Corporate Finance Review Chapter 9

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

9.70%

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

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.

Which of the following are weaknesses of the payback method?

Cash flows received after the payback period are ignored, time value of money principles are ignored and the cut off date is arbitrary.

What is the PI of a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12 percent?

P1= ($80/1.12) + ($20/1.12^2)/ $30 = 2.91

This capital budgeting method allows lower management to make similar, everyday financial decisions effectively.

Payback method

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

True

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

a target average accounting return

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

independant

The present value of all cash flows after the initial investment is divided by the ________ to calculate the profitability index.

initial investment

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

payback period

When cash flows are conventional, NPV is ___________.

positive for discount rates below IRR, negative for discounts above IRR and equal to zero when the discount rate equals the IRR.

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

0

The discounted payback period has which of these weaknesses?

Arbitrary cutoff date, Loss of simplicity as compared to the payback method and exclusion of some cash flows.

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

False

True or false: Investing more money in a project is a guarantee of greater profits.

False

Which of the following are advantages of AAR?

Is easy to compute and needed information is always available

According to Grahams and Harvey's 1999 survey of 392 CFOs, which of the following two capital budgeting methods are most used by firms in the U.S. and Canada?

NPV and IRR

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

NPV and MIRR

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?

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

A project should be _______ if its NPV is greater than zero.

accepted

The IRR rule can lead to bad decisions when _________ or ________.

cash flows are not conventional; projects are mutually exclusive

NPV _______ cash flows properly

discounts

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

it gives a rate of return rather than a dollar value

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

present value or (NPV)

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

The three attributes of NPV are that it:

uses cash flows, discounts the cash flows properly and uses all the cash flows of a project.

The IRR is the discount rate that makes the NPV of a project equal to ____________.

zero

If the IRR is greater than the __________ __________, we should accept the project.

required return

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

internal rate of return

Internal rate of return(IRR) must be compared to the ____________ in order to determine the acceptability of a project.

required rate

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

True

True or False: Two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing.

True