Chapter 8 LearnSmart

The Average Accounting Return is defined as:

average net income/average book value

The payback period can lead to foolish decisions if it is used too literally because:

it ignores cash flows after the cutoff date

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

payback

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%?

$5.94 NPV= -$95 + ($107/1.06) = $5.94

Higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on. - more - less

more

A project should be ___________ if its NPV is greater than zero.

accepted

The spreadsheet function for calculating net present value is:

=NPV(CF1, ..., CFn) + CFO

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

budgeting

Which of the following are reasons why IRR continues to be used in practices? - The IRR of a proposal can be calculated without knowing the appropriate discount rate. - The IRR allows the correct ranking of projects. - Business people prefer to talk about rates of return - It is easier to communicate information about a proposal with an IRR

- The IRR of a proposal can be calculated without knowing the appropriate discount rate. - Business people prefer to talk about rates of return - It is easier to communicate information about a proposal with an IRR

Which of the following is a disadvantage of the Profitability Index? - Is closely related to NPV - Cannot rank mutually exclusive projects - Easy to understand - Useful when capital is rationed

- Cannot rank mutually exclusive projects

In general, NPV is _________.

- equal to zero when the discount rate equal the IRR. - negative for discount rates above the IRR. - positive for discount rates below the IRR.

True or false: A project with non-conventional cash flows will produce two or more IRRs.

True (An IRR will result for every change in sign in the cash flow stream)

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

a target average accounting return

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

net present value

The Combination MIRR is used by the Excel MIRR function and uses which of the following? - A single discount rate for both discounting and compounding - A reinvestment rate for compounding - Discounting ALL cash flows to time 0 - Discounting all negative cash flows to time 0 - Compounding cash inflows to the end of the project - A financing rate for discounting - Compounding ALL cash flows to the end of the project

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

Which of the following are weaknesses of the payback method? - All cash flows are included in the payback period. - The cutoff date is arbitrary. - Time value of money principles are ignored. - Cash flows received after the payback period are ignored.

- The cutoff date is arbitrary. - Time value of money principles are ignored. - Cash flows received after the payback period are ignored.

According to the basic IRR rule, we should:

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

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

Net Present Value

If the IRR is greater than the __________ _________, we should accept the project.

required return

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

required return

When calculating NPV, the present value of the Nth cash flow by 1 plus _________ rate raised to the Nth power. - the discount - the prime - the federal funds - the LIBOR

the discount

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

- NPV - MIRR

Which of the following are methods of calculating the MIRR of a project? - The Reinvestment Approach - The Discounting Approach - The Combination Approach - The Present Value Approach

- The Reinvestment Approach - The Discounting Approach - The Combination Approach

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. - The Excel NPV function is actually a PV function - With the Excel NPV function, Cashflow #0 must be handled outside the NPV function.

- 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. - The Excel NPV function is actually a PV function - With the Excel NPV function, Cashflow #0 must be handled outside the NPV function.

Which of the following present problems when using the IRR method? - a high discount rate - larger cash flows later in the project - mutually exclusive projects - non-conventional cash flows

- mutually exclusive projects - non-conventional cash flows

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 adjusts for the discount rate - The payback period method is easy to use

- 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

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 - accounting rate of return - profitability index - payback method

- net present value - internal rate of return

The basic NPV investment rule is:

- 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

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

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 profitability index is also called the _________ index

cost-benefit

A(n) __________ project does not rely on the acceptance or rejection of another project. - mutually exclusive - independent - dependent - co-dependent

independent

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

payback period; NPV

The NPV is _______ if the required return is less than the IRR, and it is _______ if the required return is greater than the IRR. - negative, positive - negative, negative - positive, negative - positive, positive

positive, negative

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

accept