Chapter 9 Finance
2. The process of valuing an investment by determining the present value of its future cash flows is called (the): a. constant dividend growth model. b. discounted cash flow valuation. c. average accounting valuation. d. expected earnings model. e. Capital Asset Pricing Model.
B discounted cash flow valuation
3. Which one of the following statements concerning net present value (NPV) is correct? a. An investment should be accepted if, and only if, the NPV is exactly equal to zero. b. An investment should be accepted only if the NPV is equal to the initial cash flow. c. An investment should be accepted if the NPV is positive and rejected if it is negative. d. An investment with greater cash inflows than cash outflows, regardless of when the cash flows occur, will always have a positive NPV and therefore should always be accepted. e. Any project that has positive cash flows for every time period after the initial investment should be accepted.
C An investment should be accepted if the NPV is positive and rejected if it is negative.
The length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment is called the: a. net present value. b. internal rate of return. c. payback period. d. profitability index. e. discounted cash period.
C Payback period
A situation in which accepting one investment prevents the acceptance of another investment is called the: a. net present value profile. b. operational ambiguity decision. c. mutually exclusive investment decision. d. issues of scale problem. e. multiple choices of operations decision.
c. mutually exclusive investment decision.
Which one of the following statements is correct concerning the payback period? a. An investment is acceptable if its calculated payback period is less than some pre-specified period of time. b. An investment should be accepted if the payback is positive and rejected if it is negative. c. An investment should be rejected if the payback is positive and accepted if it is negative. d. An investment is acceptable if its calculated payback period is greater than some pre-specified period of time. e. An investment should be accepted any time the payback period is less than the discounted payback period, given a positive discount rate.
a. An investment is acceptable if its calculated payback period is less than some pre-specified period of time.
Given that the net present value (NPV) is generally considered to be the best method of analysis, why should you still use the other methods? a. The other methods help validate whether or not the results from the net present value analysis are reliable. b. You need to use the other methods since conventional practice dictates that you only accept projects after you have generated three accept indicators. c. You need to use other methods because the net present value method is unreliable when a project has unconventional cash flows. d. The average accounting return must always indicate acceptance since this is the best method from a financial perspective. e. The discounted payback method must always be computed to determine if a project returns a positive cash flow since NPV does not measure this aspect of a project.
a. The other methods help validate whether or not the results from the net present value analysis are reliable.
The internal rate of return tends to be: a. easier for managers to comprehend than the net present value. b. extremely accurate even when cash flow estimates are faulty. c. ignored by most financial analysts. d. used primarily to differentiate between mutually exclusive projects. e. utilized in project analysis only when multiple net present values apply.
a. easier for managers to comprehend than the net present value.
An investment is acceptable if the profitability index (PI) of the investment is: a. greater than one. b. less than one. c. greater than the internal rate of return (IRR). d. less than the net present value (NPV). e. greater than a pre-specified rate of return.
a. greater than one
Capital budgeting decisions generally: a. have long-term effects on a firm. b. are of short-duration. c. are easy to revise once implemented. d. focus solely on whether or not a particular asset should be purchased. e. have minimal effects on a firm's operations.
a. have long-term effects on a firm
1. The difference between the present value of an investment and its cost is the: a. net present value. b. internal rate of return. c. payback period. d. profitability index. e. discounted payback period.
a. net present value
The discounted payback rule may cause: a. some positive net present value projects to be rejected. b. the most liquid projects to be rejected in favor of less liquid projects. c. projects to be incorrectly accepted due to ignoring the time value of money. d. projects with negative net present values to be accepted. e. some projects to be accepted which would otherwise be rejected under the payback rule.
a. some positive net present value projects to be rejected.
No matter how many forms of investment analysis you do: a. the actual results from a project may vary significantly from the expected results. b. the internal rate of return will always produce the most reliable results. c. a project will never be accepted unless the payback period is met. d. the initial costs will generally vary considerably from the estimated costs. e. only the first three years of a project ever affect its final outcome.
a. the actual results from a project may vary significantly from the expected results.
