Finance 303 CH 8
Which of the following are methods of calculating the MIRR of a project?
- The Reinvestment Approach - The Discounting Approach - The Combination Approach
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%?
2.91
True or false: The IRR is easy to use because you only need to know the appropriate discount rate.
False
True or false: The payback period takes into consideration the time value of money.
False
What is the primary concern of the payback period rule?
how long it takes to recover the initial investment
The payback period can lead to foolish decisions if it is used too literally because:
it ignores cash flows after the cutoff date
If the IRR is greater than the __________ _________, we should accept the project.
required return
Internal rate of return (IRR) must be compared to the _______ in order to determine the acceptability of a project.
required return
When calculating NPV, the present value of the Nth cash flow by 1 plus _________ rate raised to the Nth power.
the discount
Which of the following present problems when using the IRR method?
- mutually exclusive projects - non-conventional cash flows
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 discount rate in Excel is entered is decimal, or as a percentage with a percent sign - the range of cash flows specified in Excel begins with cashflow #1, not cashflow 0 - with the Excel NPV function, Cashflow #0 must be handled outside the NPV function - the Excel NPV function is actually a PV function
The present value of the future cash inflows are divided by the _____ to calculate profitability index
Initial investment
The NPV is _______ if the required return is less than the IRR and it is ______if the required tern is greater than the IRR
Positive, negative
IF the IRR is greater than the ___________ we should accept the project
Required return
In capital budgeting, _______ determines the dollar value of a project to the company.
net present value
One of the flaws of the payback period method is that cash flows after the cutoff date are___________
not considered in the analysis
The ______ method evaluates a project by determining the time needed to recoup the initial investment.
payback
The ________ is best suited for decisions on relatively small, minor projects while ______ is more appropriate for large complex projects.
payback period; NPV
When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus ______ rate raised to the nth power.
the discount
T/F: When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus the discount rate raised to the nth power.
true
accept or reject? The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.
accept
Based on the average accounting return rule, a project is _____ if its average accounting return exceeds a target average accounting return.
acceptable
A project should be __________ if its NPV is greater than zero.
accepted
Capital _______ is the decision-making process for accepting and rejecting projects.
budgeting
What is a disadvantage of the profitability index?
cannot rank mutually exclusive projects
A __________ project does not rely on the acceptance or rejection of another project
independent
A(n) __________ project does not rely on the acceptance or rejection of another project.
independent
The present value of the future cash inflows are divided by the ______ to calculate the profitability index.
initial investment
Higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on.
more
Higher cash flows earlier in a projects life are ______ valuable than higher cash flows later on
more
A project should be ____ if its NPV is greater than zero
Accepted
_______ is a measure of how much value is created or added by undertaking an investment.
Net Present Value
(T/F) payback period ignores time value of money
True
The NPV is _______ if the required return is less than the IRR, and it is _______ if the required return is greater than the IRR.
positive, negative
According to the basic IRR rule, we should:
reject a project if the IRR is less than the required return
What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%?
$5.94 NPV= -$95 + ($107/1.06) = $5.94
What are the advantages of the payback period method for management?
- The payback period method is easy to use. - It allows lower level managers to make small decisions effectively. - The payback period method is ideal for minor projects.
In general, NPV is _________.
- equal to zero when the discount rate equal the IRR. - negative for discount rates above the IRR. - positive for discount rates below the IRR.
The spreadsheet function for calculating net present value is:
=NPV(CF1, ..., CFn) + CFO
The spreadsheet function for calculating net present value is ______.
=NPV(rate,CF1, ..., CFn) + CF0
internal rate of return IRR must be compared to the ______ in order to determine the acceptability of a project
Required return
The Average Accounting Return is defined as:
average net income/average book value
(T/F) an advantage of the ARR is that it is based on book values not market values
false
in capital budgeting _________ determines the dollar value of a project to the company
net present value
One of the flaws of the payback period method is that cash flows after the cutoff date are ___.
not considered in the analysis
The Combination MIRR method is used by the Excel MIRR function and uses which of the following?
- A reinvestment rate for compounding - Discounting all cash outflows to time 0 - Compounding cash inflows to the end of the project - A financing rate for discounting
Which of the following is a disadvantage of the Profitability Index?
- Cannot rank mutually exclusive projects
If a project has multiple internal rates of return, which of the following methods should be used?
- NPV - MIRR
According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the US and Canada?
- internal rate of return - net present value
What 3 methods are used for calculating MIRR of a project
1)Reinvestment approach 2)Discounting approach 3)Combination approach
True or false: According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), the internal rate of return and the NPV are the two most popular capital budgeting methods used by firms in the US and Canada.
True
The PI rule for an independent project is to ______ the project if the PI is greater than 1.
accept
The profitability index is also called the _________ index
cost-benefit
The payback period can lead to foolish decisions if it is used to literally because
it ignores cash flows after the cutoff date
Which of the following is a disadvantage of the payback period rule?
requires an arbitrary cutoff point
The IRR is the discount rate that makes NPV equal to ______.
zero
T/F: The discounted cash flow (DCF) valuation estimates future value as the difference between the market price and the cost of the investment.
False
True or false: The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its future cost.
False
The profitability index is calculated by dividing the PV of the _________ cash inflows by the initial investment.
Future
True or false: When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus the discount rate raised to the nth power.
True
True or false: 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 (Whenever subsequent cash flows are both negative and positive, multiple internal rates of return may occur)
According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:
a target average accounting return
according to the aver accounting return rule, a project is acceptable if its average accounting return exceeds
a target average accounting return
A project should be ___________ if its NPV is greater than zero.
accepted
T/F: The payback period takes into consideration the time value of money.
false
If a firm is evaluating two possible projects, both of which require the use of the same production facilities, these projects would be considered
mutually exclusive
In capital budgeting, ______ determines the dollar value of a project to the company.
net present value
The _______ method evaluates a project by determining the time needed to recoup the initial investment.
payback
the spreadsheet function for calculation net present value is
=NPV (rate, cf1.....,cfn)+ cf0
Accept or reject? 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 lifetime.
An increase in the size of the first cash inflow will decrease the payback period, all else held constant.
The discounted cash flow valuation shows that higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on.
more
The __________ is best suited for decisions on relatively small, minor projects while ______ is more appropriate for large complex projects.
payback period; NPV
The average accounting return is defined as
average net income/ average book value
The profitability index is also called the ______ ratio
cost-benefit
Which of the following are reasons why IRR continues to be used in practices?
- The IRR of a proposal can be calculated without knowing the appropriate discount rate. - Business people prefer to talk about rates of return - It is easier to communicate information about a proposal with an IRR
Which of the following are reasons 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.
The basic NPV investment rule is:
- accept a project if the NPV is greater than zero - reject a project if its NPV is less than zero - if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference
if a project has multiple internal rates of rerun, what methods should be used (2)
1) NPV 2) MIRR
which of the following are reasons why IRR continues to be used in practice (3)?
1) business people prefer to talk about rates of rerturn 2) it is easier to communicate information about proposal with an IRR 3) The IRR of a proposal can be calculated without knowing the appropriate discount rate
Which 2 capital budgeting methods are widely used by firms in the US and Canada
1) net present value 2) internal rate of return
what are weaknesses of the payback method (3)?
1)time value of money principles are ignored 2)cash flows relied after the payback period are ignored 3)the cuffoff date is arbitrary
The ______ method evaluates a project by determining the time needed to recoup the initial investment
Payback
True or false: A project with non-conventional cash flows will produce two or more IRRs.
True
The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.
accepts
One of the weaknesses of the payback period is that the cutoff date is a(n) ______ standard.
arbitrary