FIN 3113 Chapter 9

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

An increase in the size of the first cash inflow will decrease the payback method, all else held constant

Capital budgeting decision method finds the present value of each cash flow before calculating a payback period

Discounted payback period

Length of time until the sum of the discounted cash flows is equal to the initial investment.

Discounted payback period

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

Economic

Investing more money in a project is a guarantee of greater profits.

False

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

NPV & MIRR

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

Negative

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

Payback method

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

The crossover rate is the rate at which the NPV's of 2 projects are equal.

True

Two challenges with the IRR approach when comparing 2 mutually exclusive projects are scale and cash flow timing.

True

IRR is 14%, if required return is 14%, the project's NPV is:

Zero

Weaknesses of the payback method

cash flows received after the payback period are ignored, time value of money principles are ignore, cutoff date is arbitrary

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

payback period

If NPV is positive, the project should be ______.

Accepted

Decision making process for accepting and rejecting projects

Capital budgeting

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

Internal Rate of Return

Most important alternative to NPV is the ____ method.

IRR

Budgeting methods are most used by the firms in the US and Canada

IRR & NPV

Weaknesses of Discounted payback period

Arbitrary cutoff date, exclusion of some cash flows, and loss of simplicity as compared to the payback method

Point at which the NPV profile crosses the horizontal axis is the:

IRR

Profitability index is calculated by dividing the PV of the ______ CF by initial investment.

Future

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

Present Value

The IRR rule can lead to bad decisions when _____ or ______.

Projects are mutually exclusive, cash flows are not conventional.

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

The present value of all cash flows after the initial investment is divided by the _____to calculate the profitability index.

initial investment

Payback period tells the time it takes to break even in an _________ sense.

Accounting

Discounted payback rule has an objective benchmark to use in decision making. True/False

False

An ______ project does not rely on the acceptance or rejection of another project

Independent

When cash flows are conventional, NPV is ______.

Positive for discount rates below the IRR, equal to zero when the discount rate equals the IRR, and negative for discount rates above the IRR.

Mutually exclusive investment decisions

a situation in which taking one investment prevents the taking of another.

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

gives a rate of return rather than a dollar value

3 attributes of NPV are that it:

uses all the cash flows of a project, uses cash flows, & discounts the cash flows properly.

According to the basic IRR rule, we should____

reject a project if the IRR is less than the required return.

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

zero

NPV accounts for the size of the project and eliminates the effects of _______

Scale

Point at which the NPV profile crosses the vertical axis is the:

Sum of the cash flows of the project.

Mutually exclusive investments

2 different choices for the assembly lines that will make the same product, & a restaurant or gas station on the same piece of land.

If NPV is negative, the project should be _______.

Rejected