The internal rate of return for a project will increase if: a. the initial cost of the project can be reduced. b. the total amount of the cash inflows is reduced. c. each cash inflow is moved such that it occurs one year later than originally projected. d. the required rate of return is reduced. e. the salvage value of the project is omitted from the analysis.
a. the initial cost of the project can be reduced.
If a project is assigned a required rate of return equal to zero, then: a. the timing of the project's cash flows has no bearing on the value of the project. b. the project will always be accepted. c. the project will always be rejected. d. whether the project is accepted or rejected will depend on the timing of the cash flows. e. the project can never add value for the shareholders.
a. the timing of the project's cash flows has no bearing on the value of the project.
The primary reason that company projects with positive net present values are considered acceptable is that: a. they create value for the owners of the firm. b. the project's rate of return exceeds the rate of inflation. c. they return the initial cash outlay within three years or less. d. the required cash inflows exceed the actual cash inflows. e. the investment's cost exceeds the present value of the cash inflows.
a. they create value for the owners of the firm.
An investment is acceptable if its average accounting return (AAR): a. is less than a target AAR. b. exceeds a target AAR. c. exceeds the firm's return on equity (ROE). d. is less than the firm's return on assets (ROA). e. is equal to zero and only when it is equal to zero.
b exceeds the target AAR.
The discount rate that makes the net present value of an investment exactly equal to zero is called the: a. external rate of return. b. internal rate of return. c. average accounting return. d. profitability index. e. equalizer.
b internal rate of return
The internal rate of return (IRR): I. rule states that a project with an IRR that is less than the required rate should be accepted. II. is the rate generated solely by the cash flows of an investment. III. is the rate that causes the net present value of a project to exactly equal zero. IV. can effectively be used to analyze all investment scenarios. a. I and IV only b. II and III only c. I, II, and III only d. II, III, and IV only e. I, II, III, and IV
b. II and III only
Which of the following may have contributed to the change in the primary methods used by chief financial officers to evaluate projects over the past forty years? I. an increased emphasis on ease of use and simplicity of method II. an increased availability of computers and financial calculators to handle the more complex computations III. an increased level of financial knowledge by increasing sophisticated business executives IV. an increasing emphasis by financial executives on accounting values rather than financial values a. I and II only b. II and III only c. III and IV only d. I, II, and IV only e. II, III, and IV only
b. II and III only
Which of the following methods of project analysis are biased towards short-term projects? I. internal rate of return II. accounting rate of return III. payback IV. discounted payback a. I and II only b. III and IV only c. II and III only d. I and IV only e. II and IV only
b. III and IV only
When the present value of the cash inflows exceeds the initial cost of a project, then the project should be: a. accepted because the internal rate of return is positive. b. accepted because the profitability index is greater than 1. c. accepted because the profitability index is negative. d. rejected because the internal rate of return is negative. e. rejected because the net present value is negative.
b. accepted because the profitability index is greater than 1.
Graphing the crossover point helps explain: a. why one project is always superior to another project. b. how decisions concerning mutually exclusive projects are derived. c. how the duration of a project affects the decision as to which project to accept. d. how the net present value and the initial cash outflow of a project are related. e. how the profitability index and the net present value are related.
b. how decisions concerning mutually exclusive projects are derived.
When computing the net present value of a project, the net amount received from salvaging the fixed assets used in the project is: a. subtracted from the initial cash outlay. b. included in the final cash flow of the project. c. excluded from the analysis since it occurs only when the project ends. d. subtracted from the original cost of the assets. e. added to the net present value of the project to determine if the project is acceptable.
b. included in the final cash flow of the project.
The average accounting return: a. reflects the projected net effect of the cash flows from a project on the overall firm. b. is comparable to the return on assets and thus provides a similar measure of performance. c. reflects the anticipated net impact of a project on the shareholders of the firm. d. rule, when applied, guarantees that only projects that increase shareholder wealth will be accepted. e. ignores all income produced by a project after an arbitrarily assigned cutoff point.
b. is comparable to the return on assets and thus provides a similar measure of performance.
