FIN: Ch 9 Net Present Value and other Investment Criteria

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

Budgeting

According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following two capital budgeting budgeting methods are most used by firms in the U.S. and Canada?

- Net present value - Internal rate of return

The discounted payback period has which of these weaknesses?

-Exclusion of some cash flows -Loss of simplicity as compared to payback method -Arbitrary cutoff date

Arrange the steps involved in the discounted payback period in order starting with the first step.

1. Discount the cash flows using the discount rate 2. Add the discounted cash flows 3. Accept if the discounted payback period is less than some pre-specified number of years

What is the IRR for a project with an annual initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?

9.70% solve for I/Y =9.7

The spreadsheet function for calculating net present value is ______.

=NPV()

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

Accept

Payback period tells the time it takes to break even in an _________ sense. Discounted payback period tells the time it takes to break even in an _________ or financial sense.

Accounting; Economic

True or False: Investing more money in a project is a guarantee of greater profits.

False

True or False: The MIRR function eliminates multiple IRRs and should replace NPV.

False

True or False: The discounted payback rule has an objective benchmark to use in decision making.

False

IRR continues to be very popular in practice, partly because:

It gives a rate of return rather than a dollar value

This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively.

Payback method

In which of the following scenarios would IRR always recommend the wrong decision?

Starting Cash Flow= 1000 Ending Cash Flow= -2000

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

Suggests accepting

True or False: The crossover rate is the rate at which the NPV's of two projects are equal.

True

True or False: Some projects, such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return.

True

What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%?

$5.94 NPV=-$95+(107/1.06)=5.94

The most important alternative to NPV is the _______ method.

internal rate of return

The IRR is the discount rate that makes the NPV of a project equal to _________.

zero

Which of the following are mutually exclusive investments?

- Two different choices for the assembly lines that will make the same product - A restaurant or a gas station on the same piece of land

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

NPV & MIRR

The amount of time needed for the cash flows from an investment to pay for its initial cost is the:

Payback period

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

Present Value

Project alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If projects alpha and beta have conventional cash flows, are mutually exclusive and the NPV profiles cross at 15% (Where the NPV's are positive), which of the projects has a higher internal rate of return?

Project Beta: The 2 projects have a crossover point above the horizontal axis, and Alpha crosses the vertical axis above beta. Because the cash flows are conventional, their NPV profiles cross only once, so alpha must have a steeper NPV profile, but beta must have a higher IRR.

The IRR rule can lead to bad decisions when ________________ or ___________________.

Projects are mutually exclusive; cash flows are not conventional.

The point at which the NPV profile crosses the vertical axis is the:

Sum of the cash flows of the project

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

a target average accounting return

Capital Corp is considering a project whose internal rate of return is 14%. If Capital's required return is 14%, the project's NPV is:

zero

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

Required Return

The basic NPV investment rule is:

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

Which of the following projects is acceptable if the average accounting return is required to be at lease 20%?

- Restaurant: Average income = $450,000; average book value = $2.180,000 - Book store: Average income = $140,000; average book value = $600,000

Which of the following are weaknesses of the payback method?

-The cutoff date is arbitrary -Time value of money principles are ignored -Cash flows received after the payback period are ignored

The three attributes of NPV are that it:

1. uses all the cash flows of a project 2. uses cash flows 3. discounts the cash flows properly

What is the PI for a project with an initial cash outflow of $30 and a subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12%?

2.91 =((80/1.12)+(20/1.12^2))/30=2.91

Saxon company is considering a project that will generate net income of $50,000 in year 1, $75,000 in year 2, and $90,000 in year 3. the cost of the project is $700,000, and this cost will be depreciated to zero in the three years of the investment. what is their average accounting return?

20.48%

Which of the following are advantage(s) of ARR?

- Is easy to compute - Needed information is always available

When cash flows are conventional, NPV is ______________.

- Positive for discount rates below the IRR - Equal to zero when the discount rate equals the IRR - Negative for discount rates above the IRR.

How does the timing and the size of cash flows affect the payback method?

Assume the project does pay back within the project's lifetime an increase in the size of the first cash inflow will decrease the payback period, all else held constant

The profitability index is calculated by dividing the PV of the ________ cash flows by the initial investments.

Future

A(n) __________ project does not rely on the acceptance or rejection of another project.

Independent