Wk 5 - Practice: Ch. 13, Weighing Net Present Value and Other... [due Day 5]

Which of these project PI's indicate a reject decision? Select all that apply. 0.9 1.0 0 1.2

0.9 0

Which one of these is a weakness of MIRR? MIRR relies on an unreasonable reinvestment rate assumption. MIRR ignores project sizes. MIRR has no decision rule. MIRR ignores some cash flows.

MIRR ignores project sizes.

Which one of these is an advantage of the net present value (NPV) method?

NPV can be used with both independent and mutually exclusive projects.

True or false: For most projects, net present value is the generally preferred method for making capital budgeting decisions.

True

Explain the disadvantage of the net present value (NPV) method.

Uninformed managers may compare the NPV value to the cost of the project rather than to the benchmark value of zero.

To solve for the IRR statistic, set NPV equal to ______.

zero

What does a positive net present value (NPV) represent?

A project more than covers all of its necessary costs

Rate-based decision statistics provide a rate of return based on which one of these?

Each $1 of investment

Which one of these is the primary advantage of the payback method?

Easy to compute

Which of these apply to the payback method? Select all that apply. Easy to compute Considers the total dollar cost of the initial investment Considers the project's risk level Can be used for all projects

Easy to compute Considers the total dollar cost of the initial investment

Rate-based decision statistics are popular because managers like to compare the expected rate of return to which one of these?

Borrowing rates

Why is the IRR formula set equal to zero?

By definition, IRR is the interest rate that makes the summation of the present values of all the cash flows equal zero.

How can the profitability index (PI) be defined?

Dollar return per dollar invested

What does the term "mutually exclusive projects" imply?

Only one of the two or more projects can be accepted.

A project has been assigned a maximum allowable payback period of 2.5 years. How is the reject decision expressed for this project?

PB > 2.5 years

Which of these is a weakness of the payback method? Select all that apply. The present value of the inflows is ignored. The payback benchmark must always be set at three years. All cash flows after the payback period are ignored. The initial investment is ignored.

The present value of the inflows is ignored. All cash flows after the payback period are ignored.

Which one of these best describes the NPV profile given non-normal cash flows?

The profile will switch from downward-sloping to upward-sloping at least once.

When is a cash flow not discounted when using the discounted payback method for project analysis?

When the cash flow occurs at time zero

Which one of these statements is correct? Multiple choice question. A negative NPV indicates the initial cost exceeds the cash inflows. A negative NPV indicates a project is desirable. A zero NPV indicates a project's discounted cash inflows equal the discounted cash outflows. Accepting a zero NPV project will lower the value of a firm.

A zero NPV indicates a project's discounted cash inflows equal the discounted cash outflows.

Which one of these correctly states the accept rule for the payback statistic?

Accept any project that pays back within the maximum allowable period

What is the profitability index (PI) accept rule?

Accept when PI > or = 1

What type of return are firms seeking when considering a real asset project?

Economic profit

Which of these are strengths of the MIRR process? Select all that apply.

Non-normal cash flows can be converted into normal cash flows. The reinvestment rate assumption is more reasonable than in the IRR process.

What does the net present value (NPV) of a project represent?

The expected increase in wealth from accepting a project

What is the internal rate of return (IRR)?

The implicit expected geometric average of a project's rate of return

Which of these defines the internal rate of return (IRR)? Assume the cash flows are normal. Select all that apply.

The interest rate that causes NPV to equal (-1)(Cash flow at time 0) The interest rate that causes the NPV to equal zero.

Which of these are strengths of the MIRR process?

The reinvestment rate assumption is more reasonable than in the IRR process. Non-normal cash flows can be converted into normal cash flows.

A project is acceptable if it graphs at the x-axis intersection point on a NPV profile graph. Where else can the project graph and be acceptable? Assume normal cash flows.

To the left of and above the x-axis intersection point. Reason: Projects are acceptable when the NPV equals zero or is positive. These projects appear on and to the left and above the x-axis intersection point.

You are considering two mutually exclusive projects, A and B. Which of these options do you have? Select all that apply.

Accept A, reject B Accept B, reject A Reject both A and B

What is the accept decision rule for discounted payback (DPB)?

Accept when the DPB is equal to or less than the maximum allowable period

You are considering three mutually exclusive projects. Which one of these options is immediately eliminated as a possible decision?

Accepting more than one project

How are non-normal cash flows modified for MIRR purposes? Select all that apply.

All cash inflows are moved to the end of the project. All cash outflows are moved to time zero.

Which of these requires modification so MIRR can be applied to non-normal cash flows?

All cash outflows that occur at any time other than time zero

Given a set of normal cash flows, which shape does the NPV profile have?

Downward-sloping

A project has cash flows of -$400, $200, $200, -$100, $300, and -$50. How many x-axis intersection points will the NPV profile for this project have?

Four

What is the definition of net present value (NPV)?

NPV is a technique that generates a decision rule based on the total discounted values of a project's lifetime cash flows.

The profitability index (PI) is most closely associated with which other decision method?

Net present value (NPV)

Which one of these capital budgeting techniques is preferred for most projects?

Net present value (NPV)

What should the decision be if the maximum allowable discount period is less than the discounted payback (DPB) statistic?

Reject the project

Which one of these is the IRR benchmark?

Required rate of return

In the NPV formula, what does CF0 represent?

The cash flow at time zero, or the project start-up costs

What is the internal rate of return (IRR)? The implicit expected arithmetic average of a project's rate of return. The firm's cost of capital. The implicit expected geometric average of a project's rate of return. The rate of return required by the financiers of a project.

The implicit expected geometric average of a project's rate of return

What value should be used to discount the cash flow that occurs in time period N when computing a net present value?

(1 + i)N

How can the IRR benchmark best be described?

The rate required by investors to compensate for a project's level of risk

What is the discounted payback method designed to compute?

The time period required to return the initial investment plus interest

Which one of these is a weakness of the payback method?

The time value of money is ignored.

Why do firms purchase real assets in the form of capital equipment?

To create value for their customers