Chapter 9

Saxon co will generate income of $50,000 in year 1, $75,000 in year 2, and $90,000 in year 3. The cost of the project is $700,000, and the cost will be depreciated to zero in 3 years of the investment. what is their average accounting return?

1. avg net income= 71,666.67 2. avg book value= 700,000/2=350,000 3. 20.48%

steps involved in the discounted payback period in order

1. discount cash flows using the discount rate 2. add the discounted cash flows 3. accept if the discounted payback period is less than some prespecified number of years

When cash flows are conventional, NPV is ______ if the discount rate is above the IRR.

Negative

The PV of all Cf's (after 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

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

What is the payback period for the following set of cash flows? Year Cash Flow 0 -$5,700 1 1,350 2 1,550 3 1,950 4 1,450

=3.59 to find the .59: 850 (remainder) /1450

IRR continues to be very popular in practice bc:

It gives rate or return rather than dollar value

the discounted payback rule has an objective benchmark to use in decision making.

False

The IRR rule can lead to bad decisions when __________ or _________.

-Cf's are not conventional -Projects are mutually exclusive

How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the projects lifetime.

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

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 NPV's are positive), which of the projects has a higher internal rate of return?

Beta: The 2 projects have a crossover point above the horizontal axis, and Alpha crosses the vertical axis above beta. Because the cash flows are conventional, their NPV profiles cross only once, so alpha must have a steeper NPV profile, but beta must have a higher IRR.

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 ______ or financial sense.

accounting, economic

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

solve for I/Y =9.7%

In which of the following scenarios would IRR always recommend the wrong decision?

start CF= 1000 End CF= -2000

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

A target average accounting return

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

IRR

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

PV

This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively.

Payback method

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

Payback period

The MIRR function eliminates multiple IRRs and should replace NPV

false

If IRR is greater than the _________ we should accept the project.

required return

which are mutually exclusive investments?

-A restaurant or gas station on the same piece of land -2 Different choices for the assembly lines that will make the same product

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

independent

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 NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%?

1. 107 * ((1-(1/1.06)^1)/.06) = 100.94 2. 100.94-95= 5.94

What are advantages of AAR?

-Easy to compute -Info always available

The discounted payback period has which of these weaknesses.

-Exclusion of some cash flows -Loss of simplicity as compared to payback method -Arbitrary cutoff date

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

-NPV -MIRR

When cash flows are conventional, NPV is _________.

-Negative for discount rates above the IRR -Equal to 0 when the discount rate = IRR -Positive for discount rates below the IRR

the 3 attributes of NPV are that it:

-Uses cash flows -Uses all the cash flows of a project -Discounts the cash flows properly

An investment project has annual cash inflows of $3,800, $4,700, $5,900, and $5,100, for the next four years, respectively. The discount rate is 14 percent. What is the discounted payback period for these cash flows if the initial cost is $6,500?

1. calculate pv@ 14%: inflow/1.14^t 2. subtract from initial investment until you find how many years

A firm evaluates all of its projects by applying the NPV decision rule. A project under consideration has the following cash flows: Year Cash Flow 0 -$27,100 1 11,100 2 14,100 3 10,100 What is the NPV for the project if the required return is 12 percent?

1. find pv 2. npv= pv- initial cost =1240.13; accept bc positive