chapter 9

The financing decision

Find the right kind of debt for your firm and the right kind of mix of debt and equity to fund your operations.

The dividend decision

If you cant find investments that make your minimum acceptable rate, return the cash to owners of your business.

The investment decision

Invest in assets that earn a return greater than the minimum acceptable hurdle rate.

False

It should not usually be clear whether we are describing independent or mutually exclusive projects in the following chapters because when we only describe one project then it can be assumed to be independent

False, NPV reinvested at the cost of capital and IRR assumes reinvested at IRR

NPV assumes intermediate cash flows are reinvested at the cost of equity, while IRR assumes that they are reinvested at the cost of capital:

False, is by subtracting a project initial investment.

Net present value (NPV) is a sophisticated capital budgeting technique; found by adding projects initial investment from the present value of its cash inflows discounted at a rate equal to the firms cost of capital:

True

The Internal Rate of Return (IRR) is the discount rate that equates the NPV of an investment opportunity with $0

Requires a lot of date(estimates of all CFS) Only works for normal cash flows Requires complex calculations

The disadvantages of the IRR period method is that:

Does not require complex calculations Measures Liquidity, Easy to communicate Does not require discount rate

What are advantages of payback period:

CF0:-100,000 CO1: 50,000 FO1: 3 I: 6.45% CPT NPV:32,545.60

What is the NPV of a project that costs $100,000 and returns $50,000 annually for three years if the opportunity cost of capital is 6.45%

PV: -10,000 PMT: 2,000 FV: 0 N: 6 CPT I: 5.47

What is the internal rate of return of return for a project with an initial outlay of $10,000 that is expected to generate cash flows of $2,000 per year for 6 years.

Profitability Index=(NPV+CFO)/CF) 1 step: Find NPV of project A. Which is $13,897.94 2 step= Compute PI=($13,897.94+$42,000)/$42,000=1.33

What is the profitability index for Project A with a cost of capital of 8%?

The cost of capital exceeds the IRR

Which of the following statements is correct for a project with a negative NPV?

CF0: -5,000 CF1: 141 FO1:3 CF2; 1,833 FO2: 3 I: 1.06% CPT NPV: $630.98

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $141 at the end of the next three years and then $1,833 per year for the three years after that. If the discount rate is 1.06% then what is the NPV?

1 step: Compute the NPV of all three projects. 2 step: Choose the project with the highest NPV. Which was project 3. 3 step: Plug in all Cash flows for project 3 then Click IRR CPT: 14.23

You are considering the following three mutually exclusive projects. The required rate of return for all three projects is 14%. What is the IRR of the best project? % terms to 2 decimal places w/o % sign

NPV

The "gold standard" of investment criteria refers to:

Weeds out proposals with weaker or biased NPVs.

Capital rationing may be beneficial to a firm if it:

Mutually Exclusive

Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function.

Steps capital budgeting process

Step 1: Proposal generation Step 2: Review and analysis Step 3: Decision making Step 4: Implementation Step 5: Follow-up

maximize the shareholders wealth.

The primary purpose of capital budgeting is to:

Payback period= number of whole years+(additional cash flows to break even)/(total cash flows in next year)

Compute the payback period for a project that requires an initial outlay of $138,098 that is expected to generate $40,000 per year for 9 years.

True

The multiple IRR problem occurs when the signs of a projects cash flows change more than once.

Profitability Index=(NPV+CFO)/CFO 1 step: Find NPV=$183.48 2 step: Compute PI= ($183.48+$5000)/$5000=*100=103.67%

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $900 at the end of the next three years and then $1400 per year for the three years after that. If the discount rate is 8% then what is the PI? Answer in % format with 2 number after the decimal point