Chapter 9 LearnSmart
By ignoring time value, the payback period rule may accept projects with a _________ NPV.
negative
In which of the following scenarios would ITT always recommend the wrong decision?
Starting cash flow: 1000 Ending cash flow: -2000
The amount of time needed for the cash flows from an investment to pay for its initial cost is the ___________
payback period
Capital Corp is considering a project whose internal rate of return is 14%. If Capital's required return is 14%, the project's NPV is:
zero
The internal rate of return is a function of __________
a project's cash flows
According to the average accounting return rule, a project is acceptable if its average accounting return exceeds:
a target average accounting return
Capital ____ is the decision-making process for accepting and rejecting projects.
budgeting
The payback period can lead to incorrect decisions if it is used too literally because it _________.
ignores cash flows after the cutoff date
An ____ project does not rely on the acceptance or rejection of another project.
independent
The most important alternative to NPV is the _________ method.
internal rate of return
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
Which of the following are mutually exclusive investments?
A restaurant or a gas station on the same piece of land Two different choices for the assembly lines that will make the same product
If a project has multiple internal rates of return, which of the following methods should be used?
NPV MIRR
Which of the following are advantages of AAR?
Needed information is usually available Is easy to compute
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.
An increase in the size of the first cash inflow will decrease the payback period, all else held constant.
When cash flows are conventional, NPV is ____.
equal to zero when the discount rate equals the IRR negative for discount rates about the IRR positive for discount rates below IRR
The point at which the NPV profile crosses the horizontal axis is the:
internal rate of return
In capital budgeting, the net _________ determines the value of a project to the company.
present value
The IRR rule can lead to bad decisions when ___________ or _____________.
projects are mutually exclusive cash flows are not conventional
According to the basic IRR rule, we should:
reject a project if the IRR is less than the required return
The three attributes of NPV are that it:
- discounts the cash flows properly - use cash flows - uses all the cash flows of a project
What are the advantages of the payback period method for management?
The payback period method is easy to use The payback period method is ideal for short projects It allows lower level managers to make small decisions effectively
When cash flows are convenient, NPV is _______ if the discount rate is about the IRR
negative
Which of the following projects is acceptable if the average accounting return is required to be at least 20%?
Restaurant: Average Income = $450,000, Average book value = $2,180,000 Book store: Average Income = $140,000, Average book value = $600,000
The point at which the NPV profile crosses the vertical axis is the:
sum of the cash flows of the project Because of the vertical axis crosses the horizontal axis where the discount rate is zero, the NPV profile crosses the vertical axis at the sum of the cash flows (or the pv of the cash flows with a discount rate of 0.)
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 -$95 + ($107/1.06) = $5.94
The spreadsheet function for calculating net present value is:
= NPV ()
The capital budgeting method allows lower management to make smaller, everyday financial decisions effectively.
Payback method
A project should be ____ if its NPV is greater than zero
accepted
Saxon Company is considering a project that will generate net income of $50,000 in Year 1, $75,000 in Year 2, and $90,000 in Year 3. The cost of the project is $700,000, and this cost will be depreciated to zero in the three years of the investment. What is their average accounting return?
20.48% Average net income is (50,000+75,000+90000)/3 = 71,667. The average book value of the investment is (700,000+0)/2 = $350,000. The average accounting return is 71,667/350,000 = 20.48%
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 basic NPV investment rule is:
- accept a project if the NPV is greater than zero - reject a project if the NPV is less than zero - If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference
IRR continues to be very popular in practice, partly because:
It gives a rate of return rather than a dollar value
Project Alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If Projects Alpha and Beta have conventional cash flows, are mutually exclusive and the NPV profiles cross at 15% (where the NPVs are positive), which of the projects has a higher internal rate of return?
Project Beta
