Chapter 8
o T/F: 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
o What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6 percent? $5.94 $11.32 $12 $6.17
• $5.94
o What is the net present value of a project with the following cash flows if the discount rate is 15 percent? Year-0 -$48,100, Year-1 $15,600, Year 2- $28,900, Year-3 $15,200 -$2687.98 -$1618.48 $1044.16 $1035.24 $9593.19
• -$2687.98
o Which of the following present problems when using the IRR method? (2) Larger cash flows later in the project Mutually exclusive projects A high discount rate Non-conventional cash flows
• Mutually exclusive projects • Non-conventional cash flows
o Which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities? Payback Profitability index Accounting rate of return Internal rate of return Net present value
• Net present value
o One of the flows of the payback period method is that cash flows after the cutoff date are____ Given greater value Not considered in the analysis Reserved for future projects Given special consideration
• Not considered in the analysis
o What is the IRR for a project with in initial investment of $250 and subsequent cash inflows of $100 per year for 3 years? 9.7% -13.67% 21.86% 23.38%
• 9.7%
o The spreadsheet function for calculating net present value is _______. =NPV)rate,CF0....CFn) =MIRR(rate,CF0,.... CFn) =NPV(rate,CF1,...,CFn)+ CF0 =PV(rate,CF0...CFn))
• =NPV(rate,CF1,...,CFn)+ CF0
o According to the average accounting return rule, a project is acceptable if its average accounting return exceeds: The internal rate of return A target average accounting return The required rate of return The net present value
• A target average accounting return
o The average net income of a project divided by the project's average book value is referred to as the project's: Required return Market rate of return Internal rate of return Average accounting return Discounted rate of return
• Average accounting return
o If an investment is producing a return that is equal to the required return, the investment's net present value will be: Positive Greater than the project's initial investment Zero Equal to the project's net profit Less than, or equal to zero
• Zero
o Molly is considering a project with cash inflows of $811, $924, $638, and $510 over the next four years, respectively. The relevant discount rate is 11.2 percent. What is the net present value of this project if the startup cost is $2700? -$425.91 -$131.83 -$383.01 $10.45 $229.50
• -$425.91
o The NPV is _____ if the required return is less than the IRR, and it is _____ if the required return is greater than the IRR Positive, negative Negative, negative Negative, positive Positive, positive
• Positive, negative
o The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to: Produce a positive annual cash flow Produce a positive cash flow from assets Offset its fixed expenses Offset its total expenses Recoup its initial cost
• Recoup its initial cost
o Which of the following are methods of calculating the MIRR of a project? (3) The discounting approach The reinvestment approach The present value approach The combination approach
• The discounting approach • The reinvestment approach • The combination approach
o The payback method of analysis ignores which one of the following? Initial cost of an investment Arbitrary cutoff point Cash flow direction Time value of money Timing of each cash inflow
• Time value of money
o The IRR is the discount rate that makes NPV equal to ________ The payback period The terminal book value of the project's fixed assets Zero $42
• Zero
o The ____________ method evaluates a project by determining the time needed to recoup the initial investment Internal rate of return Payback Accounting rate of return
• Payback
o The _____ is best suited for decisions on relatively small, minor projects while _____ is more appropriate for large complex projects IRR; NPV Payback period: NPV Payback period; URL
• Payback period: NPV
o Which one of the following indicated that a project is expected to create value for its owners? Profitability index less than 1 Payback period greater than the requirement Positive net present value Positive average accounting rate of return Internal rate of return that is less than the requirement
• Positive net present value
o 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? (4) The Excel NPV function is actually a PV function There are no significant differences between variable entry in Excel and in a financial calculator 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 range of cash flows specified in Excel begins with cash flow #1, not cash flow 0
• The Excel NPV function is actually a PV function • 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 range of cash flows specified in Excel begins with cash flow #1, not cash flow 0
o If a project has multiple internal rates of return, which of the following methods should be used? (2) NPV MIRR IRR
• NPV • MIRR
o T/F an advantage of the Aar is that it is based on book values, not market values.
