Chapter 5: 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. a. The timing but not the size of the cash flows affects the payback period. b. Receiving every cash inflow sooner will increase the payback period, all else held constant. c. A delay in receiving the cash inflows will decrease the payback period. d. An increase in the size of the first cash inflow will decrease the payback period, all else held constant.
An increase in the size of the first cash inflow will decrease the payback period, all else held constant.
For "normal" cash flows (the outflows occur before the inflows), the NPV is ______ if the discount rate is less than the IRR, and it is ______ if the discount rate is greater than the IRR. a. negative; negative b. negative; positive c. positive; negative d. positive; positive
Positive; Negative
What does value additivity mean for a firm? a. A new project will always add value to a firm. b. The NPV values of individual projects can be added together. c. All projects with positive NPVs will add an equal amount of value to a firm.
The NPV values of individual projects can be added together.
True or false: Two challenges with the IRR approach when comparing two projects are scale and differing cash flow patterns over time. True False
True
The payback rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date. a. rejects b. accepts
accepts
The property of value ______ implies that the contribution of any project to a firm's value is simply the NPV of the project. a. duplicity b. exclusivity c. additivity d. multiplicity
additivity
Internal rate of return (IRR) must be compared to the ______ rate in order to determine the acceptability of a project. a. discount b. federal funds c. inflation
discount
One of the flaws of the payback period method is that cash flows after the cutoff date are ___. a. given special consideration b. reserved for future projects c. not considered in the analysis d. given greater value
not given consideration
The ______ method differs from NPV because it evaluates a project by determining the time needed to recoup the initial investment. a. accounting rate of return b. internal rate of return c. payback
payback
A project with a cash inflow of $200 followed by a cash outflow of (-$250) one year later will have an IRR of ___ percent. 30 20 25 -20
25 (250/200) - 1
Which of the following is true for a project with a negative initial cash flow followed by positive cash flows? a. Accept if IRR is less than the market rate of financing b. Reject if IRR is greater than market rate of financing. c. Accept if NPV is greater than zero.
Accept if NPV is greater than zero
Which of the following are weaknesses of the payback method? (Select all that apply) a. It gives equal weight to all cash flows before the cutoff date. b. All cash flows are included in the payback period. c. Cash flows received after the payback period are ignored.
It gives equal weight to all cash flows before the cutoff date. Cash flows received after the payback period are ignored.
If the IRR is greater than the opportunity cost of capital, we should ___. a. revise the cash flows b. reject the project c. accept the project
accept the project
According to the basic IRR rule, we should ____ a project if the IRR is ____ than the opportunity cost of capital. a. accept; less b. accept; greater c. reject; greater d. reject; less
accept; greater reject; less
A major problem that still exists with the discounted-payback-period method is the: a. market rate of return b. opportunity costs c. arbitrary cutoff date d. cost to implement
arbitrary cutoff date
Higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on. a. less b. more
more
Higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on. a. more b. less
more
In capital budgeting, the net ______ is the value of a project to the company. a. sales b. future value c. income d. present value
present value
Capital ______ occurs when a firm doesn't have enough capital to fund all its positive NPV projects. a. relief b. yielding c. rationing d. structure
rationing
According to the basic IRR rule, we should ____ a project if the IRR is ____ than the opportunity cost of capital. (select all that apply) a. reject; greater b. accept; less c. reject; less d. accept; greater
reject; less accept; greater
The payback rule ______ a project if it has a payback period that is greater than a particular cutoff date. a. rejects b. accepts
rejects
Three attributes of NPV are that it: (select all that apply) a. uses all the cash flows of the project. b. uses cash flow. c. discounts the cash flows properly. d. doesn't rely on the discount rate.
uses all the cash flows of the project. uses cash flow. discounts the cash flows properly.
The IRR is the discount rate that makes the NPV of a project equal to ______. a. the terminal book value of the project's fixed assets b. the project's initial cost c. the payback period d. zero
zero
A project with a cash inflow of $185 followed by a cash outflow of (-$250) one year later will have an IRR of ___ percent. a. -20 b. 20 c. 30 d. 35
35% IRR = (250/180)-1
Which of the following are weaknesses of the payback method? (select all that apply) a. All cash flows are included in the payback period. b. Cash flows received after the payback period are ignored. c. It gives equal weight to all cash flows before the cutoff date.
Cash flows received after the payback period are ignored. It gives equal weight to all cash flows before the cutoff date.
Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period? a. Discounted payback period b. payback rate of return c. Modified internal rate of return
Discounted payback period
A project with an initial cash outflow followed by a cash inflow has an NPV that is positively related to the discount rate. True False
False
True or false: A project with an initial cash outflow followed by a cash inflow has an NPV that is positively related to the discount rate. True False
False
True or false: Investing more money in a project is a guarantee of greater profits. True False
False
When an initial cash outflow is followed by cash inflows, NPV is ______ if the opportunity cost of capital is greater than the IRR. a. zero b. negative c. positive
Negative
For a project with a positive initial cash flow followed by negative cash flows, we should: a. accept if the IRR is greater than R b. accept if the IRR is equal to R c. accept if the IRR is less than R
accept if the IRR is less than R
For a project with a positive initial cash flow followed by negative cash flows, we should: a. accept if the IRR is greater than R b. accept if the IRR is less than R c. accept if the IRR is equal to R
accept if the IRR is less than R
NPV ______ cash flows properly. a. discounts b. compounds
discounts
True or false: The scale of a project is never a concern when using IRR. True False
false
Which type of rationing occurs when a firm can't raise more money from the capital markets? a. linear b. soft c. index d. hard
hard
The payback period can lead to _____________ because it ignores cash flows after the cutoff date. a. an arbitrary discount rate b. correct decisions c. incorrect decisions d. negative cash flows for every project
incorrect decisions
The most important alternative to NPV is the ______ method. a. payback period b. discounted payback period c. average accounting return d. internal rate of return
internal rate of return
Capital rationing requires a company to: a. limit their investments. b. accept all projects with positive NPVs. c. accept all projects with positive IRRs. d. accept all projects with profitability indexes greater than 1.
limit their investments.
A project with an initial cash outflow followed by a cash inflow and then a cash outflow ____. a. never occurs b. may have multiple rates of return c. should never be considered d. will have a single rate of return
may have multiple rates of return
When an initial cash outflow is followed by cash inflows, NPV is ______ if the opportunity cost of capital is greater than the IRR. a. negative b. positive c. zero
negative
In capital budgeting, the net present value is the value of a project's ______ to the company. a. expenses b. future value c. cash flows d. sales
cash flows
Two mutually exclusive projects can be evaluated by: a. comparing the IRR of the two projects b. comparing the NPVs of the two projects c. comparing the IRR to the accounting rate of return
comparing the NPVs of the two projects
The IRR is the _________ that makes the NPV of a project equal to zero. a. project's initial cost b. payback period c. terminal book value of the project's fixed assets d. discount rate
discount rate
What is the profitability index for a project with an initial investment of $30 and subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12 percent? a. 1.91 b. 3.67 c. .52 d. .67
1.91 =(-30+(80/1.12)+(20/1.254))/30
______ cash flows earlier in a project's life are more valuable than higher cash flows later on. a. Higher b. Lower
Higher
The payback method differs from ______ because it evaluates a project by determining the time needed to recoup the initial investment. a. accounting rate of return b. NPV c. internal rate of return
NPV
You must know the discount rate to compute ____, while the discount rate is necessary to apply ___. a. IRR, NPV b. NPV, IRR c. either IRR or NPV; either IRR or NPV
NPV, IRR
Which of the following are true for a project with a negative initial cash flow followed by positive cash flows? (select all that apply) a. Accept if IRR is less than the market rate of financing b. Reject if IRR is less than market rate of financing. c. Accept if NPV is greater than zero.
Reject if IRR is less than market rate of financing. Accept if NPV is greater than zero.
True or false: A project with an initial cash outflow followed by a cash inflow has an NPV that is negatively related to the discount rate. True False
True
True or false: The scale of a project can be an issue with IRR when choosing between mutually exclusive projects. True False
True
The decision rule for a project for which the first cash flow is an inflow and subsequent cash flows are negative states that we should ____ the project when the IRR is ____ than the discount rate. (select all that apply) a. accept; greater b. reject; greater c. accept; less d. reject; less
reject; greater accept; less
The discount rate assigned to a project reflects the ____. (select all that apply) a. risk of the project b. opportunity cost to the investor c. current interest rate set by the Fed d. sunk cost incurred by the investor
risk of the project opportunity cost to the investor
What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years? a. -13.67% b. 23.38% c. 9.70% d. 21.86%
9.70%
