Chapter 8 Net Present Value and Other Investment Criteria

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The basic NPV investment rule is:

- Accept a project if the NPV is grater than zero - Reject a project if it is less than zero - If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference

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 life

- An increase in the size of the first cash inflow will decrease the payback period, all else held constant

The NPV IS ____ if the required return is greater than the IRR

- Negative

The____ is more appropriate for large complex pojects

- Net Present Value

____ is the measure of how much value is created or added by undertaking an investment

- Net Present Value

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

- Net present value

Which of the following present problems when using the IRR method.

- Non-conventional cash flows - Mutually exclusive projects

- 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%

- PI= PV(future cash flow)/initial cost= (80/1.12)+(20/1.12^2)/30 = 87.3724/30 = 2.91

The ____ is the best suited for decision on relatively small, minor projects

- Payback

The method ____ evaluates a project by determining the time needed to recoup the initial investment

- Payback

The NPV is_____ if the required return is less that the IRR

- Positive

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

- Required return

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

-

The internal rate of return is a function of _____

- A project cash flows

The PI rule for an independent project is to___ the project if the PI is greater that 1

- Accept

Higher cash flows earlier in a project's life are ____ valuable than higher cash flows later on.

- More

Internal rate of return (IRR) must be compare to the ____ in order to determine the acceptability of a project

- Required return

What is the NPV of A project with an initial investment of $95, a cash flow in once year of $107, and a discount rate of 6 percent?

NVP = - $95 + ($107/1.06) = $5.94

A project with non-conventional cash flows will produce two or more IRR

- True

The combination MIRR method is used by the Excel MIRR function and uses which of the following?

- A reinvestment rate for compounding - Discount all negatives cash flows to time 0 - Compounding cash inflows to the end of the project - A financial rate for discounting

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

- Budgeting

Disadvantage of the Profitability Index

- Cannot rank mutually exclusive projects

The profitability index is calculated by dividing the PV of the ____ cash inflows by the initial investment

- Future

According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following to capital budgeting methods are widely used by firms in the US and Canada

- Internal payback - Net present value

The payback period can lead to foolish decisions if it is used too literally because:

- It ignores cash flows after the cutoff date

The Average Accounting Return is defined as:

- Average net income/average book value

Which of the following present problems when using the IRR method?

- Mutually exclusive projects - Non-conventional cash flows

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

- NPV - MIRR

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 Excel NPV function is actually a PV function - The discount rate in Excel is entered as a decimal - With the Excel NPV function, cashflow#0 must be handled outside the NPV function - The range of cash flows specified in Excel begins with cashflow#1, not cashflow#0

Which of the following are reason 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

When calculating NPV, the present value of the nth cash flow is found by diving the nth cash flow by 1 plus ____ rate raised to he nth power.

- The discount

Which of the following are methods of calculating the MIRR of a project?

- The discount approach - The combination approach - The reinvestment approach

Which of the following are weaknesses of the payback method

- Time value of money principles are ignored. - Cash flows received after the payback period are ignored. - The cutoff date is arbitrary

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

What are the advantages of the payback period method for management

- It allows lower level managers to make small decisions effectively. - The payback period method is deal for minor projects - The payback period method is easy to use

If a firm is evaluating two possible project, both of which require the use of the same production facilities, these projects would be considered___

- Mutually exclusive

The spreadsheet function for calculating net present value is:

- NPV(rate, CF1, ..., CFn) + CF0


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