Financial management ch 8
Which of the following is a disadvantage of the profitability index?
It cannot rank mutually exclusive projects.
Which of the following are reasons why IRR continues to be used in practice?
It is easier to communicate information about a proposal with an IRR. Businesspeople prefer to talk about rates of return. The IRR of a proposal can be calculated without knowing the appropriate discount rate.
The profitability index is calculated by dividing the PV of the Blank______ cash inflows by the initial investment.
future
Capital budgeting is probably the most important of the three key areas of concern to the financial manager because Blank______.
it defines the business of the firm
The payback period can lead to foolish decisions if it is used too literally because:
it ignores cash flows after the cutoff date.
The NPV is Blank______ if the required return is less than the IRR, and it is Blank______ if the required return is greater than the IRR.
positive; negative
If the IRR is greater than the Blank______, we should accept the project.
required return
The IRR is the discount rate that makes NPV equal to Blank______.
zero
The multiple rates of return problem is the possibility that more than one discount rate may make the net present value of an investment equal to .
zero
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
The discounted cash flow valuation shows that higher cash flows earlier in a project's life are Blank______ valuable than higher cash flows later on.
more
Based on the average accounting return rule, a project is Blank______ if its average accounting return exceeds a target average accounting return.
acceptable
A project should be Blank______ if its NPV is greater than zero.
accepted
The payback period rule Blank______ a project if it has a payback period that is less than or equal to a particular cutoff date.
accepts
One of the weaknesses of the payback period is that the cutoff date is a(n) Blank______ standard.
arbitrary
The average accounting return is defined as:
average net income/average book value
The profitability index is also called the Blank______ ratio.
benefit-cost
Capital Blank______ is the decision-making process for accepting and rejecting projects.
budgeting
A(n) Blank______ project does not rely on the acceptance or rejection of another project.
independent
The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its Blank______.
initial cost
If a firm is evaluating two possible projects, both of which require the use of the same production facilities, and taking one project means that we cannot take the other, these projects would be considered Blank______.
mutually exclusive
Which of the following present problems when using the IRR method?
mutually exclusive projects nonconventional cash flows
In capital budgeting, Blank______ determines the dollar value of a project to the company.
net present value
According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the United States and Canada?
net present value internal rate of return
The Blank______ method evaluates a project by determining the time needed to recoup the initial investment.
payback
The Blank______ is best suited for decisions on relatively small, minor projects, while Blank______ is more appropriate for large, complex projects.
payback period; NPV
According to the basic IRR rule, we should:
reject a project if the IRR is less than the required return
Internal rate of return (IRR) must be compared to the Blank______ in order to determine the acceptability of a project.
required return
Which of the following is a disadvantage of the payback period rule?
requires an arbitrary cutoff point
When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus Blank______ rate raised to the nth power.
the discount
Which of the following are methods of calculating the MIRR of a project?
the reinvestment approach the discounting approach the combination approach
True or false: A disadvantage of the AAR is that it does not take into account the time value of money.
true
The spreadsheet function for calculating net present value is Blank______.
=NPV(rate,CF1, ..., CFn) + CF0
If a project has multiple internal rates of return, which of the following methods should be used?
NPV MIRR
______ is a measure of how much value is created or added by undertaking an investment.
Net present value
True or false: An advantage of the AAR is that it is based on book values, not market values.
False
True or false: The IRR is easy to use because you only need to know the appropriate discount rate.
False
True or false: The PI always results in correct decisions in comparisons of mutually exclusive investments.
False
True or false: The discounted cash flow (DCF) valuation estimates future value as the difference between the market price and the cost of the investment.
False
True or false: The payback period takes into consideration the time value of money.
False
True or false: The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its future cost.
False
True or false: The profitability index rule for an independent project states that, if a project has a positive NPV, then the present value of the future cash flows must be smaller than the initial investment.
False
True or false: There is only one way to calculate the modified IRR.
False
What is the primary concern of the payback period rule?
How long it takes to recover the initial investment
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.
Specifying variables in the Excel NPV function differs from the manner in which they are entered in a financial calculator in which of the following ways?
The range of cash flows specified in Excel begins with Cashflow 1, not Cashflow 0. The discount rate in Excel is entered as a decimal, or as a percentage with a percent sign. With the Excel NPV function, Cashflow 0 must be handled outside the NPV function. The Excel NPV function is actually a PV function.
Which of the following are weaknesses of the payback method?
Time value of money principles is ignored. Cash flows received after the payback period are ignored. The cutoff date is arbitrary.
True or false: A project with nonconventional cash flows will produce two or more IRRs.
True
True or false: According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), the internal rate of return and the NPV are the two most popular capital budgeting methods used by firms in the United States and Canada.
True
True or false: Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return.
True
True or false: The measure of average accounting profit is in the numerator of the average accounting return (AAR) formula.
True
True or false: When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus the discount rate raised to the nth power.
True
The combination MIRR method is used by the Excel MIRR function and uses which of the following?
a financing rate for discounting a reinvestment rate for compounding compounding cash inflows to the end of the project discounting all cash outflows to time 0
The internal rate of return is a function of Blank______.
a project's cash flows
According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:
a target average accounting return.
The profitability index (PI) rule for an independent project is to Blank______ the project if the PI is greater than 1.
accept