chapter 9- FINA

Net present value (NPV) is a sophisticated capital budgeting technique; found by adding a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital.

false

List steps of the capital budgeting process

1) Proposal generation 2) review and analysis 3) decision making 4) implementation 5) follow-up

Match those following concepts for first principle

1) The investment decision- invest in assets that earn a return greater than the minimum acceptable hurdle rate 2) The financing decision- find the right kind of debt for your firm and the right mix of debt and equity to fund your operations 3) The dividend decision- if you cant find investments that make your minimum acceptable rate, return on cash to owners of your business

What are advantages of payback period?

1) Does not require discount rate 2)Does not require complex calculations 3) Measures Liquidity, Easy to communicate

The disadvantages of the IRR period method is that it

1) Only works for normal cash flows 2)Requires a lot of data (estimates of all CFs) 3) Requires complex calculations

Which of the following statements is correct for a project with a negative NPV?

The cost of capital exceeds the IRR

You are considering the following three mutually exclusive projects. The required rate of return for all three projects is 14%. Year You are considering the following three mutually exclusive projects. The required rate of return for all three projects is 14%. Year year 0 A)$ (1,000) B)$(5,000) C) $(50,000) year 1 A)$ 300 B) $ 1,700 C) $ 0 year 2 A) $300 B) $ 1,700 C) $15,000 year 3 A) $ 600 B)$1,700 C)$ 28,500 year 4 A)$300 B) $1,700 C) $ 33,000 What is the IRR of the best project? % terms to 2 decimal places w/o % sign at is the IRR of the best project? % terms to 2 decimal places w/o % sign

CF A=17.4932 CF B=13.75 CF C=14.2286 Compute for IRR =14.23

What is the profitability index for Project A with a cost of capital of 8%?

CF for project A= NPV 1 Fo 8% 1/yr (NPV+cf0)/cfo=1.33

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $900 at the end of the next three years and then $1400 per year for the three years after that. If the discount rate is 8% then what is the PI? Answer in % format

CF0= -5,000 C01=900 FO1=3 CO2=1400 FO2=3 NPVI=8 enter down arrow Cpt NPV= 183.48 PI=(183.48+5,000)/5,000PI=1.03669 PI=103.67%

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $466 at the end of the next three years and then $1,779 per year for the three years after that. If the discount rate is 5.02% then what is the NPV?

CFO=-5,000 CO1=466 FO1=3 CO2=1779 FO2=3 EnterNPVI=5.02 Enter Down arrow CPTNPV= 449.5986

It should not usually be clear whether we are describing independent or mutually exclusive projects in the following chapters because when we only describe one project then it can be assumed to be independent

False

NPV assumes intermediate cash flows are reinvested at the cost of equity, while IRR assumes that they are reinvested at the cost of capital

False

Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function

Mutually exclusive

The "gold standard" of investment criteria refers to:

NPV

. What is the NPV of a project that costs $100,000 and returns $50,000 annually for three years if the opportunity cost of capital is 14%?

NPV = PV of inflows - required investment=50,000[1/.14 - 1/.14(1.14)^3] - 100,000=50,000[7.1429-4.8212]=50,000[2.32 7]-100,000 =16,085

What is the internal rate of return for a project with an initial outlay of $10,000 that is expected to generate cash flows of $2,000 per year for 6 years?

PV=-10,000FV=0PMT=2,000N=6CPT I/Y=5.47

The multiple IRR problem occurs when the signs of a project's cash flows change more than once.

True

Capital rationing may be beneficial to a firm if it:

Weeds out proposals with NPVs that have been overstated

Compute the payback period for a project that requires an initial outlay of $231,091 that is expected to generate $40,000 per year for 9 years.

initial outlay=-231091 40,000 for 9 years -231091+40,000= year 1+40,000... year 4 year 4/40,000=1.78 1.78+4=5.78

The primary purpose of capital budgeting is to:

maximize the shareholders' wealth.

The Internal Rate of Return (IRR) is the discount rate that equates the NPV of an investment opportunity with $0

true