Exam 3: Chapter 8

The basic NPV investment rules are:

1) Accept a project if the NPV is greater than zero 2) If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference 3) Reject a project if its NPV is less than zero

What are the advantages of the payback period method for management?

1) It allows lower level managers to make small decisions effectively 2) The payback period method is ideal for minor projects 3) The paycheck period is method is easy to use

According to Graham and Harvey's 1999 survey of 392 CFO's, what two capital budgeting methods are widely used by firms in the US and Canada?

1) NPV 2) IRR

If a project has multiple internal rates of return, what methods should be used?

1) NPV 2) MIRR

What presents problems when using the IRR method?

1) Non-conventional cash flows 2) Mutually Exclusive Projects

What are the reasons why IRR continues to be used in practice?

1) The IRR of a proposal can be calculated without knowing the appropriate discount rate 2)Business people prefer to talk about rates of return 3) It is easier to communicate information about a proposal with an IRR

What are the methods of calculating the MIRR of a project?

1) The Reinvestment Approach 2)The Discounting Approach 3) The Combination Approach

When calculating NPV, the present value of the Nth cash flow is found by dividing the Nth cash flow by 1 plus ______ rate raised to the Nth power

The Discount

Which of the following statement is correct?

The payback method is biased toward short-term projects

True or False: A project with non-conventional cash flows will produce two or more IRRs

True

The IRR is the discount rate that makes NPV equal to _______.

Zero

What are weaknesses of the payback method?

1) The cutoff date is arbitrary 2) Time value of money principles are ignored 3) Cash flows received after the paycheck period is ignored

The internal rate of return is a function of ________.

A Projects cash flows

Capital _______ is the decision-making process for accepting and rejecting projects

Budgeting

The Profitability Index is also called the ______ ratio.

Cost-Benefit

If a firm is evaluating two possible projects, both of which require the use of the same production facilities, these projects would be considered ____________.

Mutually Exclusive

The ______ is best suited for decisions on relatively small, minor projects while _______ is more appropriate for large complex projects.

Payback Period; NPV

If the IRR is greater than the _______ ________, we should accept the project.

Required Return Rate

Which for the following indicates that a project should be rejected? Assume the cash flows are normal, i.e., the initial cash flow is negative.

Profitability Index less than 1.0

The PI rule for an independent project is to ______ the project if the PI is greater than 1.

Accept

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

A target average accounting return

In general, NPV is _____.

1) Positive for discount rates below the IRR 2) Negative for discount rates above the IRR 3) Equal to zero when the discount rate equals the IRR

A project should be _____ if the NPV is greater than zero

Accepted

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

Accepts

The Average Accounting Return is defined as:

Average NI / Average BV

What is a disadvantage of the Profitability Index?

Cannot Rank mutually exclusive projects

True or False: An advantage of the AAR is that is based on book values, not market values

False

Capital budgeting is probably the most important of the three key areas of concern to the financial manager because _________.

It defines the business of the firm

The payback period can lead to foolish decisions if it is used too literally because:

It ignores cash flows after the cutoff date

Which one of the following is specifically designed to compute the rate of return on a project that has multiple negative cash flows that are interrupted by one or more positive cash flows?

Modified internal rate of return

Higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on.

More

Both projects A and B are acceptable as independent projects. However, the selection of either one of these projects eliminates the option of selecting the other project. Which one of the following terms best describes the relationship between Project A and Project B?

Mutually Exclusive

In capital budgeting, ______ determines the dollar value of a project to the company

NPV

Mary has just been asked to analyze an investment to determine if it is acceptable. Unfortunately, she is not being given sufficient time to analyze the project using various methods. She must select one method of analysis and provide an answer based solely on that method. Which method do you suggest she use in this situation?

Net Present Value

True or False: Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return

True (Whenever subsequent cash flows are both negative and positive, multiple internal rates of return may occur)

An investment has initial cost of $2.7 million net income of $189,400, $178,600 and $172,500 for Years 1 to 3. This investment will be depreciated by $900,000 a year over the three-year life of the project. Should this project be accepted based on the average accounting rate of return if the required rate is 12.5 percent? Why or Why not?

Yes, because the AAR is greater than 12.5 percent

The _____ method evaluates a project by determining the time needed to recoup the initial investment

Payback

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