308 Midterm 3

Of the different techniques available for evaluating cash​ flows, which is technically the​ worst?

The payback period

Which of the following statements is correct? a. If a bank uses quarterly compounding for saving accounts, the simple rate will be greater than the effective annual rate. b. The present value of a future sum increases as the simple interest rate increases or the number of discount periods per year decreases. c. The present value of a future sum increases as either the simple interest rate or the number of discount periods per year increases. d. The present value of a future sum decreases as either the simple interest rate or the number of discount periods per year increases.

The present value of a future sum decreases as either the simple interest rate or the number of discount periods per year increases.

When a project's NPV exceeds zero, a. The project will also be acceptable using payback criteria. b. The IRR should be calculated to insure that the project's projected rate of return exceeds the required rate of return. c. The project should be accepted without any further consideration, assuming we are confident that the cash flows and the required rate of return have been properly estimated. d. Only answers a and c are correct.

The project should be accepted without any further consideration, assuming we are confident that the cash flows and the required rate of return have been properly estimated.

Assume that you are comparing two mutually exclusive projects. Which of the following statements is most correct? a. The NPV and IRR rules will always lead to the same decision unless one or both of the projects are "non-normal" in the sense of having only one change of sign in the cash flow stream, i.e., one or more initial cash outflows (the investment) followed by a series of cash inflows. b. If a conflict exists between the NPV and the IRR, the conflict can always be eliminated by dropping the IRR and replacing it with the MIRR. c. There will be a meaningful (as opposed to irrelevant) conflict only if the projects' NPV profiles cross, and even then, only if the cost of capital is to the left of (or lower than) the discount rate at which the crossover occurs. d. Statements a, b, and c are true.

There will be a meaningful (as opposed to irrelevant) conflict only if the projects' NPV profiles cross, and even then, only if the cost of capital is to the left of (or lower than) the discount rate at which the crossover occurs.

In capital budgeting analyses, it is possible that NPV and IRR will both involve an assumption of reinvestment of the project's cash flows at the same rate. a. True b. False

True

True or False: Equal annual annuities assume projects are renewable indefinitely.

True

True or False: Operating cash flow​ (OCF) is calculated by adding back depreciation to the net operating profit after taxes.

True

True or False: Projects should be evaluated on the basis of accounting​ profits, as these profits actually cover the​ company's obligations.

True

True or false: An investment may change the whole face of a firm.

True

Working capital management involves decisions related to a. labor contracts b. current assets and liabilities c. fixed asset acquisition d. long term debt

current assets and liabilities

Net working capital is defined as a. current assets plus current liabilities b. current liabilities c. current assets d. current assets minus current liabilities

current assets minus current liabilities

The internal rate of return of a capital investment a. Changes when the cost of capital changes. b. Is equal to the annual net cash flows divided by one half of the project's cost when the cash flows are an annuity. c. Must exceed the cost of capital in order for the firm to accept the investment. d. Is similar to the yield to maturity on a bond. e. Answers c and d are correct.

e. Answers c and d are correct.

Which of the following is most correct? a. The NPV and IRR rules will always lead to the same decision in choosing between mutually exclusive projects, unless one or both of the projects are "non-normal" in the sense of having only one change of sign in the cash flow stream. b. The modified Internal Rate of Return (MIRR) compounds cash outflows at the cost of capital. c. Conflicts between NPV and IRR rules arise in choosing between two mutually exclusive projects (that each have normal cash flows) when the cost of capital exceeds the crossover point (that is, the point at which NPV profiles cross). d. The discounted payback method overcomes the problems that the payback method has with cash flows occurring after the payback period. e.None of the statements above is correct.

e.None of the statements above is correct.

The ____ is the average length of time required to convert materials into finished goods and then to sell those goods. a. payables deferral period b. receivables collection period c. cash conversion period d. inventory conversion period

inventory conversion period

When the net present value is negative, the internal rate of return is ________ the cost of capital. A) greater than B) greater or equal to C) less than D) equal to

less than

When evaluating a new​ project, the firm should consider all of the following factors except

previous expenditures associated with a market testing.

The book value of an asset is equal to the

purchase price minus accumulated depreciation.

All of the following are weaknesses of the payback period technique​ except:

Difficulty of calculation.

Which of the following is not a cash flow that results from the decision to accept a project? a. Changes in working capital. b. Shipping and installation costs. c. Sunk costs. d. Opportunity costs.

Sunk costs.

Which of the following statements is false? a. The NPV will be positive if the IRR is less than the required rate of return. b. If the multiple IRR problem does not exist, any independent project acceptable by the NPV method will also be acceptable by the IRR method. c. When IRR = r (the required rate of return), NPV = 0. d. The IRR can be positive even if the NPV is negative.

The NPV will be positive if the IRR is less than the required rate of return.

Capital Budgeting​ is:

The process of deciding which​ long-term investments or projects to acquire.

You are considering the purchase of an investment that would pay you $5,000 per year for Years 1-5, $3,000 per year for Years 6-8, and $2,000 per year for Years 9 and 10. If you require a 14 percent rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?

