CH9 3040

Which of the following is (are) biased in favour of liquid investments? I. Payback period II. AAR III. Discounted payback

I and III only

If financial managers only invest in projects that have a profitability index greater than one: I. firm value will be maximized. II. shareholder wealth will be maximized. III. share price will be maximized.

I, II, and III

Which of the following are advantages of using net present value when evaluating projects? I. NPV lets you know in today's dollars how much better off or worse off you will be if you accept a project. II. NPV includes time value of money considerations. III. The NPV method quickly determines the discount rate that changes an accept decision into a reject decision and vice versa. IV. NPV indicates the expected impact on the owners of the firm.

I, II, and IV only

Which capital investment evaluation technique is described by the following characteristics? (1) Easy to understand and communicate; (2) May result in multiple answers; (3) May lead to incorrect decisions when applied to mutually exclusive investments.

IRR

Net present value can be defined as

A measure of the value created or added today by undertaking a project

The average accounting return (AAR) rule can be best stated as:

An investment is acceptable if its AAR exceeds a target AAR.

The internal rate of return (IRR) rule can be best stated as:

An investment is acceptable if its IRR exceeds the required return, or else it should be rejected.

Your firm's CFO presents you with two capital budgeting analyses: one that involves buying a new delivery truck to replace the existing truck and one that involves the purchase of a three-ton metal stamping press to replace the existing press on the plant floor. This is an example of a decision involving ___________

independent projects

To find the __________ we begin by setting the NPV of a project equal to zero.

internal rate of return

A project whose NPV equals zero ______________.

is expected to earn a return equal to the firm's required return

The possibility that more than one discount rate will make the NPV of an investment zero is called the ___________ problem.

multiple rates of return

A firm seeks to accept projects with a high degree of liquidity, avoid the higher forecasting error associated with cash flows occurring in the distant future, and avoid projects that require a large amount of research and development expenses. This firm may be justified in using the ____________ to evaluate its projects.

payback rule

The use of which of the following could lead to incorrect decisions when comparing mutually exclusive investments? I. Internal rate of return II. Profitability index III. Average accounting return

I and II only

Which capital investment evaluation technique offers the following advantages? (1) Easy to calculate; (2) Needed information will usually be available

AAR

The discounted payback rule can be best stated as:

An investment is acceptable if its discounted payback period is less than some prespecified number of years

The net present value (NPV) rule can be best stated as:

An investment should be accepted if the NPV is positive and rejected if it is negative.

Which of the following decision rules has the advantage that the information needed for the calculation is readily available?

Average accounting return

Generally, the most difficult part of utilizing the net present value concept is:

Estimating the future cash flows given the initial investment in the project.

The profitability index will be:

Greater than 1.0 when the IRR is greater than the discount rate.

The use of which of the following could lead to incorrect decisions in comparing mutually exclusive investments? I. Internal rate of return II. Profitability index III. Average accounting return

I and II only

Which of the following will NOT lead to ambiguous decision-making when considering mutually exclusive projects? I. AAR II. PI III. IRR IV. NPV

I and IV only

By definition, the net present value is equal to zero when the discount rate is equal to the:

Internal rate of return.

The primary idea behind the net present value rule is that an investment:

Is worthwhile if it creates value for the owners.

The payback method assumes that the cash flows:

Occur evenly throughout the year.

A conventional cash flow is defined as a series of cash flows where:

Only the initial cash flow is negative.

Which of the following decision rules is best for evaluating projects for which cash flows beyond a specified point in time, and the time value of money, can both be ignored?

Payback

The length of time required for an investment to generate cash flows sufficient to recover its initial cost is the:

Payback period

Which capital investment evaluation technique is described by the following characteristics? (1) Easy to understand; (2) Biased towards liquidity; (3) Requires an arbitrary cutoff point; (4) Ignores the time value of money.

Payback period

A manager will prefer the IRR rule over the NPV rule if the manager:

Prefers to talk in terms of rates of return

As the required rate of return increases, the:

Profitability index decreases.

If a project with conventional cash flows has a profitability index less than one, then:

The discounted payback period is greater than the project's life

Which of the following is NOT a true statement?

The profitability index is closely related to the payback period.

