Chapter 10

The most critical aspect of determining the acceptability of a capital budgeting project is the impact the project will have on the company's net income over the projects entire useful life.

False; cash flows

If project A generates $10 million of free cash flow over its five year useful life and project B generates $8 million of free cash flow over its useful life, then project A will have a shorter payback period than project B, assuming both projects require the same initial investment.

False; depends on timing of cash flows

The payback period ignores the time value of money and therefore should not be used as a screening device for the selection of capital budgeting projects.

False; payback period is still worthwhile

Advantages of the payback period include that it is easy to calculate, easy to understand, and that it is based on cash flows rather than on accounting profits.

True

An acceptable project should have a net present value greater than or equal to zero and a profitability index greater than or equal to one.

True

If a project is acceptable using the NPV criteria, it will also be acceptable when using the profitability index and IRR criteria.

True

NPV is the most theoretically correct capital budgeting decision tool examined in the text.

True

One drawback of the payback method is that some cash flows may be ignored.

True

The internal rate of return is the discount rate that equates the present value of the project's future free cash flows with the project's initial outlay.

True

The main disadvantage of the NPV method is the need for detailed, long-term forecasts of free cash flows generated by prospective projects.

True

The net present value of a project will increase as the required rate of return is decreased.

True

The profitability index can be helpful when a financial manager encounters a situation where capital rationing is required.

True

The size disparity problem occurs when mutually exclusive projects of unequal size are being examined.

True

When several sign reversals in the cash flow stream occur, a project can have more than one IRR.

True