False
o An _________ of the payback period rule is that it is easy to understand
Advantage
o What is the profitability index for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in year one and $20 in year two if the discount rate is 12%? (2.91) 0.52 (0.52) 2.91
• 2.91
o 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. The timing but not the size of the cash flows affects the payback period Receiving every cash inflow sooner will increase the payback period, all else held constant. An increase in the size of the first cash inflow will decrease the payback period, all else held constant A delay in receiving the cash inflows will decrease the payback period
• An increase in the size of the first cash inflow will decrease the payback period, all else held constant
o The Average Accounting Return is defined as: Average net income/average book value Average book value/average net income Average net income/initial project cost Average book value/initial project cost
• Average net income/average book value
o Which of the following is a disadvantage of the profitability index? Cannot rank mutually exclusive projects Useful when capital is rationed Is closely related to NPV Easy to understand
• Cannot rank mutually exclusive projects
o The profitability index is also called the _______ ratio Cost-cash flow Cost-benefit Cost-investment Investment-benefit
• Cost-benefit
o The profitability index is calculated by dividing the PV of the _____ cash inflows by the initial investment Future Previous Positive
• Future
o A project with non-conventional cash flows will produce two or more IRR's False True
• True
o Net present value involves discounting an investment's: Assets Future profits Liabilities Costs Future cash flows
• Future cash flows
o The present value of the future cash inflows are divided by the ________ to calculate the profitability index Initial investment Discount rate Internal rate of return Net present value
• Initial investment
o The payback period can lead to foolish decisions if it is used too literally because: It ignores the initial cost It always includes all the cash flows It ignored cash flows after the cutoff date It uses an arbitrary discount rate
• It ignores cash flows after the cutoff date
o The net present value: Decreases as the required rate of return increases Is equal to the initial investment when the internal rate of return is equal to the required return Method of analysis cannot be applied to mutually exclusive projects Ignores cash flows that are distant in the future Is unaffected by the timing on an investment's cash flows
• Decreases as the required rate of return increases
o The net present value profile illustrates how the net present value of an investment is affected by which one of the following? Project's initial cost Discount rate Timing of the project's cash inflows Inflation rate Real rate of return
• Discount rate
o The internal rate of return is the: Discount rate that causes a project's after tax income to equal zero Discount rate that results in a zero net present value for the project Discount rate that results in a net present value equal to the project's initial cost Rate of return required by the project's investors Project's current market rate of return
• Discount rate that results in a zero net present value for the project
o The Combination MIRR method is used by the EXCEL MIRR function and uses which of the following?(4) A single discount rate for both discounting and compounding Discounting all cash inflows to time 0 A financing rate for discounting Compounding cash inflows to the end of the project Compounding all cash flows to the end of the project A reinvestment rate for compounding
• Discounting all cash outflows to time 0 • A financing rate for discounting • Compounding cash inflows to the end of the project • A reinvestment rate for compounding
o In general, NPV is ________ (3) Equal to zero when the discount rate equals the IRR Positive for discount rates above the IRR Positive for discount rates below the IRR Negative for discount rates above the IRR
• Equal to zero when the discount rate equals the IRR • Positive for discount rates below the IRR • Negative for discount rates above the IRR
o The basic NPV investment rule is: (3) If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference Accept a project if the discount rate is above zero Accept a project if the NPV is greater than zero Accept a project if the NPV is less than zero Reject a project if its NPV is less than zero
• If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference • Accept a project if the NPV is greater than zero • Reject a project if its NPV is less than zero
o Which one of the following statements is correct? The net present value is a measure of profits expressed in today's dollars The net present value is positive when the required return exceeds the internal rate of return If the initial cost of a project is increased, the net present value of that project will also increase In the internal rate of return equals the required return, the net present value will equal zero Net present value is equal to an investment's cash inflows discounted to today's dollars
• If the internal rate of return equals the required return, the net present value will equal zero
o Based on the most recent survey information presented in your textbook, CFO's tend to use which two methods of investment analysis the most frequently? Payback and net present value Payback and internal rate of return Internal rate of return and net present value Net present value and profitability index Profitability index and internal rate of return
• Internal rate of return and net present value
o What are the advantages of the payback period method for management? (3) It allows lower level managers to make small decisions effectively The payback period method is easy to use The payback period adjusts for the discount rate 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 • The payback period method is ideal for minor projects
o Which of the following are reasons why the IRR continues to be used in practice? (3) It is easier to communicate information about a proposal with an IRR The IRR allows the correct ranking of projects Businesspeople prefer to talk about rates of return 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 IRR of a proposal can be calculated without knowing the appropriate discount rate
o Which of the following are weaknesses of the payback method?(3) All cash flows are included in the payback period The cutoff date is arbitrary Cash flows received after the payback period are ignored Time value of money principles are ignored
• The cutoff date is arbitrary • Cash flows received after the payback period are ignored • Time value of money principles are ignored