For a project with conventional cash flows, if NPV is greater than zero, then:

The profitability index is greater than 1.

Which of the following can cause a project to have multiple IRRs?

A ten-year project has a negative cash flow in the last year of the project's life.

The profitability index (PI) rule can be best stated as:

An investment is acceptable if its PI is greater than one.

The process of valuing an investment by determining the present value of its future cash flows is called (the):

Discounted cash flow valuation.

For which capital investment evaluation technique is the following a complete list of its disadvantages when compared to NPV analysis? (1) Ignores cash flows beyond the cutoff date; (2) Requires an arbitrary cutoff point; (3) Biased against long-term projects; (4) May reject positive NPV projects

Discounted payback

Which of the following statements concerning the average accounting return is (are) correct? I. The information used in the AAR calculation is easily obtainable. II. A project is accepted if the target AAR exceeds the project AAR. III. The AAR ignores the time value of money. IV. The AAR is based on cash flows and market values

I and III only

Rank the following decision rules from worst to best in terms of their overall usefulness in capital budgeting analysis. I. NPV II. Payback III. IRR

II, III, I

In which of the following cases can NPV and IRR lead to different decisions? I. Project cash flows are conventional. II. The IRR is negative. III. An investment decision involves mutually exclusive choices.

III only

Which of the following calculations takes the time value of money into account? I. Payback II. Average accounting return III. Profitability index

III only

Complete the following decision rule: A project should be accepted if its ______ exceeds the firm's required rate of return.

IRR

A project should be accepted when the:

IRR exceeds the required rate

The discount rate that makes the net present value of investment exactly equal to zero is the:

Internal rate of return.

The internal rate of return (IRR) is often preferred by managers over the net present value (NPV) because the IRR:

Is expressed as a rate while the NPV is expressed in dollar terms

Which of the following is considered to be a redeeming feature of average accounting return analysis?

It is relatively easy to calculate.

Which of the following is NOT correct?

NPV's can normally be directly observed in the market.

The principle that an investment should be accepted if the difference between the investment's market value and its cost is positive and rejected if the difference is negative is referred to as the:

Net present value rule.

According to the capital budgeting surveys cited in the text, in general, most financial managers of large Canadian firms:

Who use payback analysis use it only in conjunction with some other type of analysis

Which of the following is a correct statement?

Discounted payback analysis requires use of a discount rate.

Which of the following capital budgeting techniques employ some sort of arbitrary value against which the project measurement must be compared when determining whether to accept or reject a project? I. Net present value II. Average accounting return III. Profitability index IV. Discounted payback

II and IV only

The internal rate of return on a project is 11.24%. Which of the following (is) are true if the project is assigned a 9.5% discount rate? I. The project will have a negative net present value. II. The profitability index will be greater than 1.0. III. The initial investment is less than the market value of the project. IV. The project will have a positive effect on shareholders if it is accepted.

II, III, and IV only

Consider a project with an initial investment and positive future cash flows. As the discount rate is increased the ____________

IRR remains constant while the NPV decreases

Which of the following statements is false?

If the cost of capital is greater than the IRR, the project should be accepted.

When the decision to accept or reject one project does not affect the decision to accept or reject any other project, the project is said to be:

Independent.

The payback method:

Is prejudiced towards short-term projects.

A situation in which taking one investment prevents the taking of another is called:

Mutually exclusive investment decisions.

The __________ decision rule is considered the "best" in principle.

Net present value

You run a small bagel shop and are considering replacing your four employees with automated machines that allow customers to buy their bagels without any human interaction. Of the following, the most difficult task you face in computing the NPV of this change is the:

estimation of the total change in sales that will result from the change.

A financial manager who consistently underestimates the ___________ will tend to incorrectly reject projects that would actually create wealth for the stockholders

future cash inflows associated with projects

If a firm uses the _____________ as an investment criterion, one of the risks it takes is that it may ignore some future cash flows.

payback rule

If an investment has a(n) ___________ of 1.2 it can be said that the investment generates $1.20 in present value benefits for each dollar of invested costs.

profitability index

The payback rule can be best stated as:

An investment is acceptable if its calculated payback period is less than some pre-specified number of years

Which of the following does NOT incorporate discounted cash flow (DCF) valuation in its calculation?