Net present value: a. cannot be used when deciding between two mutually exclusive projects. b. is more useful to decision makers than the internal rate of return when comparing different sized projects. c. is easy to explain to non-financial managers and thus is the primary method of analysis used by the lowest levels of management. d. is computed the same as present value when using excel spreadsheets to analyze a project. e. is very similar in its methodology to the average accounting return.
b. is more useful to decision makers than the internal rate of return when comparing different sized projects
Analysis using the profitability index: a. frequently conflicts with the accept and reject decisions generated by the application of the net present value rule. b. is useful as a decision tool when investment funds are limited. c. is useful when trying to determine which one of two mutually exclusive projects should be accepted. d. utilizes the same basic variables as those used in the average accounting return. e. produces results which typically are difficult to comprehend or apply.
b. is useful as a decision tool when investment funds are limited.
The final decision on which one of two mutually exclusive projects to accept ultimately depends upon the: a. initial cost of each project. b. required discount rate. c. total cash inflows of each project. d. assigned payback period of each project. e. length of each project's life.
b. required discount rate.
An investment's average net income divided by its average book value defines the average: a. net present value. b. internal rate of return. c. accounting return. d. profitability index. e. payback period.
c accounting return
Which of the following statements are correct? I. A positive net present value signals an accept decision. II. Projects should be accepted when the profitability index is less than 1. III. A payback period that is less than the required period signals an accept decision. IV. When the internal rate of return exceeds the required return, a project should be accepted. a. I and III only b. II, III, and IV only c. I, III, and IV only d. I, II, and III only e. I, II, III, and IV
c. I, III, and IV only
You are comparing two mutually exclusive projects. The crossover point is 9 percent. You determine that you should accept project A if the required return is 6 percent. This implies that you should: I. reject project B if the required return is 6 percent. II. always accept project A and always reject project B. III. always reject project A any time the discount rate is greater than 9 percent. IV. accept project A any time the discount rate is less than 9 percent. a. I and II only b. III and IV only c. I, III, and IV only d. I, II, and IV only e. I, II, III, and IV
c. I, III, and IV only
25. The advantages of the payback method of project analysis include the: I. application of a discount rate to each separate cash flow. II. bias towards liquidity. III. ease of use. IV. arbitrary cutoff point. a. I and II only b. I and III only c. II and III only d. II and IV only e. II, III, and IV only
c. II and III only
The internal rate of return is: a. more reliable as a decision making tool than net present value whenever you are considering mutually exclusive projects. b. equivalent to the discount rate that makes the net present value equal to one. c. difficult to compute without the use of either a financial calculator or a computer. d. dependent upon the interest rates offered in the marketplace. e. a better methodology than net present value when dealing with unconventional cash flows.
c. difficult to compute without the use of either a financial calculator or a computer.
When two projects both require the total use of the same limited economic resource, the projects are generally considered to be: a. independent. b. marginally profitable. c. mutually exclusive. d. acceptable. e. internally profitable.
c. mutually exclusive
Matt is analyzing two mutually exclusive projects of similar size and has prepared the following data. Both projects have 5 year lives. Project A: 15,090 NPV; PaybackP 2.76 y; Average Accounting Return 9.3%; Required Return 8.3%; Required AAR 9.0% Project B: 14,693$ NPV; PaybackP 2.51; Average Accounting Return 9.6; Required Return 8.0; Required AAR 9.0 Matt has been asked for his best recommendation given this information. His recommendation should be to accept: a. project B because it has the shortest payback period. b. both projects as they both have positive net present values. c. project A and reject project B based on their net present values. d. project B and reject project A based on their average accounting returns. e. project B and reject project A based on both the payback period and the average accounting return.
c. project A ans reject project B based on their net present values.
Payback is frequently used to analyze independent projects because: a. it considers the time value of money. b. all relevant cash flows are included in the analysis. c. the cost of the analysis is less than the potential loss from a faulty decision. d. it is the most desirable of all the available analytical methods from a financial perspective. e. it produces better decisions than those made using either NPV or IRR.
c. the cost of the analysis is less than the potential loss from a faulty decision.
