FIN CHPT 7

A project with cash inflow of $200 followed by a cash outflow of (-250) one year later will have an IRR of ____ percent.

25%

The dollar difference in value between mutually exclusive projects can be found by calculating the ___ of the incremental cash flows.

NPV

In capital budgeting, the net ___ is the value of a project to the company.

Present value

NPV accounts for the size of the project, eliminating the effects of ____.

Scale

The internal rate of return is a function of ____.

A project's cash flow

The payback period can lead to incorrect decisions if it is used too literally because it ____.

Ignores cash flows after the cutoff date

The net present value of a project's cash flows is divided by the _____ to calculate the profitability index.

Initial investment

When cash flows are conventional, NPV is ____ if the discount rate is above the IRR.

Negative

For a project with positive initial cash flow followed by negative cash flows, we should ___.

Accept if the IRR is less than R

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

Accepts

The property of value ____ implies that the contribution of any project to a firm's value is simply the NPV of the project.

Additivity

The most important alternative to NPV is the _____ method.

Internal rate of return

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

2.91

A project requires $240 of equipment that will be depreciated straight-line over 3-year project life. What is the average investment for AAR purposes?

$120

According to the basic IRR rule, we should ____ a project if the IRR is _____ than the discount rate.

• Accept; greater • Reject; less

The decision rule for a project for which the first cash inflow and subsequent cash flows are negative states that we should ____ the project when the IRR is ____ than the discount rate.

• Accept; less • Reject; greater

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

• NPV • MIRR

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

• Net present value • Internal Rate of Return

Accept a project if its NPV is _____ zero.

Greater than

The problems with scale in the profitability index can be corrected by using _____ analysis.

Incremental

The ____ method is best suited for decisions on small projects while the ____ method is most appropriate for large, complex projects.

Payback; NPV

For "normal" cash flows (the outflows occur before the inflows), the NPV is _____ if the discount rate is less than the IRR, and it is ____ if the discount rate is greater than the IRR.

Positive; negative

The movie industry frowns upon NPV analysis because their cash flows are ____ to predict.

Hard

A dollar received on year from today has ____ value than a dollar received today.

Less

Capital rationing requires a company to ___.

Limit their investments

With mutually exclusive projects, the profitability index suffers from the same problem that the IRR rule does in that it fails to consider____.

The size or scale of projects

Higher cash flows earlier in a projects life are ____ valuable than higher cash flows later on.

More

The ___ method differs from NPV because it evaluates a project by determining the time needed to recoup the initial investment.

Payback

When using the spreadsheet function NPV, the cash outflow at Time 0 must be ____.

Subtracted from PV of other cash flows.

According to the basic investment rule for NPV, a firm should _____.

• Be indifferent towards accepting a project if NPV is equal to zero • Reject a project if NPV is less than zero • Accept a project if NPV is greater than zero

Two mutually exclusive projects can be correctly evaluated by ____.

• Comparing the incremental IRR to the discount rate • Examining the NPV of the incremental cash flows • Comparing the NPVs of the two projects

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

• It allows lower level managers to make small decision effectively • The payback period method is ideal for minor projects • The payback period is easy to use

NPV, but not IRR, can be used in what situations

• Multiple internal rates of return • Multiple changes in cash flow signs

Why is a dollar received today worth more than a dollar received in the future?

Today's dollar can be invested, yielding a greater amount in the future

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

Budgeting

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

Discount

What are weaknesses of the payback method?

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

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

• Net present value • Internal rate of return

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

Not considered in the analysis

A project with a cash outflow followed by three cash inflows will always have ____ internal rate of return.

One

The ____ method is ideal for companies with limited funds that have need for a quick turn-around of their capital.

Payback

What is true for a project with a negative initial cash flow followed by positive cash flows?

• Reject if IRR is less than market rate of financing • Accept if NPV is greater than zero

A firm evaluation two mutually exclusive project can ____.

• Reject one of the project • Accept one of the projects • Reject both projects

The discount rate assigned to a project reflects the _____.

• Risk of the project • Opportunity cost to the investor

What does value additivity mean for a firm?

• The NPV values of individual projects can be added together • The value of a firm is simply the combined value of the firm's projects, divisions, and entities owned by the firm

The three attributes of NPV are that it"

• Uses cash flows • Uses all the cash flows of a project • Discounts the cash flows properly

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 percent?

$5.94

True or false: Two challenges with the IRR approach when comparing two mutally exclusive projects are scale and cash flow timing.

True

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

Accept

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 discount rate is often referred to as _____.

An opportunity cost

The average accounting return is calculated as the average net income from a project divided by the ____.

Average book value of the investment

Accepting a positive NPV project will ____ the stockholders by _____ the value of the firm.

Benefit; increasing

You must know the discount rate to apply ____.

Either NPV or IRR

True or False: A firm evaluating two mutually exclusive projects can accept both projects.

False

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

False

True or false: The scale of a project is never a concern when using IRR

False

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

Independent

Capital _____ occurs when a firm doesn't have enough capital to fund all its positive NPV projects.

Rationing

The incremental IRR is used for the problem of ___ when evaluation project cash flows.

Scale

When evaluation mutually exclusive projects, the profitability index has a problem with ___.

Scale

The IRR allows a manager to summarize the information about a project with a ____ rate of return.

Single

True or False: A project with an initial cash outflow followed by a cash inflow has an NPV that is negatively related to the discount rate.

True

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

Zero

A small project has cash flows of -$10 and $45, and a large project has cash flows of -$30 and $70. What is the incremental IRR?

25%

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

9.70%

One of the weaknesses of the payback period is that the cutoff date is a(n) ____ standard.

Arbitrary

The payback period method allows upper management to evaluate the ____ abilities of lower management.

Decision-making

We can evaluate two mutually exclusive projects by comparing the incremental IRR to the ____.

Discount rate

In general, NPV is ____.

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

Which of these are weaknesses of the AAR method of project analysis?

• No account of timing • Arbitrary target rate • Use of accounting values rather than cash flows