$21,937.26

Scott Corporation's new project calls for an investment of $10,000. It has an estimated life of 10 years. The IRR has been calculated to be 15 percent. If cash flows are evenly distributed and the tax rate is 40 percent, what is the annual before-tax cash flow each year? (Assume depreciation is a negligible amount.)

$3,321

Scotts Corporation's new project calls for an investment of $10,000. It has an estimated life of 10 years. The IRR has been calculated to be 15 percent. If cash flows are evenly distributed and the tax rate is 40 percent, what is the annual before-tax cash flow each year? (Assume depreciation is a negligible amount.)

$3,321

Alyeska salmon Inc., a large salmon canning firm operating out of Valdez, Alaska, has a new automated production line project it is considering. The project has a cost of $275,000 and is expected to provide after-tax annual cash flows of $73,306 for eight years. The firm's management is uncomfortable with the IRR reinvestment assumption and prefers the modified IRR approach. You have calculated a cost of capital for the firm of 12 percent. What is the project's MIRR?

16%

Alyeska Salmon Inc., a large salmon canning firm operating in Valdex, Alaska, has a new automated production line project it is considering. The project has a cost of $275,000 and is expected to provide after-tax annual cash flows of $73,306 for eight years. The firm's management is uncomfortable with the IRR reinvestment assumption and prefers the modified IRR approach. You have calculated a cost of capital for the firm at 12 percent. What is the projects MIRR?

16.0%

17. Michigan Mattress Company is considering the purchase of land and the construction of a new plant. The land, which would be bought immediately (at t = 0), has a cost of $100,000 and the building, which would be erected at the end of the first year (t = 1), would cost $500,000. It is estimated that the firm's after-tax cash flow will be increased by $100,000 starting at the end of the second year, and that this incremental flow would increase at a 10 percent rate annually over the next 10 years. What is the approximate payback period?

6 years

The Seattle Corporation has been presented with an investment opportunity which will yield end of year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10%. What is the NPV for this investment?

=NPV(0.1,30000,30000,30000,30000,35000,35000,35000,35000,35000,40000)-150000 $51,138

All of the following are considered to be disadvantages of using the payback method except the fact that it: A) ignores the time value of money. B) has no clearly defined decision rule. C) does not consider cash flows that occur beyond the payback period. D) does not provide a good measure of the project's liquidity.

A) ignores the time value of money.

Risk in a revenue producing project can best be adjusted for by a. Ignoring it. b. Adjusting the discount rate upward for increasing risk. c. Adjusting the discount rate downward for increasing risk. d. Picking a risk factor equal to the average discount rate.

Adjusting the discount rate upward for increasing risk.

Assume a project has a normal cash flows (i.e., the initial cash flow is negative, and all other cash flows are positive). Which of the follow1ng statements is correct?

All else equal, a project's NPV increases as the cost of capital declines

Which of the following statements is incorrect? a. Assuming a project has normal cash flows, the NPV will be positive if the IRR is less than the cost of capital. b. If the multiple IRR problem does not exist, any independent project acceptable by the NPV method will also be acceptable by the IRR method. c. If IRR = r (the cost of capital), then NPV = 0. d. NPV can be negative if the IRR is positive. e. The NPV method is not affected by the multiple IRR problem.

Assuming a project has normal cash flows, the NPV will be positive if the IRR is less than the cost of capital.

Which of the following is an advantage of the net present value​ (NPV) technique for evaluating cash​ flows?

Discount rate adjusts for risk.

True or False: Net working capital is the amount by which a​ firm's current assets exceed its current liabilities.

False

True or False: The book value of an asset is equal to the​ asset's afterminustax ​proceeds, provided after the asset has been sold.

False

True or False: When the sale of an asset is equal to its book​ value, a firm will have to pay taxes on recaptured depreciation.

False

Which of the following statements is most correct? a. If a project with normal cash flows has an IRR which exceeds the cost of capital, then the project must have a positive NPV. b. If the IRR of Project A exceeds the IRR of Project B, then Project A must also have a higher NPV. c. The modified internal rate of return (MIRR) can never exceed the IRR. d. Answers a and c are correct. e. None of the answers above is correct

If a project with normal cash flows has an IRR which exceeds the cost of capital, then the project must have a positive NPV.

Which of the following statements is most correct given conventional cash flows?

If a project's internal rate of return (IRR) exceeds the cost of capital, then the project's net present value (NPV) must be positive.

All of the following are true about profitability index​ (PI) except:

Is best used by itself.

The difference between the internal rate of return​ (IRR) and the modified internal rate of return​ (MIRR) is:

MIRR solves the reinvestment rate assumption problem.

____ are decisions about whether to purchase capital assets to take the place of existing assets so as to maintain existing operations. a. Replacement decisions b. Expansion decisions c. Independent decisions d. Mutually exclusive decisions

Replacement decisions

The internal rate of return​ (IRR) can be defined​ as:

The discount rate that sets NPV to 0.