Which one of the following is the best example of two mutually exclusive projects? a. planning to build a warehouse and a retail outlet side by side b. buying sufficient equipment to manufacture both desks and chairs simultaneously c. using an empty warehouse for storage or renting it entirely out to another firm d. using the company sales force to promote sales of both shoes and socks e. buying both inventory and fixed assets using funds from the same bond issue
c. using an empty warehouse for storage or renting it entirely out to another firm
An investment is acceptable if its IRR: a. is exactly equal to its net present value (NPV). b. is exactly equal to zero. c. is less than the required return. d. exceeds the required return. e. is exactly equal to 100 percent.
d exceeds the required return.
The discounted payback rule states that you should accept projects: a. which have a discounted payback period that is greater than some pre-specified period of time. b. if the discounted payback is positive and rejected if it is negative. c. only if the discounted payback period equals some pre-specified period of time. d. if the discounted payback period is less than some pre-specified period of time. e. only if the discounted payback period is equal to zero.
d if the discounted payback period is less than some pre-specified period of time
Which of the following are elements of the internal rate of return method of analysis? I. the timing of the cash flows II. the cutoff point after which any future cash flows are ignored III. the rate designated as the minimum acceptable rate for a project to be accepted IV. the initial cost of an investment a. I and II only b. III and IV only c. I, II, and III only d. I, III, and IV only e. II, III, and IV only
d. I, III, and IV only
If a project has a net present value equal to zero, then: I. the present value of the cash inflows exceeds the initial cost of the project. II. the project produces a rate of return that just equals the rate required to accept the project. III. the project is expected to produce only the minimally required cash inflows. IV. any delay in receiving the projected cash inflows will cause the project to have a negative net present value. a. II and III only b. II and IV only c. I, II, and IV only d. II, III, and IV only e. I, II, and III only
d. II, III, and IV only
Which of the following are disadvantages associated with the average accounting return? I. difficulty in obtaining necessary information to do computation II. exclusion of time value of money considerations III. the use of a cutoff rate as a benchmark IV. the accounting basis of the values used in the computation a. I and IV only b. II and III only c. I, II, and III only d. II, III, and IV only e. I, II, and IV only
d. II, III, and IV only
Net present value: I. when applied properly, can accurately predict the cash flows that will occur if a project is implemented. II. is highly independent of the rate of return assigned to a particular project. III. is the preferred method of analyzing a project even though the cash flows are only estimates. IV. is affected by the timing of each and every cash flow related to a project. a. I only b. III only c. II and IV only d. III and IV only e. I, III, and IV only
d. III and IV only
The discounted payback period of a project will decrease whenever the: a. discount rate applied to the project is increased. b. initial cash outlay of the project is increased. c. time period of the project is increased. d. amount of each project cash flow is increased. e. costs of the fixed assets utilized in the project increase.
d. amount of each project cash flow is increased.
All else equal, the payback period for a project will decrease whenever the: a. initial cost increases. b. required return for a project increases. c. assigned discount rate decreases. d. cash inflows are moved forward in time. e. duration of a project is lengthened.
d. cash inflows are moved forward in time.
Assuming that straight line depreciation is used, the average accounting return for a project is computed as the average: a. net income of a project divided by the average total assets of a firm. b. book value of a project multiplied by the average profit margin of the project. c. book value of a project divided by the average net income of the project. d. net income of a project divided by the average investment in the project. e. net income of the firm divided by the average investment in a project.
d. net income of a project divided by the average investment in the project.
The Liberty Co. is considering two projects. Project A consists of building a wholesale book outlet on lot #169 of the Englewood Retail Center. Project B consists of building a sit-down restaurant on lot #169 of the Englewood Retail Center. When trying to decide whether or build the book outlet or the restaurant, management should rely most heavily on the analysis results from the _____ method of analysis. a. profitability index b. internal rate of return c. payback d. net present value e. accounting rate of return
d. net present value
The profitability index is closely related to: a. payback. b. discounted payback. c. the average accounting return. d. net present value. e. mutually exclusive projects.
d. net present value
The present value of an investment's future cash flows divided by the initial cost of the investment is called the: a. net present value. b. internal rate of return. c. average accounting return. d. profitability index. e. profile period.
d. profitability index.
