FIN 3414 - Chapter 7

Care should be exercised when using the IRR approach with financing type projects because

the IRR rule is reversed for this type of project.

The capital budgeting method that allows lower management to make smaller, everyday financial decisions easily is

the payback method.

You must know the discount rate to make a decision under

either NPV or IRR.

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

zero

According to Graham and Harvey's 2001 survey of 392 CFOs, which of the following two capital budgeting methods are most used by firms in the U.S. and Canada?

Internal rate of return Net present value

In general, NPV is

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

Which of the following are general problems affecting independent and mutually exclusive projects?

The IRR rule is reversed between investing and financing type projects. The projects have multiple rates of return.

Which of the following are true of the modified IRR (MIRR)?

The idea is to modify cash flows first then calculate the IRR using the modified cash flows. There are several different ways to calculate the MIRR.

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

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

Which of the following are weaknesses of the payback method?

Timing of cash flows within the payback period are not considered. Cash flows received after the payback period are ignored. The cutoff date is arbitrary.

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

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

accepts

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

independent

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

initial investment

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

payback

The _________ tells us when the cashflow of an investment is paid back by cash inflows.

payback

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 numerator in the profitability ratio is the

present value of the future expected cash flows after the initial investment.

The incremental IRR is used to account for the problem of ______ when evaluating project cash flows.

scale

Why do companies choose to use IRR?

It summarizes information about a project in a single rate of return. It provides a simple way of discussion projects.

You must know the discount rate to compute ____, while the discount rate is necessary to apply ___.

NPV, IRR

A dollar received one year from today has ______ value than a dollar received today.

less