Average accounting return

Which of the following is calculated using ONLY accounting numbers?

Average accounting return

An investment's average net income divided by its average book value is the:

Average accounting return.

Average accounting return is defined as:

Average net income divided by average book value

The essence of _________________ is determining whether a proposed investment or project will generate positive wealth for the owners of the firm once it is in place

Capital budgeting.

Net present value _____________.

Compares project cost to the present value of the project benefits

A project which has an initial cash outlay, with all future cash flows positive, is said to be:

Conventional.

An NPV of zero implies that an investment's ____________.

Cost is equal to the present value of its cash inflows

The length of time needed to recover the initial investment once time value of money is considered is called the:

Discounted payback period.

The length of time required for an investment's discounted cash flows to equal its initial cost is the:

Discounted payback period.

Which of the following uses an arbitrary cutoff number in its decision rule? I. Payback period II. AAR III. IRR

I and II only

Which of the following questions are addressed in the capital budgeting process? I. What products or services will we offer or sell? II. In what markets will we compete? III. What new products will we introduce?

I, II, and III

Which of the following statements is (are) true concerning the comparison between payback and discounted payback? I. From a financial point of view, the discounted payback method is preferred over the payback method. II. The discounted payback is more difficult to compute and thus is not as widely used as the payback method. III. Both methods are biased towards liquidity. IV. Both methods consider the time value of money.

I, II, and III only

Which of the following statements is (are) true concerning the internal rate of return (IRR)? I. The IRR is the most widely used capital budgeting technique. II. The IRR method can produce multiple rates of return if the cash flows are nonconventional. III. If the IRR rate is used as the discount rate, then the resulting profitability index must equal 1.0. IV. The crossover point occurs where the IRR of two projects are equal

I, II, and III only

The crossover point is defined as the discount rate that:

Makes the net present values of two projects equal.

The difference between the market value of an investment and its cost is the:

Net present value.

_________ quantifies, in dollar terms, how stockholder wealth will be affected by undertaking a project.

Net present value.

The internal rate of return should

Not be used for ranking mutually exclusive projects.

Which capital investment evaluation technique is described by the following characteristics? (1) Closely related to NPV; (2) Easy to understand and communicate; (3) May lead to incorrect decisions when comparing mutually exclusive investments; (4) May be useful when the available investment funds are limited.

PI

A project has a required return of 15% and a five year life. Which of the following is inconsistent with the other four?

PI = 0

The present value created per dollar invested is called the:

Profitability index.

The present value of an investment's future cash flows divided by its initial cost is the:

Profitability index.

Randy's Manufacturing is considering two mutually exclusive projects. The company has a required rate of return of 13.5% on projects of this nature. Project A costs $100,000 and has an IRR of 14.5%. Project B costs $150,000 and has an IRR of 14%. Which project should be accepted and why?

Project B because it has the largest net present value

Ranking conflicts can arise if one relies on IRR instead of NPV when:

Projects are mutually exclusive.

An advantage of the payback method is its:

Simplicity.

The discounted payback period is best defined as the length of time until the:

Sum of the discounted cash flows is equal to the initial investment.

If the required return is zero, then:

The NPV equals the difference between the undiscounted future cash flows and the initial cost.

Which one of the following statements is correct concerning the average accounting return (AAR)?

The average book value used in the AAR formula will always equal one-half of the initial investment as long as straight-line depreciation over the life of the project is used.

Which of the following is true about using discounted payback analysis for projects which have only positive cash flows after the initial outlay and for which the discount rate is positive?

The discounted payback period will be longer than the regular payback period

An independent project has conventional cash flows and a positive net present value. It can be stated with certainty that the project is acceptable according to the capital budgeting technique known as:

The internal rate of return.

Your firm needs to buy a metal stamping press. The CFO presents you with two analyses: one for a press that is automated, requiring little labour to operate, and another that is manual, requiring a significant amount of labour. This is an example of a decision involving ______________.

mutually exclusive projects

In comparing two projects using an NPV profile, at the point where the net present value of the projects involved are equal, _______________

the discount rate that equates them is called the crossover rate