Chapter 9 learn

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

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:

0

The three attributes of NPV are that it:

1. uses all the cash flows of a project 2. uses cash flows 3. discounts the cash flows properly

Which of the following are mutually exclusive investments?

A restaurant or a gas station on the same piece of land. Two different choices for the assembly lines that will make the same product.

Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?

Discounted payback period

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

MIRR NPV

According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following two capital budgeting methods are most used by firms in the United States?

Net present value Internal rate of return

According to Graham and Harvey's 1999 survey of 392 CFOs, in addition to IRR and NPV, which were the two most widely used techniques, over half of the respondents always, or almost always, used which of the following methods?

Payback method

Using the payback period rule will bias toward accepting which type of investment?

Short-term investment

Which of the following are weaknesses of the payback method?

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

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

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

True or false: Based on the discounted payback rule, an investment is acceptable if its discounted payback is less than some prespecified number of years.

True

True or false: Some projects, such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return.

True

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

a target average accounting return

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

accepted

The _____ rate is the rate at which the NPVs of two projects are equal.

crossover

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

sum of the cash flows of the project

Based on the average accounting return rule, a project is acceptable if its average accounting return exceeds a ____ average accounting return.

target

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

Payback method

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

Based on the average _____ return rule, a project is acceptable if its average _____ return exceeds a target average _____ return.

all accounting

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

arbitrary

The AAR is calculated by taking the average net income and dividing it by the average ______ value.

book

According to the basic IRR rule, we should _____.

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

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

required return

The ____________ method differs from NPV because it evaluates a project by determining the time needed to recoup the initial investment.

payback

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

payback

The discounted payback is the time it takes to break even in an ______ or financial sense.

economic

A situation in which taking one investment prevents the taking of another is called a mutually _____ investment decision.

exclusive

True or false: The MIRR function eliminates multiple IRRs and should replace NPV.

false

Net _____ value is a measure of how much value is created or added today by undertaking an investment.

present

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

present value

The payback period method allows lower management to make _____ (smaller/larger), everyday financial decisions effectively.

smaller

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

True or false: IRR approach may lead to incorrect decisions in comparison of two mutually exclusive projects.

true

True or false: The crossover rate is the rate at which the NPVs of two projects are equal.

true

The IRR is the discount rate that makes the NPV of a project equal to ______.

zero

Capital ______ is the decision-making process for accepting and rejecting projects.

budgeting

_____ budgeting is the decision-making process for accepting and rejecting projects.

capital

The IRR rule can lead to bad decisions when _____ or _____.

cash flows are not conventional projects are mutually exclusive

Based on the _____ payback rule, an investment is acceptable if its _____ payback is less than some prespecified number of years.

discount, discount

NPV ______ cash flows properly.

discounts

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

future

The present value of all cash flows (after the initial investment) is divided by the ______ to calculate the profitability index.

initial investment

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

internal rate of return

With nonconventional cash flows, there is a possibility that more than one discount rate will make the NPV of an investment zero. This is called the _____ rates of return problem.

multiple

By ignoring time value, the payback period rule may incorrectly accept projects with a _____ (positive/negative) NPV.

negative

The IRR rule can lead to bad decisions when cash flows are _____ or projects are mutually exclusive.

not conventional

For a project with conventional cash flows, 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