Ch. 8 Finance -Final

Should a firm invest in projects with NPV = $0? a. Yes b. No c. The firm is indifferent between accepting or rejecting projects with zero NPVs d. The firm should look at the PI and IRR of the projects

c. The firm is indifferent between accepting or rejecting projects with zero NPVs IF a project's NPV is 0, accepting the project will neither increase shareholders' wealth nor destroy shareholders' wealth, so the firm will be indifferent between accepting or rejecting the project.

Other things the same, if the market interest rates increases, the IRR of a project: a. increases. b. decreases. c. is unaffected. d. cannot be determined with out knowing the discount rate.

c. is unaffected. IRR is the discount rate that makes NPV equal to zero, it's internally determined by the project's cash flows, not depending on market interest rates.

What is the net present value of the proposed Commerce Company project if the discount rate is 7%? a. $10,000 b. $9,347 c. $6,921 d. $5,847

d. $5,847 Input CF0 = -10,000; CF1 = 2,000; CF2 = 3,000; CF3 = 4,000, CF4 = 5,000, CF5 = 6,000 I = 7. Solve for NPV = $5,847.06.

Potential problems in using the IRR as a capital budgeting technique include: a. the timing problem b. multiple IRRs c. the scale problem d. all of the above

d. all of the above

The capital budgeting process involves a. identifying potential investments b. analyzing the set of investment opportunities, and identifying those that will create shareholder value c. implementing and monitoring the selected investment projects d. all of the above

d. all of the above

Problems of 11-14 are based on the following information NARRBEGIN: Commerce Company Commerce Company The Commerce Company is evaluating a project with the following cash flows: Year Cash Flow 0 ($10,000) 1 $ 2,000 2 $ 3,000 3 $ 4,000 4 $ 5,000 5 $ 6,000 What is the payback period of the proposed Commerce Company project? a. 1.5 years b. 2.7 years c. 3.2 years d. 4.2 years

c. 3.2 years By the end of year 3, the cumulative cash flow of this project is (-10000 + 2,000 + 3,000+4,000) = -1,000. by the end of year 4, the project produces a cumulative cash flow of -1,000+5,000 = 4000. Thus the project earns back the initial $10,000 at some point during the fourth year. (10,000 - 2,000 - 3,000-4,000)/ 5,000 = 0.20 The project's payback period is 3 + 0.20 = 3.20 years.

What is the profitability index of the proposed Commerce Company project if the discount rate is 7%? a. .58 b. 1.58 c. 2.58 d. 3.58

b. 1.58 NPV of CF1 - CF5 @ 7% = $15,487 PI = $15,487/$10,000 = 1.58

Suppose a particular investment project will require an initial cash outlay of $1,000,000 and will generate a cash inflow of $500,000 in each of the next three years. What is the project's IRR? Suppose a company's hurdle rate is 15%, should it accept the project? a. 23%; reject the project b. 23%; accept the project c. 15%; reject the project d. 15%; accept the project

b. 23%; accept the project Using your financial calculator: Press CF key, the calculator displays that CF0=0.0000 if CF0 is not equal to zero, Press 2nd key and CE/C key to clear memory. Input -1,000,000 and press enter, CF0 becomes -1,000,000.0000 Press downside arrow, , your calculator displays C01 0.0000 Input 500,000 and press enter key, now your calculator displays C01=500,000.0000, meaning the first year's cash flow has been input. Press downside arrow, , your calculator displays F01 = 1.0000, meaning that the frequency of cash flow of $500,000 is 1. This is the defaulted value, leave it there, Press downside arrow, , your calculator displays C02 0.0000, Input 500,000 and press enter key, now your calculator displays C02=500,000.0000, meaning the second cash flow has been input. Press downside arrow, , your calculator displays F02= 1.0000, leave it there, Press downside arrow, , your calculator displays C03 0.0000, Input 500,000 and press enter key, now your calculator displays C03=500,000.0000, meaning the second cash flow has been input. Press downside arrow, , your calculator displays F03= 1.0000, leave it there Now you have input all the cash flows, then press IRR key, your calculator displays IRR = 0.0000 Press CPT key , your calculator displays IRR = 23.3752, meaning the internal rate of return of this project is 23.3752%, which is greater than the company's hurdle rate of 15%, so the correct answer is B. After you have input the cash flows, you may press NPV to calculate the NPV of this project, then your calculator displays I = 0.0000, then you need to input the discount rate, press key 1, 5 and enter, the display becomes I=15.0000, meaning the discount rate is 15% now, then press , your calculator displays NPV = 0.0000, press CPT key, now it shows that NPV = 141,612.5586, meaning the NPV of this project is about $141,613, which is greater than 0, so the project should be accepted.

Other things the same, if the market interest rates increase, the NPV of a project: a. increases. b. decreases. c. is unaffected. d. cannot be determined with out knowing the discount rate.

b. decreases.

When the IRR is equal to the discount rate, the NPV is: a. positive. b. equal to zero. c. negative. d. cannot be determined without knowing the discount rate.

b. equal to zero.

The profitability index is most useful a. when the NPV method and the IRR method give conflicting signals on mutually exclusive projects b. in capital rationing situations c. when the cash flow pattern is unusual d. when project scales are of concern

b. in capital rationing situations

A firm has 10 million shares outstanding with a current market price of $20 per share. There is one investment project available to the firm. The initial investment of the project is $20 million, and the NPV of the project is $10 million. What will be the firm's stock price if capital markets fully reflect the value of undertaking the project? a. $19 b. $20 c. $21 d. $22

c. $21 The stock price will increase by $1 per share (= $10m/10m shares)

What is the IRR of the proposed Commerce Company project? a. 7.00% b. 15.24% c. 23.29% d. 42.85%

c. 23.29% Input CF0 = -10,000; CF1 = 2,000; CF2 = 3,000; CF3 = 4,000, CF4 = 5,000, CF5 = 6,000 Solve for IRR = 23.29% REF: 8.5 Internal Rate of Return, 8.4 Net Present Value

You must know all the cash flows of an investment project to compute its a. NPV, IRR, PI, and discount payback period b. NPV, IRR, PI, payback period, and discount payback period, c. NPV, PI, IRR d. NPV, accounting rate of return, IRR, PI

c. NPV, PI, IRR