Financial Analysis - USCA MBA - CH5 SB
What is the decision-making process for accepting or rejecting projects?
capital budgeting
The payback period method allows upper management to evaluate the ______ abilities of lower management.
decision-making
Net present value is the ______ between the sum of the present value of all future cash flows and the ______ cost.
difference; initial
Internal rate of return (IRR) must be compared to the ______ rate in order to determine the acceptability of a project.
discount
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
We can evaluate two mutually exclusive projects by comparing the incremental IRR to the ______.
discount rate
Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?
discounted payback period
NPV ____ cash flows properly
discounts
NPV ______ cash flows properly.
discounts
The discounted payback period ______ account for the time value of money, and the payback period ______ account for the time value of money.
does; does not
Accept a project if its NPV is ______ zero.
greater than
According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following capital budgeting techniques is least used?
profitability index
Which of the following is the best tool for ranking projects in the presence of capital rationing?
profitability index
A project with a negative NPV should be ______.
rejected
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
The discount rate is determined by the ______ of a project.
risk
When evaluating mutually exclusive projects, the profitability index has a problem with ______.
scale
When computing the IRR, alternatives to the guess and check method is to use which of the following ______.
spreadsheet software financial calculator
The NPV ______ the initial investment, while the profitability index ______ the initial investment from the present value of all future cash flows.
subtracts; divides
In capital budgeting, the net ______ is the value of a project to the company.
Present Value
The three attributes of NPV are that it ______. - doesn't rely on a discount rate - discounts the cash flows properly - uses cash flows - uses all the cash flows of a project
- discounts the cash flows properly - uses cash flows - uses all the cash flows of a project
Two mutually exclusive projects can be correctly evaluated by ______.
- examining the NPV of the incremental cash flows - comparing the incremental IRR to the discount rate - comparing the NPVs of the two projects
In general, NPV is Blank______. - positive for discount rates above the IRR - positive for discount rates below the IRR - equal to zero when the discount rate equals the IRR - negative for discount rates above the IRR
- positive for discount rates below the IRR - equal to zero when the discount rate equals the IRR - negative for discount rates above the IRR
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%?
$2.73 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 is the NPV of a project with an initial investment of $95, a cash flow in 1 year of $107, and a discount rate of 6 percent?
$5.94 NPV = −$95 + ($107/1.06) = $5.94.
Which of the following are true for a project with a negative initial cash flow followed by positive cash flows?
- Reject if IRR is less than the market rate of financing. - Accept if NPV is greater than zero.
What does value additivity mean for a firm? - The NPV values of individual projects can be added together. - A new project will always add value to a firm. - The value of a firm is simply the combined value of the firm's projects, divisions, and entities owned by the firm. - All projects with positive NPVs will add an equal amount of value to a firm.
- The NPV values of individual projects can be added together. - The value of a firm is simply the combined value of the firm's projects, divisions, and entities owned by the firm.
What are the advantages of the payback period method for management? - The payback period adjusts for the discount rate. - The payback period method is ideal for minor projects. - 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 minor projects. - The payback period method is easy to use. - It allows lower level managers to make small decisions effectively.
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. - A new project will always add value to a firm. - The NPV values of individual projects can be added together. - All projects with positive NPVs will add an equal amount of value to 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.
According to the basic investment rule for NPV, a firm should ______. - be indifferent toward accepting a project if NPV is equal to zero - accept a project if the NPV is greater than zero - reject a project if NPV is less than zero - accept a project if the discount rate is greater than zero
- be indifferent toward accepting a project if NPV is equal to zero - accept a project if the NPV is greater than zero - reject a project if NPV is less than zero
According to the basic investment rule for NPV, a firm should ______. - reject a project if NPV is less than zero - accept a project if the discount rate is greater than zero - be indifferent toward accepting a project if NPV is equal to zero - accept a project if the NPV is greater than zero
- reject a project if NPV is less than zero - be indifferent toward accepting a project if NPV is equal to zero - accept a project if the NPV is greater than zero
A firm evaluating two mutually exclusive projects can ______.
- reject one of the projects - accept one of the projects - reject both projects
Which of the following cause issues when comparing two mutually exclusive projects using IRR?
- timing of cash flows - scale of cash flows
A project with a cash flow stream with three changes in sign can have ______ internal rate(s) of return.
1, 2, or 3
Arrange the steps involved in the discounted payback period in order starting with the first step.
1. Discount the cash flows using the discount rate 2. Add the discounted cash flows 3. Accept if the discounted payback period is lass than some pre-specified number of years
What is the PI for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12 percent?
2.91 PI = [($80/1.12)+($20/1.122)]/$30 = 2.91.
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 IRR?
25% −$30 − (−$10) + ($70−45)/(1+IRR) = $0. →IRR = ($70−45)/($30−10) − 1 = 25%.
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%
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 2 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 2 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. because initial CF is positive and subsequent CFs are negative
A project that results in the firm receiving funds first and pays out funds later should not be accepted.
False
True or false: A firm evaluating two mutually exclusive projects can accept both projects.
False
True or false: The scale of a project is never a concern when using IRR.
False
______ cash flows earlier in a project's life are more valuable than ______ cash flows later on.
Higher; lower Higher; higher
The ______ (IRR/NPV) 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
Which of the following techniques eliminates the multiple IRR problem?
MIRR
You must know the discount rate to compute ______, while the discount rate is necessary to apply ______.
NPV; IRR
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 and Canada?
Net present value Internal rate of return
Identify a true statement about a project that has both positive and negative cash flows after the first one.
The project should be accepted if the net present value of the project is greater than zero.
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: 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
True or false: The MIRR method eliminates multiple IRR problem and it is an alternative to the NPV method.
True
True or false: The crossover rate is the rate at which the NPVs of two projects are equal.
True
True or false: The property of value additivity implies that the contribution of any project to a firm's value is simply the NPV of the project.
True
True or false: Two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing.
True
The internal rate of return is a function of ______.
a project's cash flows
The IRR rule summarizes the information about the project in ______.
a single rate of return
The incremental IRR is the rate that causes the incremental cash flows to have ______.
a zero NPV
The PI rule for an independent project is to ______ the project if the PI is greater than 1.
accept
If the IRR is greater than the discount rate, we should ______.
accept the project
According to the basic IRR rule, we should ______ a project if the IRR is ______ than the discount rate.
accept; greater or reject; less
A project with a positive NPV should be ______.
accepted
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
The value of a firm is simply the combined value of the firm's projects, divisions, and entities owned by the firm. This property is called value ______.
additivity
One of the weaknesses of the payback period is that the cutoff date is a(n) ______ standard.
arbitrary
Capital ______ is the decision-making process for accepting and rejecting projects.
budgeting
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
Two mutually exclusive projects can be correctly evaluated by comparing the ______ IRR to the discount rate.
incremental
Using ______ cash flows corrects the problems of scale in the profitability index.
incremental
The net present value of a project's cash flows is divided by the ______ to calculate the profitability index.
initial investment
IRR refers to ______.
internal rate of return
The most important alternative to NPV is the ______ method.
internal rate of return
The IRR ______ to distinguish between investing or financing.
is unable
A dollar received 1 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
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
Projects with cash inflow and outflow change 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 in the analysis
When computing the IRR, the discount rate is ______.
not needed
The discount rate is often referred to as an ______ cost.
opportunity
The ______ method is ideal for companies with limited funds that have a need for a quick turnaround of their capital.
payback
This capital budgeting method allows lower management to make smaller, everyday financial decisions easily is ______.
payback method
Which of the following allows management to know if a correct decision was made sooner?
payback method
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 is ______ to account for the scale of the project.
unable