FIN 3403 (FSU) Exam 2

Which of the following are mutually exclusive investments? - 2 different choices for the assembly lines that will make the same product - a restaurant or gas station on the same piece of land - a restaurant or gas station on opposite corners - Two computer systems - one for the administrative office and one for the security cameras.

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

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 a _________ or financial sense. - Accounting, economic - economic, economic - Accounting, accounting - Economic, accounting

- Accounting, economic

Advantages of AAR? - Relies on cash flows, rather than accounting values - Is easy to compute - Incorporates time value of money - Needed info is always available - Has an objective benchmark

- Is easy to compute - Needed info is always available

The discounted payback period has which of these weaknesses? - Lack of a decision rule - Loss of simplicity - Arbitrary cutoff date - Exclusion of some cash flows

- Loss of simplicity - Arbitrary cutoff date - Exclusion of some cash flows

If a project has multiple IRR, which of the following should be used? - IRR - NPV - MIRR

- NPV - MIRR

This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively. - NPV - IRR - Payback method - AAR

- Payback method

According to the AAR rule, a project is acceptable if its AAR exceeds: - IRR - required RoR - NPV - a target AAR

- a target AAR

When cash flows are conventional, NPV is __________. - negative for discount rates above the IRR - positive for discount rates below the IRR - equal to 0 when the discount rate equals the IRR - Positive for discount rates above the IRR

- negative for discount rates above the IRR - positive for discount rates below the IRR - equal to 0 when the discount rate equals the IRR

Steps of the discounted payback period

1. Discount the cash flows using the discount rate 2. Add the discounted cash flows 3. Accept if the discounted payback period is less than some pre-specified number of years

Weakness of Discounted payback period

1. May reject positive NPV investment 2. requires an arbitrary cutoff point 3. ignores cash flows beyond the cutoff date 4. biased against long-term projects, such as research and development, and new projects 5. loss of simplicity as compared to the payback method

Saxon Company is considering a project that will generate NI 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 this cost will be depreciated to $0 in the 3 years of the investment. What is their AAR?

20.48%

Excel NPV

=NPV()

The IRR is a function of

A project's cash flows

Whenever cash inflows __________ cash outflows, the NPV profile is _________ sloping; the IRR will give the wrong decision.

Exceed, upward

T or F: Investing more money is a guarantee of greater profits

False

T or F: the MIRR function eliminates multiple IRRs and should replace NPV

False

T or F: The discounted payback rule has an objective benchmark to use in decision-making.

False, the rule is somewhat arbitrary - corporate financial managers determine the number of years to beat.

How does timing and size affect the payback method?

an increase in the size of the first cash flow will decrease the payback period, all else held constant

NPV accounts for the size of the project and thus mitigates the effects of __________. - growth - scale - timing - risk

scale

T or F: the crossover rate is the rate at which the NPVs of two projects are equal.

True

T or F: 2 challenges with the IRR approach when comparing 2 mutually exclusive projects are scale and cash flow timing.

True, if either of these issues are present, IRR may disagree with NPV over which project should be chosen.

The amount of time needed for the cash flows from an investment to pay for its initial cost is the ___________. - Payback period - IRR - NPV period - discounted payback period

- Payback period

The profitability index is calculated by dividing the PV of the ________ cash flows by the initial investment - positive - future - previous

- future

IRR is popular because - it gives RoR rather than a $ value - it gives a $ value rather than RoR - easier to compute than NPV - gives the correct answer more often than NPV

- it gives RoR rather than a $ value

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 - suggests rejecting

- suggests accepting

Advantages of Discounted payback period

1. includes time value of money 2. easy to understand 3. does not accept negative estimated NPV investments 4. biased towards liquidity

The PI rule for an independent project is to _________ the project if the PI is greater than 1. - Delay - Reject - Accept

Accept

Capital ______ is the decision making process for accepting and rejecting projects. - spending - relevance - budgeting - structure

Budgeting

The most important alternative to NPV is the ________ method. - IRR - AAR - Discounted payback period - payback period

IRR

Project A's NPV profile crosses the vertical axis at $230,000. Project B's NPV crosses the vertical axis at $150,000. If A and B have conventional cash flows, are mutually exclusive and the NPV profiles cross at 15% (NPV is positive), which of the projects has a higher IRR?

Project B