Chapter 8 Business Finance

Which of the following is a disadvantage of the payback period rule?

Requires an arbitrary cutoff point

The internal rate of return is a function of ____.

a project's cash flows

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

2. False

Which of the following are reasons why IRR continues to be used in practice?

Businesspeople prefer to talk about rates of return. The IRR of a proposal can be calculated without knowing the appropriate discount rate. It is easier to communicate information about a proposal with an IRR.

The Combination MIRR method is used by the Excel MIRR function and uses which of the following?

Discounting all cash outflows to time 0 Compounding cash inflows to the end of the project A reinvestment rate for compounding A financing rate for discounting

An increase in the size of the first cash inflow will decrease the payback period, all else held constant.

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

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

Net Present Value

Which of the following are methods of calculating the MIRR of a project?

The Combination Approach The Reinvestment Approach The Discounting Approach

What are the advantages of the payback period method for management?

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 PI rule for an independent project is to ______ the project if the PI is greater than 1.

accept

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

accepted

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

arbitrary

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

future

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

independent

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

initial cost

The present value of the future cash inflows are divided by the ______ to calculate the profitability index.

initial investment

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

net present value

According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the US and Canada?

net present value internal rate of return

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

payback

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

payback period; NPV

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

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

required return

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

accepts

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

3. True or false: A project with non-conventional cash flows will produce two or more IRRs.

3. True

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

4. False

5. 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.

5. False

Which of the following present problems when using the IRR method?

mutually exclusive projects non-conventional cash flows

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.

The basic NPV investment rule is:

-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 -Reject a project if its NPV is less than zero

1. 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.

1. True

6. True or false: According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), the internal rate of return and the NPV are the two most popular capital budgeting methods used by firms in the US and Canada.

6. True

In general, NPV is ____.

Equal to zero when the discount rate equals the IRR Negative for Discount Rates above the IRR Positive for Discount Rates below the IRR

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.