FIN4424 Test 1 Conceptual Questions
The survey of CFOs indicates that the IRR method is used for evaluating investment projects by approximately
75% of firms
The survey of CFOs indicates that the NPV method is always, or almost always, used for evaluating investment projects by approximately
75% of firms
Which of the following statements regarding the NPV rule and the rate of return rule is false?
Accept a project if its rate of return > 0.
Costs associated with the conflicts of interest between the bondholders and the shareholders of a corporation are called
Agency Costs
Disadvantages of the corporate form include
Agency costs, double taxation, and cost of managing a corporation
The Important point(s) to remember while estimating the cash flows of a project
Are cash flow is relevant, always estimate cash flows on an incremental basis, and be consistent in the treatment of inflation
You are given a job to make a decision on project X, which is composed of three independent projects A, B, and C that have NPVs of + $70, -$40 and + $100, respectively. How would you go about making the decision about whether to accept or reject the project?
Break up the project into its components: Accept A and C, but reject B.
Suppose a firm has $100 million in excess cash. It could
Buy another firm, pay high dividends to the shareholders, and invest the funds in projects with positive NPVs
A firm's investment decision is also called its
Capital budgeting decision
Which of the following assets is tangible?
ExxonMobil's corporate headquarters building
A firm's total asset value belongs entirely to the shareholders.
False
Accounting earnings from a firm's income statement, prepared according to generally accepted accounting principles (GAAP), are typically the best data source for calculating a project's NPV.
False
In the case of a loan project (borrowing), one should accept the project if the IRR is more than the cost of capital.
False
The profitability index is always less than 1.
False
The following are some of the shortcomings of the IRR method except
IRR is conceptually easy to communicate
A reduction in the sales of existing products caused by the introduction of a new product is an example of
Incidental effects
The financial goal of a corporation is to
Maximize the value of the firm for the shareholders
A high proportion of the value of a growth stock typically comes from
PVGO (present value of growth opportunities).
Which of the following investment rules may not use all possible cash flows in its calculations?
Payback period
The net present value of a project depends upon the
Project's cash flows and opportunity cost of capital.
Which of the following statements regarding the NPV rule and the rate of return rule is true?
Reject a project if the NPV < 0. Accept a project if its rate of return > opportunity cost of capital. Accept a project if its NPV > 0.
Generally, a corporation is owned by its
Shareholders
Money that a firm has already spent, or committed to spend regardless of whether a project is taken, is called a(n)
Sunk cost
Costs incurred as a result of past irrevocable decisions and irrelevant to future decisions are called
Sunk costs
For the case of an electric car project, which of the following costs or cash flows should be categorized as incremental when analyzing whether to invest in the project?
Tax savings resulting from the depreciation charges
Which of the following investment rules has the value additivity property?
The net present value method
Which of the following investment rules does not use the time value of money concept?
The payback period
Real assets of a corporation are claims on their financial assets.
True
The IRR rule states that firms should accept any project offering an internal rate of return in excess of the cost of capital
True
The payback rule ignores all cash flows after the cut-off date
True
If the sign of the cash flows for a project changes two times, then the project likely has
Two IRRs
If an investment project (normal project) has an IRR equal to the cost of capital, the NPV for that project is
Zero
Preferably, a financial analyst estimates cash flows for a project as
cash flows after taxes.
If the discount rate is stated in nominal terms, then in order to calculate the NPV in a consistent manner, the project requires that
cash flows be estimated in nominal terms.
Limited liability is an important feature of
corporations
For the case of an electric car project, the following costs should be treated as incremental costs when deciding whether to go ahead with the project except
interest payments on debt incurred to finance the project
The payback period rule
requires an arbitrary choice of a cut-off point.
A project will have only one internal rate of return if
there is a one-sign change in the cash flows.
One should consider net working capital (NWC) in project cash flows because
typically firms must invest cash in short-term assets to produce finished goods
The quickest way to calculate the internal rate of return (IRR) of a project is by
using a financial calculator
