chapter 6 Homework

rejected

If a​ project's profitability index is less than​ one, then the project should be ____

zero, one

If the net present value of a project is​ ___ , then the profitability index will equal ___.

payback method

Many firms today continue to use the ___ ___ but also employ the NPV or IRR​ methods, especially when large projects are being analyzed.

payback method

One drawback of the __ ___ is that some cash flows may be ignored.

D

Project Alpha has an internal rate of return​ (IRR) of 15 percent. Project Beta has an IRR of 14 percent. Both projects have a required return of 12 percent. Which of the following statements is MOST​ correct? A. Project Beta has a higher profitability index than Project Alpha. B. If the required return were less than 12​ percent, Project Beta would have a higher IRR than Project Alpha. C. Project Alpha must have a higher NPV than Project Beta. D. Both projects have a positive net present value​ (NPV).

main disadvantage

The __ __ of the NPV method is the need for​ detailed, long-term forecasts of free cash flows generated by prospective projects.

discounted payback period

The ___ ___ ___ takes the time value of money into account in that it uses discounted free cash flows rather than actual undiscounted free cash flows in calculating the payback period.

profitability index

The ___ ___ is the ratio of the present value of the future free cash flows to the initial investment.

profitability index

The ___ ___ provides an advantage over the net present value method by reporting the present value of benefits per dollar invested.

internal rate of return

The ____ ____ ___ ___ is the discount rate that equates the present value of the​ project's future free cash flows with the​ project's initial outlay.

free cash flows, initial cash outlay

The internal rate of return is the discount rate that equates the present value of the​ project's __ ___ __ with the​ project's __ __ __

C

Which of the following statements is MOST​ correct? A. If Project A has a higher IRR than Project​ B, then Project A must also have a higher NPV. B. A project with a NPV​ = 0 is not acceptable. C. The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the IRR. D. If a​ project's internal rate of return​ (IRR) exceeds the required​ return, then the​ project's net present value​ (NPV) must be negative.

NPV, IRR

___ assumes reinvestment of intermediate free cash flows at the cost of​ capital, while ___ assumes reinvestment of intermediate free cash flows at the IRR.

NPV

___ is the most theoretically correct capital budgeting decision tool examined in the text.

true

true or false? "Capital rationing may force the firm to reject projects with positive net present​ values, which is contrary to the​ firm's goal of maximization of​ shareholder's wealth, and it is thus not an optimal​ strategy."

false

true or false? A project that is very sensitive to the selection of a discount rate will have a steep net present value profile.

false

true or false? Because the NPV and PI methods both yield the same​ accept/reject decision, a company attempting to rank capital budgeting projects for funding consideration can use either method and get the same results.

true

true or false? If a​ project's internal rate of return is greater than the​ project's required​ return, then the​ project's profitability index will be greater than one.

false

true or false? 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 five year useful​ life, then Project A will have a shorter payback period than Project​ B, assuming both projects require the same initial investment.

true

true or false? The capital budgeting decision-making process involves measuring the incremental cash flows of an investment proposal and evaluating the attractiveness of these cash flows relative to the​ project's cost.

false

true or false? The net present value profile clearly demonstrates that the NPV of a project increases as the discount rate increases.

false

true or false? Two projects that have the same cost and the same expected cash flows will have the same net present value.

maximum desired payback period

A major disadvantage of the discounted payback period is the arbitrariness of the process used to select the ___ ___ ___ ___

target payback period

A project with a payback period of four years is acceptable as long as the​ company's __ __ ___ is greater than or equal to four years.

payback period

Advantages of the ___ ___ include that it is easy to​ calculate, easy to​ understand, and that it is based on cash flows rather than on accounting profits.

traditional payback period

Any project deemed acceptable using the discounted payback period will also be acceptable if using the ___ ___ ___

discount rate

A​ project's net present value profile shows how sensitive the project is to the choice of a ___ ___

benefits generated

Free cash flows represent the ___ ___ from accepting a capital-budgeting proposal.

highest possible NPV

If a firm imposes a capital constraint on investment​ projects, the appropriate decision criterion is to select the set of projects that has the ___ ____ ____ subject to the capital constraint.

acceptable

If a project is ____ using the NPV​ criteria, it will also be ___ when using the profitability index and IRR criteria.