Capital Budgeting
A major disadvantage of the discounted payback period is the arbitrariness of the process used to select the maximum desired payback period.
True
A project that is very sensitive to the selection of a discount rate will have a steep net present value profile.
True
A project with a payback period of four years is acceptable as long as the company's target payback period is greater than or equal to four years.
True
Project Alpha has an internal rate of return (IRR) of 15 percent. Project Beta has an IRR of 14 percent. Both projects have a required return of 12 percent. Which of the following statements is MOST correct?
Both projects have a positive Net Present Value (NPV)
If a project is acceptable using the NPV criterion, then it will also be acceptable using the discounted payback period since both methods use discounted cash flows to make the accept/reject decision.
False
The net present value profile clearly demonstrates that the NPV of a project increases as the discount rate increases.
False
Which of the following statements is MOST correct?
The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the IRR.
Advantages of the payback period include that it is easy to calculate, easy to understand, and that it is based on cash flows rather than on accounting profits.
True
An acceptable project should have a net present value greater than or equal to zero and a profitability index greater than or equal to one.
True
Any project deemed acceptable using the discounted payback period will also be acceptable if using the traditional payback period.
True
A project's net present value profile shows how sensitive the project is to the choice of a discount rate.
True
Free cash flows represent the benefits generated from accepting a capital−budgeting proposal.
True
If a firm imposes a capital constraint on investment projects, the appropriate decision criterion is to select the set of projects that has the highest positive net present value subject to the capital constraint.
True
If a project is acceptable using the NPV criteria, it will also be acceptable when using the profitability index and IRR criteria.
True
If a project's internal rate of return is greater than the project's required return, then the project's profitability index will be greater than one.
True
NPV assumes reinvestment of intermediate free cash flows at the cost of capital, while IRR assumes reinvestment of intermediate free cash flows at the IRR.
True
If a project's profitability index is less than one, then the project should be rejected.
True
If the net present value of a project is zero, then the profitability index will equal one.
True
Many firms today continue to use the payback method but also employ the NPV or IRR methods, especially when large projects are being analyzed.
True
NPV is the most theoretically correct capital budgeting decision tool examined in the text.
True
One drawback of the payback method is that some cash flows may be ignored.
True
One of the disadvantages of the payback method is that it ignores time value of money.
True
The capital budgeting decision−making process involves measuring the incremental cash flows of an investment proposal and evaluating the attractiveness of these cash flows relative to the project's cost.
True
The discounted payback period takes the time value of money into account in that it uses discounted free cash flows rather than actual undiscounted free cash flows in calculating the payback period.
True
The internal rate of return is the discount rate that equates the present value of the project's free cash flows with the project's initial cash outlay.
True
The internal rate of return is the discount rate that equates the present value of the project's future free cash flows with the project's initial outlay.
True
The internal rate of return will equal the discount rate when the net present value equals zero.
True
The main disadvantage of the NPV method is the need for detailed, long−term forecasts of free cash flows generated by prospective projects.
True
The profitability index is the ratio of the present value of the future free cash flows to the initial investment.
True
The profitability index provides an advantage over the net present value method by reporting the present value of benefits per dollar invested.
True
The search for new profitable projects is so important because without the flow of new projects and ideas most firms cannot grow and even survive for long
True
Whenever the internal rate of return on a project equals that project's required rate of return, the net present value equals zero.
True
It is so difficult to find an exceptionally profitable project because
competition is brisk and will push down prices and profits.
Project Alpha has an internal rate of return (IRR) of 15 percent. Project Beta has an IRR of 14 percent. Both projects have a required return of 12 percent. Which of the following statements is MOST correct?
Both projects have a positive net present value (NPV).
Because the NPV and PI methods both yield the same accept/reject decision, a company attempting to rank capital budgeting projects for funding consideration can use either method and get the same results.
False
If a project is acceptable using the net present value criteria, then it will also be acceptable under the less stringent criteria of the payback period.
False
If project A generates $10 million of free cash flow over its five year useful life and project B generates $8 million of free cash flow over its five year useful life, then Project A will have a shorter payback period than Project B, assuming both projects require the same initial investment.
False
Two projects that have the same cost and the same expected cash flows will have the same net present value.
False