CH 9 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

Steps involved in the discounted payback period.

1. Discount the cash flows using the discount rate. 2. Add the discounted cash flows. 3. Accept if the discounted payback period is less than some prespecified number of years.

According to the average accounting return rule, a project is acceptable if its average accounting return exceeds __________.

A target average accounting return

A project should be ________ if its NPV is greater than zero.

Accepted

Payback period tells the time it takes to break even in an _________ sense. Discounted payback period tells the time it takes to break even in an _________ or financial sense.

Accounting Economic

The AAR is calculated by taking the average net income and dividing it by the average ___________ value.

Book

__________ budgeting is the decision-making process for accepting and rejecting projects.

Capital

The IRR rule can lead to bad decisions when _________ or ________.

Cash flows are not conventional Projects are mutually exclusive

Based on the __________ payback rule, an investment is acceptable if its __________ payback is less than some prespecified number of years.

Discounted Discounted

Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?

Discounted payback period

NPV ________ cash flows properly.

Discounts

True or false: the MIRR function eliminates multiple IRRs and should replace NPV.

False

The profitability index is calculated by dividing the PV of the ________ cash flows by the initial investment.

Future

The basic NPV investment rule is:

If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference Accept a project if the NPV is greater than zero Reject a project if its NPV is less than zero

One of the main disadvantages of the discounted payback period rule is that the cutoff is arbitrarily set and cash flows beyond that point are __________.

Ignored

The present value of all cash flows (after the initial investment) is divided by the _________ to calculate the profitability index.

Initial investment

The point at which the NPV profile crosses the horizontal axis is the:

Internal rate of return

According to Graham and Harvey's 1999 survey of 392 CFO's, which of the following two capital budgeting methods are most used by firms in the United States?

Internal rate of return Net present value

If a project has multiple internal rates of return, which of the following methods should be used?

MIRR NPV

The _________ method differs from NPV because it evaluates a project by determining the time needed to recoup the initial investment.

Payback

The amount of time needed for the cash flows from an investment to pay for its initial cost is the __________ period.

Payback

If the IRR is greater than the _________ _________ we should accept the project.

Required return

Using the payback period rule will bias toward accepting which type of investment?

Short-term investment

The payback period method allows lower management to make _________, everyday financial decisions effectively.

Smaller

The payback period rule _________ a project if it has a payback period that is less than or equal to a particular cutoff date.

Suggests accepting

The point at which the NPV profile crosses the vertical axis is the:

Sum of the cash flows of the project

Which of the following are weaknesses of the payback method?

The cutoff date is arbitrary Time value of money principles are ignored Cash flows received after the payback period are ignored

True or false: Based on the discounted payback rule, an investment is acceptable if its discounted payback is less than some prespecified number of years.

True

True or false: IRR approach may lead to incorrect decisions in comparison of two mutually exclusive projects.

True

Which of the following are mutually exclusive investments?

Two different choices for the assembly lines that will make the same product A restaurant or a gas station on the same piece of land

The three attributes of NPV are that it:

Uses cash flows Discounts the cash flows properly Uses all the cash flows of a project

Capital Corp is considering a project whose internal rate of return is 14%. If Capital's required return is 14%, the project's NPV is:

Zero

The IRR is the discount rate that makes the NPV of a project equal to _________.

Zero

The discounted payback is the time it takes to break even in an __________ or financial sense.

Economic

The discounted payback period has which of these weaknesses?

Exclusion of some cash flows Arbitrary cutoff date Loss of simplicity as compared to the payback method

By ignoring time value, the payback period rule may incorrectly accept projects with a _________ NPV.

Negative

The IRR rule can lead to bad decisions when cash flows are ________ or projects are mutually exclusive.

Not conventional

According to Graham and Harvey's 1999 survey of 392 CFOs, in addition to IRR and NPV, which were the two most widely used techniques, over half of the respondents always, or almost always, used which of the following methods?

Payback method

This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively.

Payback method

For a project with conventional cash flows, the NPV is _________ if the required return is less than the IRR, and it is ________ if the required return is greater than the IRR.

Positive Negative

Net _________ value is a measure of how much value is created or added today by undertaking an investment.

Present

In capital budgeting, the net __________ determines the value of a project to the company.

Present value

According to the basic IRR rule, we should __________.

Reject a project if the IRR is less than the required return.