FIN 101 Chapter 8 Study Set

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

payback

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

required return

What are the advantages of the payback period method for management?

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

If a firm is evaluating two possible projects, both of which require the use of the same production facilities, and taking one project means that we cannot take the other, these projects would be considered

mutually exclusive

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

accepted

The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.

accepts

One of the weaknesses of the payback period is that the cutoff date is a(n) ______ standard.

arbitrary

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

budgeting

The profitability index is also called the ______ ratio.

cost-benefit

True or false: The IRR is easy to use because you only need to know the appropriate discount rate

false

True or false: The payback period takes into consideration the time value of money.

false

True or false: The profitability index rule for an independent project states that, if a project has a positive NPV, then the present value of the future cash flows must be smaller than the initial investment.

false

True or false: There is only one way to calculate the modified IRR.

false

The basic NPV investment rule is:

if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference. reject a project if its NPV is less than zero. accept a project if the NPV is greater than zero.

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

independent

The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its

initial cost

According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the United States and Canada?

internal rate of return net present value

Capital budgeting is probably the most important of the three key areas of concern to the financial manager because

it defines the business of the firm

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?

nonconventional cash flows mutually exclusive projects

The ______ is best suited for decisions on relatively small, minor projects, while ______ is more appropriate for large, complex projects.

payback period; npv

In general, NPV is _____

positive for discount rates below the IRR negative for discount rates above the IRR equal to zero when the discount rate equals the IRR

Which of the following is a disadvantage of the payback period rule?

requires an arbitrary cutoff point

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

the combination approach the discounting approach the reinvestment approach

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

the discount

internal rate of return (IRR)

the discount rate that makes the NPV of an investment zero

multiple rates of return

the possibility that more than one discount rate will make the NPV of an investment zero

True or false: A project with nonconventional cash flows will produce two or more IRRs.

true

True or false: 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

The spreadsheet function for calculating net present value is

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

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 reasons why IRR continues to be used in practice?

Businesspeople prefer to talk about rates of return. It is easier to communicate information about a proposal with an IRR. The IRR of a proposal can be calculated without knowing the appropriate discount rate.

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 range of cash flows specified in Excel begins with Cashflow 1, not Cashflow 0. The discount rate in Excel is entered as a decimal, or as a percentage with a percent sign. With the Excel NPV function, Cashflow 0 must be handled outside the NPV function. The Excel NPV function is actually a PV function.

Which of the following are weaknesses of the payback method?

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

The internal rate of return is a function of ____

a project's cash flows

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

a reinvestment rate for compounding a financing rate for discounting discounting all cash outflows to time 0 compounding cash inflows to the end of the project

The profitability index (PI) rule for an independent project is to ______ the project if the PI is greater than 1.

accept

______ is a measure of how much value is created or added by undertaking an investment.

Net present value