Ch8 notes

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

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

payback period; NPV

The IRR is the discount rate that makes NPV equal to ______.

zero

Which of the following present problems when using the IRR method?

mutually exclusive projects,non-conventional cash flows

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

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

cant rank mutually exclusive

True or false: The PI always results in the correct decision in comparisons of mutually exclusive investments.

false, The PI may lead to incorrect decisions in comparisons of mutually exclusive investments.

If the IRR is greater than the _______ ________, we should accept the project.

required return

The spreadsheet function for calculating net present value is ______.

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

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

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.

According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:

a target average accounting return

The Combination MIRR method is used by the Excel MIRR function and uses which of the following?

A financing rate for discounting Compounding cash inflows to the end of the project A reinvestment rate for compounding Discounting all cash outflows to time 0

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 profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its future cost.

False. The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its initial cost.

What is the primary concern of the payback period rule?

How long it takes to recover the initial investment

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

Net Present Value

The ______ method evaluates a project by determining the time needed to recoup the initial investment.

Payback

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

net present value

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?

net present value internal rate of return

True or false: There is only one way to calculate the modified IRR.

false

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

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

The Average Accounting Return is defined as:

average net income/average book value

What are the advantages of the payback period method for management?

-The payback period method is easy to use. -It allows lower level managers to make small decisions effectively. -The payback period method is ideal for minor projects.

The basic NPV investment rule is:

-reject a project if its NPV is less than zero. -accept a project if the NPV is greater than zero. -if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference

According to the basic IRR rule, we should:

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

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

required 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: The measure of average accounting profit is in the numerator of the average accounting return (AAR) formula.

true

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

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

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

MIRR, NPV

The profitability index is calculated by dividing the PV of the _________ cash inflows by the initial investment.

future

The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its _____ _____.

initial cost

True or false: The IRR is easy to use because you only need to know the appropriate discount rate.

false, You need the discount rate to calculate the NPV but it is not required for the IRR calculation.

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.

The Profitability Index is also called the __________ ratio.

cost-benefit

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

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:Whenever subsequent cash flows are both negative and positive, multiple internal rates of return may occur.

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

accept

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

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

False, this is a disadvantage

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.

Falseto

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

arbitrary