FIN 320F Unit 10

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

- the reinvestment approach - the discounting approach - the combination approach

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

-Discounting all negative cash outflows to time zero -A financing rate for discounting -A reinvestment rate for compounding -Compounding cash inflows to the end of the project

The basic NPV investment rule is:

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

Which of the following are reasons why IRR continues to be used in practice?

-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 -Businesspeople refer to talk about rates of return

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

-MIRR -NPV

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

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

-net present value -internal rate of return

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

1. the payback period method is easy to use 2. it allows lower level managers to make small decisions effectively 3. the payback period method is ideal for minor projects

What is the IRR for a project with an initial investment of $500 and subsequent cash inflows of $145 per year for 5 years?

13.82%

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%?

2.91

The PI rule for an independent project is to _____ the project if the PI is greater than 1.

accept

One of the weaknesses of the payback period is that the cutoff date is a _____ standard

arbitrary

The Average Accounting Return is defined as:

average net income/average book value

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

budgeting

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

it ignores cash flows after the cutoff date

The possibility that more than one discount rate can cause the net present value of a project to equal zero is referred to as:

multiple rates of return

According to the basic IRR rule, we should:

reject a project if the IRR is less than the required return

If an investment is producing a return that is equal to the required return, the investment's net present value will be:

zero

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

Requires an arbitrary cutoff point

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

Accepts

Which of the following is a disadvantage of the Profitability Index?

Cannot rank mutually exclusive projects.

True or False; An advantage of the AAR is that it is based on book values, not market values.

False

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

Future

An engineer is considering upgrading four production-lines. She has determined that upgrading all four lines is economically justifiable and proposes to invest the $64,000 necessary to make these improvements. Her boss declines her request for all of the funds and states she may spend only $40,000 for improvements this year. Given her discount rate of 8%, what is the highest NPV she can obtain from her total investment? Project Initial NPV Investment A $12,000 $1,250 B $15,000 $1,150 C $12,000 $1,640 D $25,000 $2,840

Steps: 1. Project A PI = 13,250/12,000 = 1.10 2. Project B PI = 16,150/15,000 = 1.08 3. Project C PI = 13,640/12,000 = 1.14 4. Project D PI = 27,840/25,000 = 1.11 5. Project A, C, and D have the highest PI 6. Project C+D = $37,000 leaving $3,000 for Project A 7. 3,000/12,000 = 25% of project A 8. (1,250*.25) + 1,640 + 2,840 = $4,792.50

Our engineer is now considering three new production lines. While each of these lines appear to have a positive NPV, their total cost would be $39 million. Her capital budget cannot exceed $30 million. The designs on each line have been optimally engineered, so no further design changes will be possible: these projects are not divisible. Given her discount rate of 8%, what projects should she invest in? Project Initial NPV Investment A $12 $1.250 B $15 $1.150 C $12 $1.640

A and C With a capital budget of $30 million she can't take on all projects. Additionally, each project must be accepted or rejected as a whole, so we cannot take part of a project. The engineer must therefore identify the portfolios of assets that are acceptable. This would produce the following alternatives. Project/Projects Initial NPV Investment A $12 $1.2 B $15 $1.1 C $12 $1.6 A+B $27 $2.3 A+C $24 $2.8 B+C $27 $2.7 A+B+C $39 $3.9 A+B+C is not on the table because it would exceed the capital budget. The optimal choice is A+C, which produces the highest NPV. She could invest more in A+B, but this produces a lower total NPV. The objective is to increase wealth, not spend money!

Which one of the following is specifically designed to compute the rate of return on a project that has a multiple negative cash flows that are interrupted by one or more positive cash flows?

Modified internal rate of return

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

More

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

Mutually Exclusive

The Management of Premium Manufacturing Company is evaluating two forklift systems to use in its plant that produces the towers for a windmill power farm. The costs and the cash flows from these systems are shown below. If the company uses a 12 percent discount rate for all projects, determine which forklift system should be purchased using the net present value (NPV) approach.

NPV for Otis Forklifts: NPV = PVinflows - PVoutflows $337,075 = $979,225/(1.12) + $1,358,886/(1.12)^2 + $2,111,497/(1.12)^3 - $3,123,450 NPV for Craigmore Forklifts: $90,606 = $875/236/(1.12) + $1,765,225/(1.12)^2 + $2,865,110/(1.12)^3 - $4,137,410 As these are mutually-exclusive projects, Premium should purchase Otis forklift since it has a larger NPV. NPV for Otis Forklifts: NPV for Craigmore Forklifts: As these are mutually-exclusive projects, Premium should purchase Otis forklift since it has a larger NPV.

The NPV is ___ if the required return is less than the IRR, and it is ___ if the required return is greater than the IRR.

NPV is Positive if required return is less than IRR NPV is Negative if required return is greater than IRR

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%?

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

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

Net Present Value

Mary has just been asked to analyze an investment to determine if it is acceptable. Unfortunately, she is not being given sufficient time to analyze the project using various methods. She must select one method of analysis and provide an answer based solely on that method. Which method do you suggest she use in this situation?

Net present value

Which one of the following indicators offers the best assurance that a project will produce value for its owners?

Positive NPV

True or false: Payback period ignores time value of money

True

True or false: A project with non-conventional cash flows will produce two or more IRRs.

True (An IRR will result for every change in sign in the cash flow stream)

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 (Whenever subsequent cash flows are both negative and positive, multiple internal rates of return may occur)

The internal rate of return is a function of

a project's cash flows

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

a target average accounting return