Financial MGMT CH9

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%

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%

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

A target average accounting return

(3) The basic NPV investment rule is:

Accept a project if the NPV is greater than zero

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.

NPV ___ cash flows properly.

Discounts

(1) The basic NPV investment rule is:

If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference

An ___ project does not reply on the acceptance or rejection of another project.

Independent

The present value of all cash flows (after the initial investment) is divided by the ___ to calculate the profitability index.

Initial investment

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

Internal rate of return

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

It gives a rate of return rather than a dollar value

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

MIRR and NPV

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

Negative ( ͡° ͜ʖ ͡°)

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

Payback method

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.

(2) The basic NPV investment rule is:

Reject a project if its NPV is less than zero

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

Sum of the cash flows of the project

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

The IRR and NPV

The crossover rate is the rate at which the NPVs of two projects are equal.

True

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

(1) Which of the following are weaknesses of the payback method?

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

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

The discounted payback period has which of these weaknesses?

(1) Exclusion of some cash flows (2) Arbitrary cutoff date (3) Loss of simplicity as compared to the payback method

When cash flows are conventional, NPV is ___.

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

Advantages of AAR

(1)Easy to calculate (2)Needed information usually available

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?

(107)/(1.06)+95=5.94

3 attributes of NPV are that it:

(A) Discounts the cash flows properly. (B) Uses all the cash flows of a project. (C) Uses cash flows.

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

ZERO

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

Zero. The IRR is the rate that makes NPV=0.

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.

accounting

Payback Period Rule

an investment is acceptable if its calculated payback is less than some prespecified number of years

(2) The IRR rule can lead to bad decisions when ___ or ___.

cash flows are not conventional

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

economic

The profitability index is calculated by dividing the PV of the ___ cash flows by the initial investment.

future

By ignoring time value, the payback rule may accept projects with a ___ NPV.

negative

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

(1) The IRR rule can lead to bad decisions when ___ or ___.

projects are mutually exclusive

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

required return

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