Chapter 13 finance

Which of the following best describes the NPV profile?

A graph of a project's NPV as a function of possible capital costs.

Which of the following statements is correct?

A weakness of both payback and discounted payback is that neither accounts for cash flows received after the payback.

Which of the following is incorrect regarding the IRR statistic?

For the IRR statistic to give a different accept/reject decision from NPV, the cash flows must be non-normal and the projects must be mutually exclusive

All of the following capital budgeting tools are suitable for non-normal cash flows except

IRR

Under what conditions can a rate-based statistic yield a different accept/reject decision than NPV?

Mutually exclusive projects that exhibit differences in scale or timing.

. A capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows is referred to as

NPV

All of the following capital budgeting tools are suitable for firms facing time constraints except ______.

NPV

All of the following capital budgeting tools are suitable for non-normal cash flows except

Payback

A decision rule and associated methodology for converting the NPV statistic into a ratebased metric is referred to as

Profitability Index

Which rate-based decision statistic measures the excess return (the amount above and beyond the cost of capital for a project), rather than the gross return?

Profitability Index, PI

Projects A and B are mutually exclusive. Project A costs $20,000 and is expected to generate cash inflows of $7,500 for 4 years. Project B costs $10,000 and is expected to generate a single cash flow in year 4 of $20,000. The cost of capital is 12%. Which project would you accept and why?

Project A because it has the higher NPV.

Projects A and B are mutually exclusive. Project A costs $10,000 and is expected to generate cash inflows of $4,000 for 4 years. Project B costs $10,000 and is expected to generate a single cash flow in year 4 of $20,000. The cost of capital is 12%. Which project would you accept and why?

Project B because it has the higher NPV.

. For a project with normal cash flows, what would you expect the relationship to be between the MIRR and the IRR?

Since the reinvestment rate of the MIRR statistic is lower than that of the IRR, you would expect the MIRR to be less than the IRR.

Which of the following statements is correct regarding the NPV profile?

The IRR appears as the intersection of the NPV profile with the x-axis.

The MIRR statistic is different from the IRR statistic in that

The MIRR assumes that the cash inflows can be reinvested at the cost of capital

Which of the following tools is suitable for choosing between mutually exclusive projects?

. NPV

All of the following are strengths of payback except

. None of these

All capital budgeting techniques

. exclude some crucial information.

This technique for evaluating capital projects tells how long it will take a firm to earn back the money invested in a project.

. payback

A company is considering two mutually exclusive projects, A and B. Project A requires an initial investment of $200, followed by cash flows of $185, $40 and $15. Project B requires an initial investment of $200, followed by cash flows of $0, $50 and $230. What is the IRR of the project that is best for the company's shareholders? The firm's cost of capital is 10%.

12.71%

A company is considering two mutually exclusive projects, A and B. Project A requires an initial investment of $100, followed by cash flows of $95, $20 and $5. Project B requires an initial investment of $100, followed by cash flows of $0, $20 and $130. What is the IRR of the project that is best for the company's shareholders? The firm's cost of capital is 10%.

15.24%

A project costs $101,000 today and is expected to generate cash flows of $31,000 per year for the next 15 years. At what rate is the NPV equal to zero?

30.10%

A financial asset will pay you $10,000 at the end of 10 years if you pay premiums of $175 per year at the end of each year for 10 years. What is the IRR of this financial asset?

35.93%

A firm is evaluating a potential investment that is expected to generate cash flows of $100 in years 1 through 4 and $400 in years 5 through 7. The initial investment is $750. What is the payback for this investment?

4.88 years

A financial asset will pay you $50,000 at the end of 20 years if you pay premiums of $975 per year at the end of each year for 20 years. What is the IRR of this financial asset?

9.02%

We accept projects with a positive NPV because it means that

All of these

A disadvantage of the payback statistic is that

All of these are disadvantages of payback

Why is a project's cost not an appropriate benchmark for its NPV?

Because the NPV has already subtracted out the project's cost.

All of the following capital budgeting tools are suitable for non-normal cash flows except

Discounted Payback

Suppose you have a project whose discounted payback is equal to its termination date. What can you say for sure about its PI?

It will have a PI and NPV of zero.

A capital budgeting method that converts a project's cash flows using a more consistent reinvestment rate prior to applying the IRR decision rule is referred to as ______________.

MIRR

The least-used capital budgeting technique in industry is

MIRR

All of the following are strengths of NPV except

Managers have a preference for using a statistic that is in percent instead of dollars

Suppose two projects with normal cash flows, X and Y, have exactly the same required initial investment, but X has a longer payback. Can we say anything about X's IRR versus that of Y?

The project with the longer payback will have the lower IRR, as its cash flows will, on average, be later than the other project's.

Which of the following statements is correct?

The reinvestment rate of NPV and MIRR is the same.

A project costs $91,000 today and is expected to generate cash flows of $11,000 per year for the next 20 years. The firm has a cost of capital of 8%. Should this project be accepted, and why?

Yes, the project should be accepted since it has a NPV = $16,999.62

. A project has normal cash flows. Its IRR is 15 percent and its cost of capital is 10 percent. Given this, the project must have:

an NPV that is greater than zero.

Neither payback period nor discounted payback period techniques for evaluating capital projects account for

cash flows that occur after payback.

The Net Present Value decision technique uses a statistic denominated in

currency

This technique for evaluating capital projects tells how long it will take a firm to earn back the money invested in a project plus interest at market rates.

discounted payback

A capital budgeting technique that generates decision rules and associated metrics for choosing projects based upon the implicit expected geometric average of a project's rate of return.

internal rate of return

A project's IRR

is the average rate of return necessary to pay back the project's capital providers

. A capital budgeting technique that converts a project's cash flows using a more consistent reinvestment rate prior to applying the Internal Rate of Return, IRR, decision rule

modified internal rate of return

These are groups or pairs of projects where you can accept one but not all

mutually exclusive

. A graph of a project's ______ is a function of cost of capital

net present value

A capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows.

net present value

Of the capital budgeting techniques discussed, which works equally well with normal and non-normal cash flows and with independent and mutually exclusive projects?

net present value

These are sets of cash flows where all the initial cash flows are negative and all the subsequent ones are either zero or positive.

normal cash flows

This technique for evaluating capital projects is particularly useful when firms face time constraints in repaying investors.

payback

When choosing between two mutually exclusive projects using the payback period method for evaluating capital projects, one would choose

the project that pays back the soonest if it is equal to or less than managers' maximum payback period.

The Net Present Value decision technique may not be the only pertinent unit of measure if the firm is facing

time or resource constraints

The benchmark for the Profitability Index, PI, is the

zero or anything larger than zero