Capital Budgeting

True

Net present value (NPV) assumes that intermediate cash inflows are reinvested at the cost of capital, whereas internal rate of return (IRR) assumes that intermediate cash inflows can be reinvested at a rate equal to the project's IRR.

True

Net present value is considered a sophisticated capital budgeting technique since it gives explicit consideration to the time value of money.

False

Net present value profiles are most useful when selecting among independent projects.

True

Net present value profiles are most useful when selecting among mutually exclusive projects.

False

One strength of payback period is that it takes fully into account the time factor in the value of money.

False

The internal rate of return (IRR) is defined as the discount rate that equates the net present value with the initial investment associated with a project.

False

The internal rate of return assumes that intermediate cash inflows are invested at a rate equal to the firm's cost of capital.

False

A project must be rejected if its payback period is less than the maximum acceptable payback period.

False

A project's net present value profile is a graph that plots a project's IRR for various discount rates.

True

A project's net present value profile is a graph that plots a project's NPV for various discount rates.

True

A sophisticated capital budgeting technique that can be computed by solving for the discount rate that equates the present value of a projects inflows with the present value of its outflows is called internal rate of return.

False

A sophisticated capital budgeting technique that can be computed by solving for the discount rate that equates the present value of a projects inflows with the present value of its outflows is called net present value.

True

For conventional projects, both NPV and IRR techniques will always generate the same accept- reject decision, but differences in their underlying assumptions can cause them to rank projects differently.

True

Since the payback period can be viewed as a measure of risk exposure, many firms use it as a decision criterion or as a supplement to sophisticated decision techniques.

True

The IRR is the compound annual rate of return that the firm will earn if it invests in the project and receives the given cash inflows.

True

The discount rate, required return, cost of capital, or opportunity cost is the minimum return that must be earned on a project to leave the firm's market value unchanged.

False

A sophisticated capital budgeting technique that can be computed by subtracting 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 is called internal rate of return.

True

A sophisticated capital budgeting technique that can be computed by subtracting 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 is called net present value.

True

Although differences in the magnitude and timing of cash flows explain conflicting rankings under the NPV and IRR techniques, the underlying cause is the implicit assumption concerning the reinvestment of intermediate cash inflows—cash inflows received prior to the termination of a project.

True

An internal rate of return greater than the cost of capital guarantees that the firm earns at least its required return. Such an outcome should enhance the market value of the firm and therefore the wealth of its owners.

True

By measuring how quickly the firm recovers its initial investment, payback period gives some implicit consideration to the timing of cash flows and therefore to the time value of money.

True

Certain mathematical properties may cause a project with a nonconventional cash flow pattern to have zero or more than one IRR; this problem does not occur with the NPV approach.

True

Conflicting rankings using NPV and IRR result from differences in the magnitude and timing of cash flows.

False

If its IRR is greater than $0.00, a project should be accepted.

False

If its IRR is greater than 0 percent, a project should be accepted.

True

If its IRR is greater than the cost of capital, a project should be accepted.

True

If net present value of a project is greater than zero, the firm will earn a return greater than its cost of capital. Such a project should enhance the wealth of the firm's owners.

True

If the NPV is greater than $0.00, a project should be accepted.

False

If the NPV is greater than the cost of capital, a project should be accepted.

False

If the NPV is greater than the initial investment, a project should be accepted.

False

If the payback period is greater than the maximum acceptable payback period, we would accept a project.

True

If the payback period is greater than the maximum acceptable payback period, we would reject a project.

True

If the payback period is less than the maximum acceptable payback period, we would accept a project.

False

If the payback period is less than the maximum acceptable payback period, we would reject a project.

True

In capital budgeting, the preferred approaches in assessing whether a project is acceptable are those that integrate time value procedures, risk and return considerations, and valuation concepts.

False

In capital budgeting, the preferred approaches in assessing whether a project is acceptable integrate time value procedures, risk and return considerations, valuation concepts, and the required payback period.

False

In general, projects with similar-sized investments and lower early-year cash inflows (lower cash inflows in the early years) tend to be preferred at higher discount rates.

True

In general, the greater the difference between the magnitude and timing of cash inflows, the greater the likelihood of conflicting ranking between NPV and IRR.

False

In spite of the theoretical superiority of IRR, financial managers prefer to use NPV.

True

In spite of the theoretical superiority of NPV, financial managers prefer to use IRR.

True

In the case of annuity cash inflows, the payback period can be found by dividing the initial investment by the annual cash inflow.

False

On a purely theoretical basis, IRR is a better approach when selecting among two mutually exclusive projects.

True

On a purely theoretical basis, NPV is a better approach when selecting among two mutually exclusive projects.

False

On a purely theoretical basis, NPV is the better approach to capital budgeting than IRR because IRR implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

True

On a purely theoretical basis, NPV is the better approach to capital budgeting than IRR because NPV implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

True

One weakness of payback is its failure to recognize cash flows that occur after the payback period.

True

Projects having higher cash inflows in the early years tend to be preferred at higher discount rates.

True

Since the cost of capital tends to be a reasonable estimate of the rate at which the firm could actually reinvest intermediate cash inflows, the use of NPV is in theory preferable to IRR.

True

The IRR is the discount rate that equates the NPV of an investment opportunity with $0.

False

The NPV of an project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15 percent is $143.51.

False

The NPV of an project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15 percent is $856.49.

True

The NPV of an project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15 percent is -$143.51.

True

The major weakness of payback period in evaluating projects is that it cannot specify the appropriate payback period in light of the wealth maximization goal.

False

The net present value is found by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to the project's internal rate of return.

True

The payback period is generally viewed as an unsophisticated capital budgeting technique, because it does not explicitly consider the time value of money by discounting cash flows to find present value.

False

The payback period is the exact amount of time required for the firm to recover the installed cost of a new asset.

True

The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $300 for the next three years is 3.33 years.

True

The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $3,000 for the next three years is 0.333 years.

False

The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $3,000 for the next three years is 3.33 years.

False

The payback period of a project that costs $1,000 initially and promises after-tax cash inflows of $300 for the next three years is 0.333 years.