FINC 318 Chp 8: Net Present Value SmartBook 2.0

Which of the following are reasons why IRR continues to be used in practice?

>The IRR of a proposal can be calculated without knowing the appropriate discount rate. >It is easier to communicate information about a proposal with an IRR. >Businesspeople prefer to talk about rates of return.

Which of the following are methods of calculating the MIRR of a project?

>The Reinvestment Approach >The Combination Approach >The Discounting Approach

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 present problems when using the IRR method?

>non-conventional cash flows >mutually exclusive projects

True or false: An advantage of the AAR is that it is based on book values, not market values.

false

True or false: The PI always results in the correct decision 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 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

A(n) ______ project does not rely on the acceptance or rejection of another project.

independent

The present value of the future cash inflows are divided by the ______ to calculate the profitability index.

initial investment

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 _______________.

mutually exclusive

According to the basic IRR rule, we should:

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

Which of the following is a disadvantage of the payback period rule?

requires an arbitrary cutoff point

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 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 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

0

The spreadsheet function for calculating net present value is ______.

=NPV(rate,CF1, ..., CFn) + CF0

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

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 US and Canada?

>IRR >NPV

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 ideal for minor projects. >The payback period method is easy to use.

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

>NPV >MIRR

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.

The internal rate of return is a function of ____.

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 PI rule for an independent project is to ______ the project if the PI is greater than 1.

accept

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

acceptable

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

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

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

arbitrary

The Average Accounting Return is defined as:

average net income/average book value

The Profitability Index is also called the __________ ratio.

cost-benefit

Which of the following is a disadvantage of the Profitability Index?

it cannot rank mutually exclusive projects

The payback period can lead to foolish decisions if it is used too literally because:

it ignores cash flows after the cutoff date

The discounted cash flow valuation shows that higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on.

more

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

net present value

_______ is a measure of how much value is created or added by undertaking an investment.

net present value

The __________ is best suited for decisions on relatively small, minor projects while ______ is more appropriate for large complex projects

payback period; NPV

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

Internal rate of return (IRR) must be compared to the ________ in order to determine the acceptability of a project.

required return

When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus ______ rate raised to the nth power.

the discount rate

True or false: A disadvantage of the AAR is that it does not take into account the time value of money.

true

True or false: A project with non-conventional cash flows will produce two or more IRRs.

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