CHAPTER 5 FINANCE

What does value additivity mean for a firm?

-The value of a firm is simpy the combined value of the firms projects, divisions, and entities owned by the firm. -The NPV values of the individuals projects can be added together

A firm evaluating 2 mutually exclusive projects can

-accept 1 of the projects -reject both projects -reject 1 of the projects

The discount rate assigned to a project reflects

-opportunity cost ti the investor -risk of the project

T or F: A project which a firm receives funds later and needs to make payments first should only be financed.

False

Which of the following are true about the growing perpetuity model assumptions?

The cash flows occur at regular intervals. The cash flow used is that for next year. The interest rate must exceed the growth rate.

The payback period method allows upper management to evaluate the ...... abilities of lower management.

decision- making

The problems with scale in the profitability index can be corrected by using

incremental

A(n)....... project doesnt rely on the acceptanc or rejection of another project.

independent

A project with an initial cash outflow followed by a cash inflow and then a cash outflow

may have multiple rates of return

Higher cash flows earlier in a project's life are _____ valuable than higher cash flows later on.

more

You mus know the discount rate to compute... while the discount rate is necessary to apply......

NPV, IRR

the 3 attributes of NPV are that it

-uses cash flows -discounts the cash flows properly -uses all the cash flows of a project

The IRR is the discount rate that makes the NPV of a project equal to

0

The incremental us the rate that causes the incremental cash flows to have

0 NPV

If a time value of money table shows a future value of money table shows a future value interest factor of 1.21 and if the number of years is 2, then the top of the table will show an interest rate of

10%

What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?

9.70%

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 property of value .... implies that the contribution of any project to a firms value is simply the NPV of the project.

additivity

Capital.. is the decision- making process for accepting and rejecting projects.

budgeting

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

discount

When calculating NPV, the present value of the n cash flow is found by dividing the n cashfow by 1 plus the...... rate raised to the n power

discount

We can evaluate two mutually exclusive projects by comparing the incremental IRR to the

discount rate

2 mutually exclusive projects can be correctly evaluated by

examining the npv of the incremental cash flows comparing the incremental IRR to the discount rate comparing the NPV's of the 2 projects

Accept a project if its NPV is... zero

greater than

The movie industry frowns upon NPV analysis because their cash flows are ... to predict

hard.

The net present value of a projects cash flows is divided by the .... to calculate the profitability index.

initial investment

The most important alternative to the NPV is the

internal rate of return

The ...... method is ideal for companies with limited funds that have a need for a quick turn around of their capital.

payback

The capital budgeting method allows lower management to make smaller, everyday financial decisions easily is

payback method

The .... method is best suited for decisions on small projects while the ... method is most appropriate for large, complex projects.

payback: NPV

Which of the following is the best tool for ranking projects in the presence of capital rationing?

profitability index

The decision rule for a project for which the first cash flow is an inflow and subsequent cash flows are negative states that we should ....... the project when the IRR is....... than the discount rate.

reject: greater accept: less

The discount rate is determined by the ..... of a project

risk

The spreadsheet function for calculating net present value is

NPV ()

T or F: The scale of a project is never a concern when using IRR.

False

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

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

A project w/ an initial cash outflow followed by a cash inflow will have an NPV that will decrease as discount rates increase.

True

Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?

Discounting payback period

When cash flows are conventional, NPV is ____, if the discount rate is above the IRR.

negative

According to Graham and Harveys, 1999 survey of 392 CFO's, which of the following 2 capital budgeting methods are most used by firms in the US & Canada?

-Net present value -internal rate of return

The discounted payback period has which of these weaknesses?

-arbitrary cutoff date -loss of simplicity as compared to the payback method -exclusive of some cash flows

The dollar difference in value between mutually exclusive projects can be found by calculating the .... of the incremental cash flows.

NPV

Which is true about projects w/ negative cash flow followed by oisitive cash flow and then another negative?

-NPV can be used to make the correct accept/reject decision. -The NPV decision rule is "accept if NPV>0

According to the basic investment rule for NPV, a firm should

-reject a project if NPV is less than zero -accept a project if the NPV is greater than zero be indifferent towards accepting a project if NPV is equal to zero

Which of the following are weaknesses of the payback method?

-the cutoff date is arbitrary -time value of money principles ignored -cash flows received after the payback period are ignored

With mutually exclusive projects, the profitability index suffers from the same problem that the IRR rule does in that it fails to consider....

the size or scale of projects

T or F: 2 challenges with the IRR approach when comparing 2 mutually exclusive projects are scale and cash flow timing.

True

T or F: Some projects, such as mines, have cash inflows, which are then followed by cash outflows, giving the project multiple rates of return.

True

True of false: The MIRR method eliminates multiple IRR problem and it is an alternative to the NPV method.

True

A project with a cash outflow followed by 3 cash inflows will always have .... of return

one

2 mutually exclusive projects can be correctly evaluated by ......

-comparing the incremental IRR to the discount rate -comparing the NPV of the 2 projects -examining the NPV of the incremental cash flows

In capital budgeting, the net ..... is the value of a project to the company.

Present value