Net Present Value and Other Investment Criteria

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

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 percent?

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

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

accepted

Which of the following are weaknesses of the payback method?

the cutoff date is arbitrary; cash flows received after the payback period are ignored; time value of money principles are ignored

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

What is the PI for a project with an initial cash outflow of $3o and subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12 percent?

2.91

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

9.70%

The spreadsheet function for calculating net present value is ___.

=NPV()

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

MIRR; NPV

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

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

discount the cash flows using the discount rate; add the discounted cash flows; accept if the discounted payback period is less than some pre-specified number of years

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

future

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

The most important alternative to NPV is the ___ method.

internal rate of return

When cash flows are conventional, the NPV is ___ if the discount rate is about the IRR.

negative

When cash flows are conventional, NPV is ___.

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

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

payback period

For a project with conventional cash flows, the NPV is ___ if the required return is less than the IRR, and it is ___ if the required return is greater than the IRR.

positive, negative

In capital budgeting, the net ___ determines the value of a project to the company.

present value

The basic NPV investment rule is:

reject a project if its NPV is less than zero; 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

According to the basic IRR rule, we should:

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

If the IRR is greater than the ___ ___, we should accept the project.

required return

The three attributes of NPV are that it:

uses cash flows; uses all the cash flows of a project; discounts the cash flows properly

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

internal rate of return

Payback period tells the time it takes to break even in an ___ sense. Discounted payback period tells the time it takes to break even in an ___ sense.

accounting; economic

The discounted payback period has which of these weaknesses?

arbitrary cutoff date; loss of simplicity as compared to the payback method; exclusion of some cash flows

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

budgeting

The IRR rule can lead to bad decisions when ___ or ___.

cash flows are not conventional; projects are mutually exclusive

NPV accounts for the size of the project and eliminates the effect of ___.

scale

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

suggests accepting

Which of the following are mutually exclusive investments?

two different assembly lines to produce cereal; a restaurant or a gas station on the same piece of land