Under the payback method of analysis: a. the initial cash outlay is ignored. b. the cash flow in year 3 is ignored if the required payback period is 4 years. c. a project's initial cost is discounted. d. the cash flow in year 2 is valued just as highly as the cash flow in year 1 as long as the required payback period is 3 years or more. e. a project will be acceptable whenever the payback period exceeds the pre-specified number of years.
d. the cash flow in year 2 is valued just as highly as the cash flow in year 1 as long as the required payback period is 3 years or more.
All else constant, the net present value of a project increases when: a. the discount rate increases. b. each cash inflow is delayed by one year. c. the initial cost of a project increases. d. the rate of return decreases. e. all cash inflows occur during the last year of a project's life instead of periodically throughout the life of the project.
d. the rate of return decreases
The length of time required for a project's discounted cash flows to equal the initial cost of the project is called the: a. net present value. b. internal rate of return. c. payback period. d. discounted profitability index. e. discounted payback period.
e discounted payback period
In actual practice, managers frequently use the: I. AAR because the information is so readily available. II. IRR because the results are easy to communicate and understand. III. payback because of its simplicity. IV. net present value because it is considered by many to be the best method of analysis. a. I and III only b. II and III only c. I, III, and IV only d. II, III, and IV only e. I, II, III, and IV
e. I, II, III, and IV
The internal rate of return method of analysis: I. may produce multiple rates of return for a single project. II. may lead to incorrect decisions when comparing mutually exclusive projects. III. is generally more popular in practice than NPV. IV. works best for independent projects with conventional cash flows. a. I and II only b. III and IV only c. I, III, and IV only d. I, II, and IV only e. I, II, III, and IV
e. I, II, III, and IV
17. Which of the following are capital budgeting decisions? I. determining whether to sell bonds or issue stock II. deciding which product markets to enter III. deciding whether or not to purchase a new piece of equipment IV. determining which, if any, new products should be produced a. I only b. III only c. II and IV only d. I, III, and IV only e. II, III, and IV only
e. II, III, and IV only
You are considering a project with the following data: Internal rate of return 8.7 percent Profitability ratio .98 Net present value -$393 Payback period 2.44 years Required return 9.5 percent Which one of the following is correct given this information? a. The discount rate used in computing the net present value must have been less than 8.7 percent. b. The discounted payback period will have to be less than 2.44 years. c. The discount rate used to compute the profitability ratio was equal to the internal rate of return. d. This project should be accepted based on the profitability ratio. e. This project should be rejected based on the internal rate of return.
e. This project should be rejected based on the internal rate of return.
The average accounting rate of return: a. is actually based more on financial values than on accounting values. b. measures net income against the market value of a firm. c. is highly recommended by financial professionals as one of the two best methodologies used in the analysis of independent projects. d. is the primary methodology used in analyzing independent projects. e. is similar to the return on assets ratio.
e. is similar to the return on assets ratio.
Discounted payback is used less frequently than payback because: a. the methodology is less desirable from a financial perspective. b. it is so simple to calculate. c. it requires an arbitrary cutoff point. d. it is biased towards liquidity. e. it includes time value of money calculations.
e. it includes time value of money calculations.
The possibility that more than one discount rate will make the NPV of an investment equal to zero is called the _____ problem. a. net present value profiling b. operational ambiguity c. mutually exclusive investment decision d. issues of scale e. multiple rates of return
e. multiple rates of return
If you want to review a project from a benefit-cost perspective, you should use the _____ method of analysis. a. net present value b. payback c. internal rate of return d. average accounting return e. profitability index
e. profitability index
You are trying to determine whether to accept project A or project B. These projects are mutually exclusive. As part of your analysis, you should compute the crossover point by determining: a. the internal rate of return for the cash flows of each project. b. the net present value of each project using the internal rate of return as the discount rate. c. the discount rate that equates the discounted payback periods for each project. d. the discount rate that makes the net present value of each project equal to 1. e. the internal rate of return for the differences in the cash flows of the two projects.
e. the internal rate of return for the differences in the cash flows of the two projects.