FI 441 Exam 1

Which statement concerning the net present value (NPV) of an investment or a financing project is correct?

A financing project should be accepted if, and only if, the NPV is exactly equal to zero. An investment project should be accepted only if the NPV is equal to the initial cash flow. %Any type of project should be accepted if the NPV is positive and rejected if it is negative. Any type of project with greater total cash inflows than total cash outflows, should always be accepted. An investment project that has positive cash flows for every time period after the initial investment should be accepted.

the rate of return decreases.

All else constant, the net present value of a typical investment project increases when: the discount rate increases. each cash inflow is delayed by one year. the initial cost of a project increases. the rate of return decreases. all cash inflows occur during the last year instead of periodically throughout a project's life.

is the rate generated solely by the cash flows of the investment.

For investment projects, the internal rate of return (IRR): -rule indicates acceptance of an investment when the IRR is less than the discount rate. -is the rate generated solely by the cash flows of the investment. -is used primarily to rank projects of varying sizes. -is the rate that causes the net present value of a project to equal the project?s initial cost. -can effectively be used to compare all types of projects.

any delay in receiving the projected cash inflows will cause the project's NPV to be negative.

If a project has a net present value equal to zero, then: -the initial cost of the project exceeds the present value of the project's subsequent cash flows. -the internal rate of return exceeds the discount rate. -the project produces cash inflows that exceed the minimum required inflows. -any delay in receiving the projected cash inflows will cause the project's NPV to be negative. -the discount rate exceeds the internal rate of return.

is more useful than the internal rate of return when comparing different sized projects.

NPV: -cannot be used when deciding between two mutually exclusive projects. -is more useful than the internal rate of return when comparing different sized projects. -is rarely used by small firms according to the Graham and Harvey survey. -is not as widely used in practice as payback and discounted payback. -ignores the risk of a project.

net present value.

The difference between the present value of an investment's future cash flows and its initial cost is the:

computed using a project's cash flows as the only source of inputs.

The internal rate of return is: -more reliable as a decision making tool than net present value whenever you are considering mutually exclusive projects. -equivalent to the discount rate that makes the net present value equal to one. -computed using a project's cash flows as the only source of inputs. -dependent on the interest rates offered in the marketplace. -a better methodology than net present value when dealing with unconventional cash flows.

easier for managers to comprehend than the net present value.

The internal rate of return tends to be: -easier for managers to comprehend than the net present value. -extremely accurate even when cash flow estimates are faulty. -ignored by most financial managers. -used primarily to differentiate between mutually exclusive projects. -utilized in project analysis only when multiple net present values apply.

payback period.

The length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment is called the:

internal rate of return for the differences in the cash flows of the two projects.

You are trying to determine whether to accept Project A or Project B. These projects are mutually exclusive. As part of your analysis, you should compute the incremental IRR by determining the: -internal rate of return for the cash flows of each project. -net present value of each project using the internal rate of return as the discount rate. -discount rate that equates the discounted payback periods for each project. -discount rate that makes the net present value of each project equal to one. -internal rate of return for the differences in the cash flows of the two projects.

discounted payback period

a capital budgeting procedure used to determine the profitability of a project

internal rate of return

a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.

profitability index

measures the ratio between the present value of future cash flows and the initial investment