FINA 3313 Ch 9
What are advantages of payback period?
-Measures Liquidity, Easy to communicate -Does not require complex calculations -Does not require discount rate
Net present value (NPV) is a sophisticated capital budgeting technique; found by adding a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital.
False
Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function.term-2
Mutually Exclusive
The "gold standard" of investment criteria refers to:
NPV
What is the internal rate of return for a project with an initial outlay of $10,000 that is expected to generate cash flows of $2,000 per year for 6 years?
PV=-10,000 FV=0 PMT=2,000 N=6 CPT I/Y =5.47
The multiple IRR problem occurs when the signs of a project's cash flows change more than once.
True
The financing decision
Find the right kind of debt for your firm and the right mix of debt and equity to fund your operations
The Internal Rate of Return (IRR) is the discount rate that equates the NPV of an investment opportunity with $0
True
The primary purpose of capital budgeting is to:
maximize the shareholders wealth
Capital rationing may be beneficial to a firm if it:
weeds out proposals with weaker or biased NPVs.
Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $900 at the end of the next three years and then $1400 per year for the three years after that. If the discount rate is 8% then what is the PI? Answer in % format
CF0= -5,000 C01=900 FO1=3 CO2= 1400 FO2=3 NPV I=8 enter down arrow Cpt NPV= 183.48 PI= (183.48+5,000)/5,000 PI= 1.03669 PI=103.67%
What is the NPV of a project that costs $100,000.00 and returns $50,000.00 annually for three years if the opportunity cost of capital is 8.22%?
CF0=-100,000 C01=50,000 F01=3 CPT NPV I/Y= 8.22% Down Arrow NPV CPT NPV=28,345.05
Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $223 at the end of the next three years and then $1,383 per year for the three years after that. If the discount rate is 7.98% then what is the NPV?
CFO=-5,000 CO1= 223 FO1=3 CO2=1383 FO2=3 Enter NPV I= 7.98% Enter Down arrow CPT NPV= -1,593.19
It should not usually be clear whether we are describing independent or mutually exclusive projects in the following chapters because when we only describe one project then it can be assumed to be independent
False
NPV assumes intermediate cash flows are reinvested at the cost of equity, while IRR assumes that they are reinvested at the cost of capital
False
The multiple IRR problem occurs when the signs of a project's cash flows change more than once.
True
List steps of the capital budgeting process
Step 1: Personal generation Step 2: Review and analysis Step 3: Decision Making Step 4: Implementation Step 5: Follow-up
Compute the payback period for a project that requires an initial outlay of $297,771 that is expected to generate $40,000 per year for 9 years.
Time Amount Cumulative (297,771) (297,771) 1 40,000 (257,771) 2 40,000 (217,771) 3 40,000 (177,771) 4 40,000 (137,771) 5 40,000 (97,771) 6 40,000 (57,771) 7 40,000 (17,771) 8 40,000 22,229 9 40,000 62,229 Look at the last number before going over the 40,000 and the year =7+(17,771/40,000) =7.44
The investment decision
invest in assets that earn a rate greater than the minimum acceptable hurdle rate
The disadvantages of the IRR period method is that it
-Requires complex calculations -Only works for normal cash flows -Requires a lot of data (estimates of all CFs)
The dividend decision
If you can't find investments that make your minimum acceptable rate, return the cash to owners of your b
Which of the following statements is correct for a project with a negative NPV?
The cost of capital exceeds the IRR
