High fixed costs relative to variable costs create high operating leverage, amplifying the impact of revenue changes on operating income.

When performing a discounted cash flow valuation, the terminal value typically represents:

Answer: The majority of total enterprise value in most valuations

Terminal value often represents 60–80% or more of total DCF value because it captures all cash flows beyond the explicit forecast period.

A strategic manager notices that the company's gross margin has declined while net margin improved. The most likely explanation is:

Answer: SG&A and other below-gross-profit costs declined significantly

If gross margin fell but net margin rose, costs below the gross profit line (like SG&A or interest) must have dropped enough to offset the weaker gross margin.