Chapter 9 Business Finance NWMSU
_____ technique is regarded as the best single measure of the increased value to shareholders.
NPV, net present value
Expansion Company is evaluating two mutually exclusive capital budgeting projects. Project A costs $250,000 and is expected to generate $100,000 for three years. Expansion's required rate of return is 6%. Project B will generate a net positive cash flow of $6,510. Which of the following statements is true?
Since Project A will generate a net positive cash flow of $17,301, it should be accepted.
Under the IRR method, a project is acceptable if
if its IRR is greater than the firm's required rate of return (hurdle rate)
Two main purposes of post-audit
improve forecasts and improve operations
The point where the NPV profile on a graph that shows the net present values for a project at various discount rates crosses the X-axis indicates a project's
internal rate of return (IRR)
modified IRR
is the discount rate at which the present value of a project's cash outflows is equal to the present value of the sum of its future cash flows
Post-audit
-Conducted following the implementation of an accepted capital project -Compares its expected and actual cash flow results
Advantages of MIRR over traditional IRR
-MIRR assumes that cash flows are reinvested at the required rate of return, which is generally more correct than the traditional IRR assumption that cash flows are reinvested at a project's own IRR -MIRR is a better indication of the project's true value.
What are the steps used to evaluate long-term assets and projects?
1.Estimating the relevant future cash flows, including taxes and financing requirements. 2.Evaluating the riskiness of the projected cash flows. This is necessary to calculate the required rate of return. 3.Computing the present value of the expected cash flows. 4.Comparing the present value of the cash flows with the initial investment, or cost, required to acquire the asset.
A project costs $400,000 and is expected to generate cash flows of $80,000 for five years. The firm's required rate of return is 11%. Compute the traditional payback (PB) period.
5.0 years
At the company's required rate of return, Project GO has a future value of the cash inflows of $11,000 and a present value of the cash outflows of $7,000 over a five-year period. Compute the MIRR for this project.
9.46%
Capital projects are either mutually exclusive or independent. Which of the following statements are correct? Check all that apply.
A project cannot be independent and mutually exclusive at the same time. Acceptance or rejection of an independent project does not affect the cash flows of other projects. Acceptance of a mutually exclusive project precludes the acceptance of any competing project.
While under IRR method, accept and reject when
Accept : when IRR > cost of capital Reject : when IRR < cost of capital
Which of the following statements is true of a project with a net present value (NPV) of zero?
An NPV of zero signifies that the project's required rate of return is equal to its internal rate of return.
Which of the following should be included in the capital budgeting process? Check all that apply.
Computing the present value of the expected cash flows. Evaluating the riskiness of the projected cash flows.
Capital budgeting is about forecasting the need for cash and other short-term assets
FALSE
Azure Inc. is evaluating two mutually exclusive projects—Project A and Project B. The initial cash outflow is $20,000 for each project. Project A results in cash inflows of $12,500 every year for two years. Project B results in cash inflows of $26,000 in the second year. The required rate of return of Azure Inc. is 10 percent. Based on the net present value approach, Azure Inc. should invest in
Project A only Project A 1. [CF], [2ND], [CLR WORK] 2. CF0 = [20,000], [+/-], [ENTER], [down arrow], [down arrow] 3. CF1 = [12,500], [ENTER], [down arrow], [down arrow] 4. CF2 = [12,500], [ENTER], [down arrow], [down arrow] 5. [NPV], [10], [ENTER], [down arrow], [CPT] = $1,694.21 Project B 1. [CF], [2ND], [CLR WORK] 2. CF0 = [20,000], [+/-], [ENTER], [down arrow], [down arrow] 3. CF1 = [12,500], [ENTER], [down arrow], [down arrow] 4. CF2 = [26,000], [ENTER], [down arrow], [down arrow] 5. [NPV], [10], [ENTER], [down arrow], [CPT] = $12,851.24
A post-audit is an important step in the capital budgeting process
TRUE
An incentive program that encourages new ideas, whether for new products or better processes, is a good way to generate capital investment proposals
TRUE
Capital expenditures are long term and expensive
TRUE
Example of independent projects
The decision to purchase a new delivery truck is not dependent on the decision to purchase, or not purchase, a new advertising campaign. It is reasonable to believe that either the truck, the advertising campaign, neither, or both can be accepted for investment, assuming that the firm has sufficient financial capital to pay for both projects.
Example of mutually exclusive projects
The decision to purchase a small parcel of land and construct either a small shopping center or a small office building is an example of two mutually exclusive projects. In this case, assume that the parcel of land is so small that it cannot accommodate both the shopping center and the office building. Therefore, the acceptance of one type of structure precludes, or makes impossible, the construction of the other type of structure. The decision to build the office building eliminates from further consideration the construction of the shopping center, or vice versa.
