Fin 3200- Ch. 8

What is the IRR for a project with an initial investment of $500 and subsequent cash inflows of $145 per year for 5 years.

13.82%

What is the profitability index for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in year one and $20 in year two if the discount rate is 12%?

2.92 ((80/1.12)+(20/1.12^2))/30

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

A target average accounting return

The PI rule for an independent project is to ____________ the project of the PI is greater than 1.

Accept

The Average Accounting Return is defined as:

Average net income/average book value

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

Budgeting

Which of the following is a disadvantage of the profitability index?

Cannot rank mutually exclusive projects

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

False

The present value of the future cash inflows are divided by the _____________ to calculate the profitability index.

Initial investment

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

More

One of the flaws of the payback period method is that cash flows after the cutoff date are _____________.

Not considered for the analysis

The ___________ is best suited for decisions on relatively small, minor projects while ______________ is more appropriate for large complex problems.

Payback period; NPV

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

According to the basic IRR rule, we should:

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

If the IRR is greater than the ___________ ____________, we should accept the project.

Required return

Internal rate of return (IRR) must be compared to the ____________ in order to determine the acceptability of a project.

Required return

Which of the following is a disadvantage of the payback period rule?

Requires an arbitrary cutoff point

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 are methods of calculating the MIRR of a project?

1. Discounting approach 2. Reinvestment approach 3. Combination approach

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

1. NPV 2. MIRR

According to Graham and Harvey's 1999 survey of 392 CGOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the US and Canada?

1. Net present value 2. Internal rate of return

The basic NPV investment rule is:

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

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

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

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

It ignores cash flows after the cutoff date

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

Mutually exclusive

________________ is a measure of how much value is created or added by undertaking an investment.

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.

Which of the following are reasons why IRR continues to be used in practice?

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

True or false: a project with a non-conventional cash flows will produce two or more IRRs.

True

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