Ch 8 Smartbook

What is the primary concern of the payback period rule?

How long it takes to recover the initial investment

Which of the following is a disadvantage of the profitability index?

It cannot rank mutually exclusive projects.

True or false: A disadvantage of the AAR is that it does not take into account the time value of money.

T

When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus ______ rate raised to the nth power.

the discount

The internal rate of return is a function of ______.

a project's cash flows

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

accepted

A(n) ______ project does not rely on the acceptance or rejection of another project.

independent

If a firm is evaluating two possible projects, both of which require the use of the same production facilities, and taking one project means that we cannot take the other, these projects would be considered ______.

mutually exclusive

True or false: The IRR is easy to use because you only need to know the appropriate discount rate.

F

True or false: The PI always results in correct decisions in comparisons of mutually exclusive investments.

F

Select all that apply In general, NPV is ______. Multiple select question. positive for discount rates below the IRR positive for discount rates above the IRR equal to zero when the discount rate equals the IRR negative for discount rates above the IRR

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

True or false: The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its future cost.

F

True or false: The profitability index rule for an independent project states that, if a project has a positive NPV, then the present value of the future cash flows must be smaller than the initial investment.

F

The basic NPV investment rule is: Multiple select question. if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference. reject a project if its NPV is less than zero. accept a project if the NPV is less than zero. accept a project if the discount rate is above zero. accept a project if the NPV is greater than zero.

if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference. reject a project if its NPV is less than zero. accept a project if the NPV is greater than zero.

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

it ignores cash flows after the cutoff date.

Select all that apply Which of the following present problems when using the IRR method? Multiple select question. nonconventional cash flows mutually exclusive projects larger cash flows later in the project a high discount rate

nonconventional cash flows mutually exclusive projects

The ______ method evaluates a project by determining the time needed to recoup the initial investment.

payback

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

required return

True or false: The discounted cash flow (DCF) valuation estimates future value as the difference between the market price and the cost of the investment.

F

The multiple rates of return problem is the possibility that more than one discount rate may make the net present value of an investment equal to _________ .

Zero

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

future

The ______ is best suited for decisions on relatively small, minor projects, while ______ is more appropriate for large, complex projects.

payback period; NPV

True or false: The payback period takes into consideration the time value of money.

F

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

a target average accounting return.

The profitability index (PI) rule for an independent project is to ______ the project if the PI is greater than 1.

accept

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

accepts

The average accounting return is defined as:

average net income/average book value.

According to the basic IRR rule, we should:

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

Internal rate of return (IRR) must be compared to the ______ in order to determine the acceptability of a project.

required return

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

False, this is a disadvantage

______ is a measure of how much value is created or added by undertaking an investment.

Net present value

True or false: A project with nonconventional cash flows will produce two or more IRRs.

T

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.

T

True or false: The measure of average accounting profit is in the numerator of the average accounting return (AAR) formula.

T

Based on the average accounting return rule, a project is ______ if its average accounting return exceeds a target average accounting return.

acceptable

Which of the following is a disadvantage of the payback period rule? Multiple choice question. easy to understand adjusts for uncertainty of later cash flows biased toward liquidity requires an arbitrary cutoff point

requires an arbitrary cutoff point

The profitability index is also called the ______ ratio.

cost-benefit

One of the weaknesses of the payback period is that the cutoff date is a(n) ______ standard.

arbitrary

Select all that apply Which of the following are reasons why IRR continues to be used in practice? Multiple select question. The IRR allows the correct ranking of projects. Businesspeople prefer to talk about rates of return. 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 prefer to talk about rates of return. 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.

True or false: When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus the discount rate raised to the nth power.

T

Select all that apply Which of the following are weaknesses of the payback method? Multiple select question. The cutoff date is arbitrary. Time value of money principles is ignored. Cash flows received after the payback period are ignored. All cash flows are included in the payback period.

The cutoff date is arbitrary. Time value of money principles is ignored. Cash flows received after the payback period are ignored.

Select all that apply What are the advantages of the payback period method for management? Multiple select question. The payback period method is ideal for minor projects. The payback period method is easy to use. It allows lower-level managers to make small decisions effectively. The payback period adjusts for the discount rate.

The payback period method is ideal for minor projects. The payback period method is easy to use. It allows lower-level managers to make small decisions effectively.

The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its ______.

initial cost

The discounted cash flow valuation shows that higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on.

more

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

net present value

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