FINA module 9
The primary purpose of capital budgeting is to:
Maximize the shareholder's wealth
What are advantages of payback period?
Measures liquidity, easy to communicate, does not require complex calculations, does not require discount rate
Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function.
Mutually Exclusive
The "gold standard" of investment criteria refers to:
NPV
List steps of the capital budgeting process
1. Proposal generation 2. Review & analysis 3. Decision making 4. Implementation 5. Follow up
The Internal Rate of Return (IRR) is the discount rate that equates the NPV of an investment opportunity with $0
True
The multiple IRR problem occurs when the signs of a project's cash flows change more than once.
True
Capital rationing may be beneficial to a firm if it:
weeds out proposals with weaker or biased NPVs
It should not usually be clear whether we are describing independent or mutually exclusive projects in the following chapters because when we only describe one project then it can be assumed to be independent
False
NPV assumes intermediate cash flows are reinvested at the cost of equity, while IRR assumes that they are reinvested at the cost of capital
False
Net present value (NPV) is a sophisticated capital budgeting technique; found by adding a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital.
False
The disadvantages of the IRR period method is that it
Requires a lot of data (estimates of all CFs), only works for normal cash flows, requires complex calculations
Which of the following statements is correct for a project with a negative NPV?
The cost of capital exceeds the IRR