Fin 3400 Chapter 9 Net present value

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

The three attributes of NPV are that it

1. uses all the cash flows of a project 2. uses cash flows 3. discounts the cash flows properly

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

9.70 Help idk how

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%

-95 + (107/1.06)= 5.94

Advantages to AAR

1. Easy to calculate 2. Needed information will usually be available

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

2.91 {(80/1.12)+(80/1.12^2)}/30

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.

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.

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

Budgeting

The IRR rule can lead to bad decissions when ____ or ____.

Cash flows are not conventional projects are mutually exclusive

True or false, the MIRR function eliminates multiple IRR and should replace NPV

False

True or false, the discounted payback rule has an objective benchmark to use in decision making

False

The profitability index is calculated by dividing the pv of the _____ cash flows by the initial investment

Future

The most important alternative to NPV is the _____ method

Internal rate of return

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

MIRR, NPV

By ignoring time value, the payback period rule may accept projects with a ______ NPV

Negative

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

Payback Method

When cash flows are conventional, NPV is ____.

Positive for discount rates below IRR Equal to zero when discount rates = IRR negative for discount rates above IRR

In capital budgeting, the net ___ determines the values of a project of the company

Present value

T or f the crossover rate is the rate at which NPV of the 2 projects are equal

True

True or false, IRR approach may lead to incorrect decisions in comparison of 2 mutually exclusive events

True

t or f some projects such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return.

True

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

accept

Arrange the steps involved in the discounted payback period in order starting with step 1

discount the cash flow using the discount rate add the discounted cash flows accept if the discounted payback period is less than some prespecified number of years

T or F investing more money in a project is a guarantee of greater projects

f

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

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

payback period

which of the following are mutually exclusive investments

a restaurant or a gas station on the same piece of land 2 different choices for assembly that will make the same product

A project should be ____ if its NPV is greater than zero

accepted

payback period tells the time it takes to break even in a ______ sense. Discounted payback period tells the time it takes to break even in a ______ or financial sense

accounting, economic

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

zero

The payback period can lead to incorrect decisions if used to literally because it

ignores cash flows after the cutoff date

a(n) ____ project does not rely on the acceptance or rejection of another project

independent

The present value of all cash flows (after the initial investment) is divided by the ______ to calculate the Profitability index

initial investment

what are the advantages of the payback period method for management

it allows the lower level management make small decisions payback period it easy to use ideal for short projects

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

it gives a rate of return rather than a dollar value

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

sum of the cash flows of the project

Saxon Company is considering a project that will generate net income of $50,000 in Year 1, $75,000 in Year 2, and $90,000 in Year 3. The cost of the project is $700,000, and this cost will be depreciated to zero in the three years of the investment. What is their average accounting return?

20.48% avg net income= net income over 3 years/3 Cost /2 AVG net income/ (Cost/2)

Project Alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If Projects Alpha and Beta have conventional cash flows, are mutually exclusive and the NPV profiles cross at 15% (where the NPVs are positive), which of the projects has a higher internal rate of return?

Project beta

internal rate of return must be compared to the ____ in order to determine the acceptability of the project

Required return

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

Target aar