Krause Corp. is evaluating a proposed capital budgeting project that will require an initial investment of $152,000. The project is expected to generate the following net cash flows: Year 1 $42,400 Year 2 $51,300 Year 3 $47,400 Year 4 $45,900 Assume the desired rate of return on a project of this type is 9%. The net present value of this project is ________. Suppose Krause Corp. has enough capital to fund the project, and the project is not competing for funding with other projects. Should Krause Corp. accept or reject this project?
The net present value (NPV) method analyzes capital investment proposals by comparing the initial cash investment with the present value of the future cash flows it is expected to generate. The NPV of the project is -$804.52. To calculate the NPV, compute the present value of the cash flows as follows: Net present value (NPV) = PV of future cash flows =-$152,000+$42,400/(1.09)^1+$51,300/(1.09)^2+ $47,400/(1.09)^3+$45,900/(1.09)^4 =−$152,000+$38,899.08+$43,178.18+$36,601.50+$32,516.72 =−$804.52 Or with a financial calculator: CF0= -152,000 CF1= 42,400 CF2= 51,300 CF3= 47,400 CF4= 45,900 I/Y= 9 NPV= -804.52 Reject the project, its NPV is less than zero
Both a firm's growth and its ability to remain competitive depend on... What must be established to evaluate the worth of the projects?
a constant flow of ideas for new products, ways to make existing products better, and ways to produce output at lower costs procedures
NPV profile
a graph or curve showing the relationship between a project's NPV and a range of discount (hurdle) rates; -Slope of the curve is an indication of the sensitivity, or riskiness, of the project given its estimated cash flows
Budget
a plan that details projected cash inflows and cash outflows during some future period
The recovery of a project's initial investment on a present value basis prior to the end of the project's useful life results in
a positive net present value (NPV).
Firms may use the traditional payback method to assess
assess risk; the longer the project, the estimated cash flows are further out into the future which lends the project to more risk
What can the post-audit review process be used to improve?
can be used to improve a firm's forecasting process as well as its operations.
net present value
capital budgeting method that gives a direct and discounted (present value) measure of the dollar benefit of a project to the value of the investing firm
required rate of return
discount rate (cost of funds) that a project's internal rate of return (IRR) must exceed for a project to be considered acceptable; -What investors require to invest in the firm, because any return over the required rate increases the wealth of the firm
What does the traditional payback not use? Is it considered a good or bad discounted pay method?
discounted cash flows so it is not considered as good a method as a discounted payback method
A(n) _____ is whether to purchase additional capital projects to increase existing operations (grow the firm).
expansion decisions
Capital budgeting refers to
fixed (long-term) assets used in production
Long-term decisions generally involve
large expenditures
If two projects are of equal size and have the same life, then the _____ and the _____ will always lead to the same project selection decision.
net present value (NPV); modified internal rate of return (MIRR)
A capital budgeting project should be accepted if its NPV is
positive after discounting all the cash inflows and outflows for the project. In Capital Budgeting, under NPV method a project is accepted when NPV is greater than zero and rejected when NPV is less than zero.
What is capital budgeting?
process of planning and evaluating expenditures on assets whose cashflows are expected to extend beyond one year
independent projects
projects whose cash flow are not affected by decisions made about other projects
A(n) _____ involves decisions to determine whether to purchase capital assets to take the place of existing assets.
replacement decision
mutually exclusive projects
the acceptance of one project eliminates one or more other projects from being accepted.
Post-Audit
the comparison of the actual results of capital investments to the projected results Compares actual results with forecasted results and explains why any differences occurred
internal rate of return
the discount rate that equates the present, or discounted, value of a project's expected cash inflows with its initial cost. It is the rate that the firm expects to earn if a project is purchased and held for its useful life.
Capital budgeting
the process of planning and managing a firm's long-term investments
(traditional) payback period
the time it takes to recover the original cost of an investment from its expected cash flows
replacement decision/analysis
used to determine if a capital asset should be purchased to take the place of a worn out, damaged, or obsolete existing asset and thereby maintain or improve the firm's existing operations
expansion decision/analysis
used to determine if additional capital projects should be added to a firm's existing asset base
The reliability of the IRR capital budgeting technique is diminished when
when applied to projects exhibiting unconventional cash flows, since it can result in more than one IRR value.
NPV profile can be used to graphically determine or decide
which proposed capital projects should be deemed acceptable using either their NPV or IRR values