Financial Management & Policy - Chapter 9

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 percent?

**$5.94 (CF0 = -95, C01 = 107, I = 6) -$6.17 -$11.32 -$12

Saxon Company is considering a project that will generate net income of $50,000 in Year 1, $75,000 in Year 2, and $90,000 in Year 3. The cost of the project is $700,000, and this cost will be depreciated to zero in the three years of the investment. What is their average accounting return?

**20.48% (average net income = 50,000+75,000+90,000 / 3 = 71,666.67 average book value = 700,000+0 / 2 = 350,000 AAR = 71,666.67 / 350,000 = 0.2047619) -25.71% -2.05% -10.24%

What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?

**9.70% (CF0 = -250, C01 = 100, F01 = 3) -23.38% - -13.67% -21.86%

The spreadsheet function for calculating net present value is _____

**=NPV() -=MIRR() -=PV() -=IRR()

If a project has multiple internal rates of return, which of the following methods should be used?

**NPV **MIRR -IRR

Project Alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If Projects Alpha and Beta have conventional cash flows, are mutually exclusive and the NPV profiles cross at 15% (where the NPVs are positive), which of the projects has a higher internal rate of return?

**Project Beta -Project Alpha -the projects have the same internal rate of return

Which of the following are mutually exclusive investments?

**a restaurant or a gas station on the same piece of land **two different choices for the assembly lines that will make the same product -two computer systems - one for the administrative office and one for the security cameras -a restaurant or a gas station on opposite corners

According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:

**a target average accounting return -the net present value -the internal rate of return -the required rate of return

The PI rule for an independent project is to _____ the project is the PI is greater than 1

**accept -delay -reject

A project should be _____ if its NPV is greater than zero

**accepted -delayed -rejected

Payback period tells the time it takes to break even in an _____ sense. Discounted payback period tells the time it takes to break even in an _____ or financial sense

**accounting; economic -economic; economic -accounting; accounting -economic; accounting

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 with decrease the payback period, all else held constant -the timing but not the size of the cash flows affects the payback period -receiving every cash inflow sooner will increase the payback period, all else held constant -a delay in receiving the cash inflows will decrease the payback period

One of the weaknesses of the payback period is that the cutoff date is a (an) _____ standard

**arbitrary -perfect -industry -market

Capital _____ is the decision-making process for accepting and rejecting project

**budgeting -structure -relevance -spending

The IRR rule can lead to bad decisions when _____ or _____

**cash flows are not conventional **projects are mutually exclusive -payback period is less than two years -NPV is positive

NPV _____ cash flows properly

**discounts -compounds

The discounted payback period has which of these weaknesses?

**exclusion of some cash flows **loss of simplicity as compared to the payback method **arbitrary cutoff date -lack of a decision rule

The profitability index is calculated by dividing the PV of the _____ cash flows by the initial investment

**future -positive -previous

A(n) _____ project does not rely on the acceptance or rejection of another project

**independent -co-dependent -mutually exclusive -dependent

The present value of all cash flows (after the initial investment) is divided by the _____ to calculate profitability index

**initial investment -discount rate -internal rate of return -net present value

The most important alternative to NPV is the _____ method

**internal rate of return -payback period -discounted payback period -average accounting return

The point at which the NPV profile crosses the horizontal axis is the:

**internal rate of return -required rate of return -sum of the cash flows of the project -cost of the project in the first year

According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following two capital budgeting methods are most used by firms in the United States?

**internal rate of return **net present value -profitability index -payback method -accounting rate of return

IRR continues to be very popular in practice, partly because:

**it gives a rate of return rather than a dollar value -it is easier to compute than NPV -it gives the correct answer more often than NPV -it gives a dollar value rather than a rate of return

Which of the following are advantage(s) of AAR?

**needed information is usually available **is easy to compute -has an objective benchmark -relies on cash flows, rather than accounting values -incorporates time value of money

When cash flows are conventional, NPV is _____ if the discount rate is above the IRR

**negative -positive -zero

This capital budgeting method allows lower management to make smaller, everyday financiala decisions effectively

**payback method -internal rate of return -average accounting return -net present value

The amount of time needed for the cash flows from an investment to pay for its initial cost is the

**payback period -net present value period -discounted payback period -internal return period

For a project with conventional cash flows, 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 -positive; positive -negative; positive -negative; negative

In capital budgeting, the net _____ determines the value of a project to the company

**present value -sales -income -future value

If the IRR is greater than the _____ _____, we should accept the project

**required return -payback period -inflation rate -tax rate

Which of the following projects is acceptable if the average accounting return is required to be at least 20%

**restaurant: average income = $450,000, average book value = $2,180,000 **book store: average income = $140,000, average book value = $600,000 -coffee shop: average income = $180,000, average book value = $1,200,000 -clothing store: average income = $230,000, average book value = $1,200,000 ++average accounting return = average net income / average book value

Using the payback period rule will bias toward accepting which type of investment?

**short-term -long-term

In which of the following scenarios would IRR always recommend the wrong decision?

**starting cash flow: 1,000; ending cash flow: -2,000 -starting cash flow: -100,000; ending cash flow: 110,000 -starting cash flow: -100; ending cash flow: 200

The payback period rule _____ a project if it has a payback period that is less than or equal to a particular cutoff date

**suggests accepting -suggests rejecting

Capital Corp is considering a project whose internal rate of return is 14%. If Capital's required return is 14%, the project's NPV is:

**zero (IRR is the rate at which NPV = 0) -negative -positive

Arrange the steps involved in the discounted payback period in order starting with the first step

1. discount the cash flows using the discount rate 2. add the discounted cash flows 3. accept if the discounted payback period is less than some pre-specified number of years

True or false: Investing more money in a project will always lead to greater profits

false

True or false: The MIRR function eliminates multiple IRRs and should replace NPV

false

True or false: Based on the discounted payback period rule, an investment is acceptable if its discounted payback is less than some prespecified number of years

true

True or false: IRR approach may lead to incorrect decisions in comparison of two mutually exclusive projects

true

True or false: Some projects, such as mines, have cash outflow followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return

true

True or false: The crossover rate is the rate at which the NPVs of two projects are equal

true