SB 13
What value should be used to discount the cash flow that occurs in time period N when computing a net present value?
(1 + i)^N
To solve for the IRR statistic, set NPV equal to
0
Which of these project PI's indicate a reject decision? Select all that apply.
0 0.9
What does a positive net present value (NPV) represent?
A project more than covers all of its necessary costs
Which one of these statements is correct?
A zero NPV indicates a project's discounted cash inflows equal the discounted cash outflows.
Why is the NPV benchmark zero?
A zero NPV means a project can cover its costs as well as its required return.
You are considering two mutually exclusive projects, A and B. Which of these options do you have? Select all that apply.
Accept B, reject A Reject both A and B Accept A, reject B
Which one of these correctly states the accept rule for the payback statistic?
Accept any project that pays back within the maximum allowable period
What is the profitability index (PI) accept rule?
Accept when PI > or = 1
What is the accept decision rule for discounted payback (DPB)?
Accept when the DPB is equal to or less than the maximum allowable period
You are considering three mutually exclusive projects. Which one of these options is immediately eliminated as a possible decision?
Accepting more than one project
How are non-normal cash flows modified for MIRR purposes? Select all that apply.
All cash outflows are moved to time zero. All cash inflows are moved to the end of the project
Which of these requires modification so MIRR can be applied to non-normal cash flows?
All cash outflows that occur at any time other than time zero
Rate-based decision statistics are popular because managers like to compare the expected rate of return to which one of these?
Borrowing rates Reason: Managers like to compare the expected rate of return to borrowing rates quoted by lenders
Why is the IRR formula set equal to zero?
By definition, IRR is the interest rate that makes the summation of the present values of all the cash flows equal zero.
Which of these apply to the payback method? Select all that apply.
Considers the total dollar cost of the initial investment Easy to compute
How can the profitability index (PI) be defined?
Dollar return per dollar invested
Given a set of normal cash flows, which shape does the NPV profile have?
Downward-sloping
Rate-based decision statistics provide a rate of return based on which one of these?
Each $1 of investment
Which one of these is the primary advantage of the payback method?
Easy to compute
What type of return are firms seeking when considering a real asset project?
Economic profit
True or false: The benchmark value for net present value (NPV) is 1.
False
A project has cash flows of -$400, $200, $200, -$100, $300, and -$50. How many x-axis intersection points will the NPV profile for this project have?
Four Reason: There are four sign changes, so there will be four intersection points and four IRRs.
When does the IRR decision rule indicate rejection for projects with normal cash flows?
IRR < Required return
Based on IRR, when should an independent project with normal cash flows be accepted?
IRR > or = to the cost of capital
Which of these statements represent differences between the discounted payback (DPB) and payback (PB)? Select all that apply.
Length of maximum allowable period Ease of computation Consideration of the time value of money
Which one of these is a weakness of MIRR?
MIRR ignores project sizes.
Which one of these is an advantage of the net present value (NPV) method?
NPV can be used with both independent and mutually exclusive projects.
What is the definition of net present value (NPV)
NPV is a technique that generates a decision rule based on the total discounted values of a project's lifetime cash flows.
The profitability index (PI) is most closely associated with which other decision method?
Net present value (NPV)
Why should the internal rate of return (IRR) not be used as the decision technique for projects with non-normal cash flows?
Non-normal cash flows produce multiple IRRs so the accept/reject decision is questionable.
What does the term "mutually exclusive projects" imply?
Only one of the two or more projects can be accepted.
A project has been assigned a maximum allowable payback period of 2.5 years. How is the reject decision expressed for this project?
PB > 2.5 years
What do you know for certain about PI if the NPV is positive and non-zero?
PI > 1
Which one of these methods best applies to a project when a firm is facing a time constraint?
Payback (PB)
If a firm is concerned about capital constraints and needs to prioritize its projects, which budgeting technique should the firm use?
Profitability index (PI)
What should the decision be if the maximum allowable discount period is less than the discounted payback (DPB) statistic?
Reject the project
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8 percent. Should the project be accepted or rejected according to discounted payback (DPB) if the maximum allowable period is two years?
Rejected; DPB = 2.29 years Reason: DCF1 = $700/1.08 = $648.15; DCF2 = $1,100/1.08^2 = $943.07; DCF3 = $900/1.08^3 = $714.45; DPB = 2 + ($1,800 - $648.15 - $943.07)/$714.45 = 2.29 years
Which one of these is the IRR benchmark?
Required rate of return
In the NPV formula, what does CF0 represent?
The cash flow at time zero, or the project start-up costs
What does the net present value (NPV) of a project represent?
The expected increase in wealth from accepting a project
Which of these defines the internal rate of return (IRR)? Assume the cash flows are normal. Select all that apply.
The implicit expected geometric average of a project's rate of return
Which of these is a weakness of the payback method? Select all that apply.
The present value of the inflows is ignored. All cash flows after the payback period are ignored.
Which one of these best describes the NPV profile given non-normal cash flows?
The profile will switch from downward-sloping to upward-sloping at least once.
How can the IRR benchmark best be described?
The rate required by investors to compensate for a project's level of risk
Which of these are strengths of the MIRR process? Select all that apply.
The reinvestment rate assumption is more reasonable than in the IRR process. Non-normal cash flows can be converted into normal cash flows.
What is the key difference between discounted payback (DPB) and regular payback (PB)?
The time value of money is considered in DPB but not in PB.
Which one of these is a weakness of the payback method?
The time value of money is ignored.
Why do firms purchase real assets in the form of capital equipment?
To create value for their customers
A project is acceptable if it graphs at the x-axis intersection point on a NPV profile graph. Where else can the project graph and be acceptable? Assume normal cash flows.
To the left of and above the x-axis intersection point
Explain the disadvantage of the net present value (NPV) method.
Uninformed managers may compare the NPV value to the cost of the project rather than to the benchmark value of zero.
