Busines Finance Ch 8
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
If a project has multiple internal rates of return, which of the following methods should be used?
- MIRR - NPV
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: 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
Capital budgeting is probably the most important of the three key areas of concern to the financial manager because _________.
it defines the business of the firm
The IRR is the discount rate that makes NPV equal to ______.
zero
The Profitability Index is also called the __________ ratio.
cost-benefit
According to the basic IRR rule, we should:
reject a project if the IRR is less than the required return
If the IRR is greater than the _______ ________, we should accept the project.
required return
Which of the following are reasons why IRR continues to be used in practice?
- Businesspeople prefer to talk about rates of return. - It is easier to communicate information about a proposal with an IRR. - The IRR of a proposal can be calculated without knowing the appropriate discount rate.
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.
The Combination MIRR method is used by the Excel MIRR function and uses which of the following?
- A reinvestment rate for compounding - Compounding cash inflows to the end of the project - A financing rate for discounting - Discounting all cash outflows to time 0
One of the weaknesses of the payback period is that the cutoff date is a(n) ______ standard.
arbitrary
The profitability index is calculated by dividing the PV of the _________ cash inflows by the initial investment.
future
The present value of the future cash inflows are divided by the ______ to calculate the profitability index.
initial investment
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
Which of the following are methods of calculating the MIRR of a project?
- The Combination Approach - The Reinvestment Approach - The Discounting Approach
The basic NPV investment rule is:
- reject a project if its NPV is less than zero. - 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.
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.
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 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 (PI) is calculated by dividing the present value of an investment's future cash flows by its future cost.
False
What is the primary concern of the payback period rule?
How long it takes to recover the initial investment
Which of the following is a disadvantage of the Profitability Index?
It cannot rank mutually exclusive projects.
_______ is a measure of how much value is created or added by undertaking an investment.
Net Present Value
Which of the following is a disadvantage of the payback period rule?
Requires an arbitrary cutoff point
Capital ______ is the decision-making process for accepting and rejecting projects.
budgeting
The internal rate of return is a function of ____.
a project's cash flows
A project should be __________ if its NPV is greater than zero.
accepted
A(n) ______ 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 _____ _____.
initial cost
The payback period can lead to foolish decisions if it is used too literally because:
it ignores cash flows after the cutoff date
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
In capital budgeting, ______ determines the dollar value of a project to the company.
net present value
The ______ method evaluates a project by determining the time needed to recoup the initial investment.
payback
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
Which of the following present problems when using the IRR method?
- mutually exclusive projects - non-conventional cash flows
In general, NPV is ___.
- negative for discount rates above the IRR - positive for discount rates below the IRR - equal to zero when the discount rate equals the IRR
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.
The spreadsheet function for calculating net present value is ______.
=NPV(rate,CF1, ..., CFn) + CF0
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
The PI rule for an independent project is to ______ the project if the PI is greater than 1.
accept
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 discounted cash flow valuation shows that higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on.
more
One of the flaws of the payback period method is that cash flows after the cutoff date are ___.
not considered in the analysis
The __________ is best suited for decisions on relatively small, minor projects while ______ is more appropriate for large complex projects.
payback period; NPV