FINA 511 Chp 5
If the IRR is greater than the discount rate, we should ___.
accept the project
The discounted payback period ______ account for time value of money and the payback period ______ account for time value of money.
does; does not
Accept a project if its NPV is ______ zero.
greater
When evaluating a project with an initial cash inflow followed by cash outflows, the NPV will _____ as the discount rate rises.
increase
A way to evaluate mutually exclusive projects is to analyze the ___________ cash flows.
incremental
The problems with scale in the profitability index can be corrected by using ______ analysis.
incremental
The discounted payback period method requires ______ steps than the payback period method.
more
A dollar today is worth ______ a dollar in the future because it can be reinvested.
more than
The IRR is ______ to account for the scale of the project.
unable
True or false: The scale of a project is never a concern when using IRR.
False
The ________________ rule summarizes the information about a project in a single rate of return. This single rate gives people a simple way of discussing the rate of return of projects. (Enter abbreviation only.)
IRR
The discount rate that makes the NPV of an investment equal to zero is:
IRR
What are the advantages of the payback period method for management?
It allows lower level managers to make small decisions effectively. The payback period method is easy to use. The payback period method is ideal for minor projects.
The discounted payback period has which of these weaknesses?
Loss of simplicity as compared to the payback method Exclusion of some cash flows Arbitrary cutoff date
From the perspective of a shareholder, the _____ method will always make the correct decision.
NPV
The dollar difference in value between mutually exclusive projects can be found by calculating the _________ of the incremental cash flows.
NPV
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 percent?
NPV = -$95 + ($107/1.06) = $5.94
The internal rate of return is a function of ____.
a project's cash flows
The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.
accepts
The property of value ______ implies that the contribution of any project to a firm's value is simply the NPV of the project.
additivity
What is the decision-making process for accepting or rejecting projects?
capital budgeting
Which of the following allows management to know if a correct decision was made sooner?
payback method
What is the best tool for ranking projects in the presence of capital rationing?
profitability index
A firm evaluating two mutually exclusive projects can ___.
reject one of the projects accept one of the projects reject both projects
A project with a negative NPV should be?
rejected
The incremental IRR is used to account for the problem of ______ when evaluating project cash flows.
scale
When evaluating mutually exclusive projects, the profitability index has a problem with ___.
scale
The incremental IRR will make ______ decision as the incremental NPV when evaluating mutual exclusive projects.
the same
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.
What is the mix of securities the company uses to finance its assets?
Capital Structure
An investment opportunity has an initial cash inflow of $75,000 and a cash outflow of $30,000 for the following 3 years. What is the IRR decision rule for this investment if his opportunity cost of capital is 11%?
Accept if IRR < 11%, reject otherwise.
Jimbo Bobcat has a book deal. He will receive $50,000 in advance to write a book about his life. It will take two years to write. In order to write it, he'll have to quit his second job, where he earns $26,000 per year, so his cash flow for each of those two years is -$26,000. What is the IRR decision rule for this investment if his opportunity cost of capital is 8%?
Accept if IRR < 8%, reject otherwise. NOTE: This is never the decision rule. In "normal" cash flows, where you spend money before you receive it, the rule is "Accept if IRR > opportunity cost of capital." In this case the NPV profile is upward sloping, because he receives his cash inflow before his cash outflows, so the rule is "Accept if IRR < opportunity cost of capital."
Identify a true statement about a project that has both positive and negative cash flows after first one.
The project should be accepted if the net present value of the project is greater than zero.
The incremental IRR is the rate that causes the incremental cash flows to have:
a zero NPV
According to the basic investment rule for NPV, a firm should ____.
accept a project if the NPV is greater than zero. reject a project if NPV is less than zero. be indifferent towards accepting a project if NPV is equal to zero
Capital ______ is the decision-making process for accepting and rejecting projects.
budgeting
The payback period method allows upper management to evaluate the ___________ abilities of lower management.
decision-making
When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus the ______ rate raised to the nth power.
discount
Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?
discounted payback period
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.
The initial cost is ______ in the cash flows of the NPV function in Excel.
not included
When computing the IRR, the discount rate is:
not needed
The discount rate is often referred to as an ________ cost
opportunity
The __________ method is best suited for decisions on small projects while the ______ method is most appropriate for large, complex projects.
payback; NPV
For "normal" cash flows (the outflows occur before the inflows), the NPV is ______ if the discount rate is less than the IRR, and it is ______ if the discount rate is greater than the IRR.
positive; negative
In capital budgeting, the net ______ is the value of a project to the company.
present value
The NPV _____ the initial investment while the profitability index _____ the initial investment from the present value of all future cash flows.
subtracts; divides
True or false: The crossover rate is the rate at which the NPVs of two projects are equal.
