Chapter 8 Net Present Value and Other Investment Criteria
The basic NPV investment rule is:
- Accept a project if the NPV is grater than zero - Reject a project if it is less than zero - If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference
A project should be ____ if its NPV is greater than zero
- Accepted
How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the project's life
- An increase in the size of the first cash inflow will decrease the payback period, all else held constant
The NPV IS ____ if the required return is greater than the IRR
- Negative
The____ is more appropriate for large complex pojects
- Net Present Value
____ is the measure of how much value is created or added by undertaking an investment
- Net Present Value
In capital budgeting, _____ determines the dollar value of a project to the company
- Net present value
Which of the following present problems when using the IRR method.
- Non-conventional cash flows - Mutually exclusive projects
- What is the profitability index for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in year one and $20 in year two if the discount rate is 12%
- PI= PV(future cash flow)/initial cost= (80/1.12)+(20/1.12^2)/30 = 87.3724/30 = 2.91
The ____ is the best suited for decision on relatively small, minor projects
- Payback
The method ____ evaluates a project by determining the time needed to recoup the initial investment
- Payback
The NPV is_____ if the required return is less that the IRR
- Positive
- If the IRR is greater than the _____ , we should accept the project
- Required return
What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?
-
The internal rate of return is a function of _____
- A project cash flows
The PI rule for an independent project is to___ the project if the PI is greater that 1
- Accept
Higher cash flows earlier in a project's life are ____ valuable than higher cash flows later on.
- More
Internal rate of return (IRR) must be compare to the ____ in order to determine the acceptability of a project
- Required return
What is the NPV of A project with an initial investment of $95, a cash flow in once year of $107, and a discount rate of 6 percent?
NVP = - $95 + ($107/1.06) = $5.94
A project with non-conventional cash flows will produce two or more IRR
- True
The combination MIRR method is used by the Excel MIRR function and uses which of the following?
- A reinvestment rate for compounding - Discount all negatives cash flows to time 0 - Compounding cash inflows to the end of the project - A financial rate for discounting
Capital ____ is the decision-making process for accepting and rejecting project.
- Budgeting
Disadvantage of the Profitability Index
- Cannot rank mutually exclusive projects
The profitability index is calculated by dividing the PV of the ____ cash inflows by the initial investment
- Future
According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following to capital budgeting methods are widely used by firms in the US and Canada
- Internal payback - Net present value
The payback period can lead to foolish decisions if it is used too literally because:
- It ignores cash flows after the cutoff date
The Average Accounting Return is defined as:
- Average net income/average book value
Which of the following present problems when using the IRR method?
- Mutually exclusive projects - Non-conventional cash flows
If a project has multiple internal rates of return, which of the following methods should be used?
- NPV - MIRR
Specifying variables in the Excel NPV function differs from the manner in which they are entered in a financial calculator in which of the following ways?
- The Excel NPV function is actually a PV function - The discount rate in Excel is entered as a decimal - With the Excel NPV function, cashflow#0 must be handled outside the NPV function - The range of cash flows specified in Excel begins with cashflow#1, not cashflow#0
Which of the following are reason why IRR continues to be used in practice?
- The IRR of a proposal can be calculated without knowing the appropriate discount rate. - It is easier to communicate information about a proposal with an IRR - Businesspeople prefer to talk about rates of return
When calculating NPV, the present value of the nth cash flow is found by diving the nth cash flow by 1 plus ____ rate raised to he nth power.
- The discount
Which of the following are methods of calculating the MIRR of a project?
- The discount approach - The combination approach - The reinvestment approach
Which of the following are weaknesses of the payback method
- Time value of money principles are ignored. - Cash flows received after the payback period are ignored. - The cutoff date is arbitrary
Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return
- True
What are the advantages of the payback period method for management
- It allows lower level managers to make small decisions effectively. - The payback period method is deal for minor projects - The payback period method is easy to use
If a firm is evaluating two possible project, both of which require the use of the same production facilities, these projects would be considered___
- Mutually exclusive
The spreadsheet function for calculating net present value is:
- NPV(rate, CF1, ..., CFn) + CF0
