Chapter 10 PP
25) A significant advantage of the payback period is that it A) places emphasis on time value of money. B) allows for the proper ranking of projects. C) tends to reduce firm risk because it favors projects that generate early, less uncertain returns. D) gives proper weighting to all cash flows.
C
26) A significant disadvantage of the payback period is that it A) is complicated to explain. B) increases firm risk. C) does not properly consider the time value of money. D) provides a measure of liquidity
C
22) The net present value method A) is consistent with the goal of shareholder wealth maximization. B) recognizes the time value of money. C) uses all of a project's cash flows. D) all of the above.
D
1) The most critical aspect in determining the acceptability of a capital budgeting project is the impact the project will have on the company's net income over the projects entire useful life.
False, cash flows
3) If project A generates $10 million of free cash flow over its five year useful life and project B generates $8 million of free cash flow over its useful life, then Project A will have a shorter payback period than Project B, assuming both projects require the same initial investment.
False, depends on timing of cash flows
12) The payback period ignores the time value of money and therefore should not be used as a screening device for the selection of capital budgeting projects.
False, payback period is still worthwhile
10) If a project is acceptable using the NPV criteria, it will also be acceptable when using the profitability index and IRR criteria
True
11) The main disadvantage of the NPV method is the need for detailed, long-term forecasts of free cash flows generated by prospective projects.
True
13) The profitability index can be helpful when a financial manager encounters a situation where capital rationing is required.
True
14) The size disparity problem occurs when mutually exclusive projects of unequal size are being examined.
True
2) Advantages of the payback period include that it is easy to calculate, easy to understand, and that it is based on cash flows rather than on accounting profits.
True
4) An acceptable project should have a net present value greater than or equal to zero and a profitability index greater than or equal to one.
True
5) One drawback of the payback method is that some cash flows may be ignored.
True
6) The net present value of a project will increase as the required rate of return is decreased.
True
7) When several sign reversals in the cash flow stream occur, a project can have more than one IRR.
True
8) NPV is the most theoretically correct capital budgeting decision tool examined in the text.
True
9) The internal rate of return is the discount rate that equates the present value of the project's future free cash flows with the project's initial outlay.
True