True
Internal rate of return (IRR) must be compared to the ______ rate in order to determine the acceptability of a project.
discount
A project that results in the firm receiving funds first and pays out funds later should not be accepted.
false; Reason: A project that results in the firm receiving funds first and pays out funds later should be accepted when the IRR is less than the discount rate.
If the initial cash flow of a project is _____ and all remaining cash flows are positive there can only be a single IRR.
negative
The discount rate is determined by the ______ of a project.
risk
The discount rate assigned to a project reflects the ____.
risk of the project opportunity cost to the investor
When computing the IRR, alternatives to the guess and check method is to use which of the following:
spreadsheet software, financial calculator
If a project relies on the acceptance or rejection of another project, it is not an __________ project.
independent
When choosing a capital budgeting technique, the ______ may play an important role in the choice.
industry
According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following capital budgeting techniques is least used.
profitability
If a firm has a payback period of 3 years and a project has a payback period of 3.5 years, the project should be: __________?
rejected
What are the steps involved in 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
A project with a cash flow stream with 3 changes in sign can have ______ internal rate(s) of return.
2 or 3
What is the PI for a project with an initial cash outflow of $50 and a present value of all future cash flows of $150?
3
What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?
9.70%
The net present value of a project's cash flows is divided by the ______ to calculate the profitability index.
Initial Investment
What is true about projects with negative cash flow followed by positive cash flow and then another negative?
NPV can be used to make the correct accept/reject decision. The NPV decision rule is "Accept if NPV > 0."
You must know the discount rate to compute ____, while the discount rate is necessary to apply ___.
NPV, IRR
What is true for a project with a negative initial cash flow followed by positive cash flows?
Reject if IRR is less than market rate of financing. Accept if NPV is greater than zero.
A small project has cash flows of -$10 and $45, and a large project has cash flows of -$30 and $70. What is the incremental NPV at a discount rate of 10%?
The answer is the NPV of the difference in cash flows between the two projects. In this case, the time 0 cash flow difference is (-$30-(-$10)=-$20) and the second cash flow difference is $70-$45 = 25. NPV = -$20+ (25/1.10) = $2.73. You can also take the difference in the NPVs of the two projects
What does value additivity mean for a firm?
The value of a firm is simply the combined value of the firm's projects, divisions, and entities owned by the firm. The NPV values of individual projects can be added together.
True or false: A project with an initial cash outflow followed by a cash inflow has an NPV that is negatively related to the discount rate.
True
True or false: The MIRR method eliminates multiple IRR problem and it is an alternative to the NPV method.
True
The IRR rule summarizes the information about the project in:
a single rate of return
For a project with a positive initial cash flow followed by negative cash flows, we should ___.
accept if the IRR is less than R
The value of a firm is simply the combined value of the firm's projects, divisions, and entities owned by the firm is due to the property called value ________.
additivity
Net present value is the ______ between the sum of the present value of all future cash flows and the ______ cost.
difference; initial
Two mutually exclusive projects can be correctly evaluated by ____.
examining the NPV of the incremental cash flows comparing the NPVs of the two projects comparing the incremental IRR to the discount rate
______ cash flows earlier in a project's life are more valuable than ______ cash flows later on.
higher; lower higher; higher
The most important alternative to NPV is the ______ method.
initial rate of return
A dollar received one year from today has ______ value than a dollar received today.
less
The PI rule for an independent project is to decline the project if the PI is _____ than 1.
less
The payback method works well for companies with ______ cash.
limited
The profitability index is preferred to the NPV rule when funds are:
limited
A project with an initial cash outflow followed by a cash inflow and then a cash outflow ____.
may have multiple rates of return
Higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on.
more
Projects with cash inflow and outflow changes over time may have ______ IRR(s).
multiple
When cash flows are conventional, NPV is ______ if the discount rate is above the IRR.
negative
One of the flaws of the payback period method is that cash flows after the cutoff date are ___.
not considered for analysis
The ______ method is ideal for companies with limited funds that have a need for a quick turn-around of their capital.
payback
This capital budgeting method allows lower management to make smaller, everyday financial decisions easily is:
payback method
What causes issues when comparing two mutually exclusive projects using IRR?
the scale and timing of cash flows
With mutually exclusive projects, the profitability index suffers from the same problem that the IRR rule does in that it fails to consider ____.
the size or scale of projects
The IRR ______ to distinguish between investing or financing.
unable
The three attributes of NPV are that it:
uses cash flows. uses all the cash flows of a project. discounts the cash flows properly.