Core Chapter 7

What method is this? Single rate of return aids people in discussing/thinking about projects. Most people know/understand the flaws of IRR and take them into account

IRR, reason why they are still using it.

If the Incremental IRR is _____ than the discount rate do the smaller project

Lower

Which of the following methods of project analysis are biased towards short-term projects?

Payback and Discount payback

Disadvantages: Problems with mutually exclusive investments (scale). Advantages: May be useful when available investment funds are limited Easy to understand and communicate. Correct decision when evaluating independent projects

profitability index

The difference between the present value of an investment and its cost is the a. net present value b. internal rate of return c. payback period d. profitability index e discounted payback period

net present value

The internal rate of return for a project will increase if: A. the initial cost of the project can be reduced. B. the total amount of the cash inflows is reduced. C. each cash inflow is moved such that it occurs one year later than originally projected. D. the required rate of return is reduced. E. the discount rate is increased.

A. the initial cost of the project can be reduced. *(IRR increase if initial outlay decreases)*

The primary reason that company projects with positive net present values are considered acceptable is that: A. they create value for the owners of the firm. B. the project's rate of return exceeds the rate of inflation. C. they return the initial cash outlay within three years or less. D. the required cash inflows exceed the actual cash inflows. E. the investment's cost exceeds the present value of the cash inflows.

A. they create value for the owners of the firm

Which of the following statement is true? A. One must know the discount rate to compute the NPV of a project but one can compute the IRR without referring to the discount rate. B. One must know the discount rate to compute the IRR of a project but one can compute the NPV without referring to the discount rate. C. Payback accounts for time value of money D. There will always be one IRR regardless of cash flows

A. One must know the discount rate to compute the NPV of a project but one can compute the IRR without referring to the discount rate.

Given that the net present value (NPV) is generally considered to be the best method of analysis, why should you still use the other methods?

A. You need to use other methods because the net present value method is unreliable when a project has unconventional cash flows

If a project is assigned a required rate of return equal to zero, then: A. the timing of the project's cash flows has no bearing on the value of the project. B. the project will always be accepted. C. the project will always be rejected. D. whether the project is accepted or rejected will depend on the timing of the cash flows. E. the project can never add value for the shareholders

A. the timing of the project's cash flows has no bearing on the value of the project

The length of time required for a project's discounted cash flows to equal the initial cost of the project is called the A. net present value. B.internal rate of return. C. payback period. D. discounted profitability index. E. discounted payback period

discounted payback period

The two fatal flaws of the internal rate of return rule are: a. arbitrary determination of a discount rate and failure to consider initial expenditures. b. arbitrary determination of a discount rate and failure to correctly analyze mutually exclusive investment projects. c. arbitrary determination of a discount rate and the multiple rate of return problem. d. failure to consider initial expenditures and failure to correctly analyze mutually exclusive investment projects. e. failure to correctly analyze mutually exclusive investment projects and the multiple rate of return problem

e. failure to correctly analyze mutually exclusive investment projects and the multiple rate of return problem

The discounted payback rule states that you should accept an investment project if its discounted payback period: A. exceeds some pre-specified period of time. B. is positive and rejected if it is negative. C. is less than the payback period. D. is less than some pre-specified period of time. E. exceeds the life of the investment

is less than some pre-specified period of time

If the Incremental IRR is ______ than the discount rate do the bigger project

Bigger

NPV ______ as the discount rate rises

Declines

is better than payback or average accounting return

IRR

If the discount rate is _____ than both projects IRR's reject both

Higher

Reinvestment assumption: All future cash flows assumed reinvested at the ____ Advantages: Easy to understand and communicate Disadvantages: Does not distinguish between investing and borrowing may not exist if Multiple ____ problems with mutual exclusive investments problem with scale and timing ignores magnitude of problem

IRR

Net present value: A. cannot be used when deciding between two mutually exclusive projects. B. is more useful than the internal rate of return when comparing different sized projects. C. is rarely used by small firms according to the Graham and Harvey survey. D. is not as widely used in practice as payback and discounted payback. E. ignores the risk of a project.

B. is more useful than the internal rate of return when comparing different sized projects.

The internal rate of return is: A. more reliable as a decision making tool than net present value whenever you are considering mutually exclusive projects. B. equivalent to the discount rate that makes the net present value equal to one. C. computed using a project's cash flows as the only source of inputs. D. dependent on the interest rates offered in the marketplace. E. a better methodology than net present value when dealing with unconventional cash flows.

C. computed using a project's cash flows as the only source of inputs.

28. The profitability index is closely related to: A. payback. B. discounted payback. C. average accounting return. D. net present value. E. internal rate of return

D. net present value.

The problem of multiple IRRs can occur when: A. there is only one sign change in the cash flows. B. the first cash flow is always positive. C. the cash flows decline over the life of the project. D. there is more than one sign change in the cash flows. E. None of the above

D. there is more than one sign change in the cash flows.

You are considering a project with the following data: Internal rate of return 8.7% Profitability ratio .98 Net present value -$393 Payback period 2.44 years Required return 9.5% Which one of the following is correct given this information? A. The discount rate used in computing the net present value must have been less than 8.7%. B. The discounted payback period will have to be less than 2.44 years. C. The discount rate used to compute the profitability ratio was equal to the internal rate of return. D. This project should be accepted based on the profitability ratio. E. This project should be rejected based on the internal rate of return

This project should be rejected based on the internal rate of return

When the present value of the cash inflows exceeds the initial cost of a project, then the project should be: A. accepted because the internal rate of return is positive. B. accepted because the profitability index is greater than 1. C. accepted because the profitability index is negative. D. rejected because the internal rate of return is negative. E. rejected because the net present value is negative

B. accepted because the profitability index is greater than 1.

Analysis using the profitability index: A. frequently conflicts with the accept and reject decisions generated by the application of the net present value rule. B. is useful as a decision tool when investment funds are limited. C. cannot be used to aid capital rationing. D. utilizes the same basic variables as those used in the average accounting return. E. produces results which typically are difficult to comprehend or apply

B. is useful as a decision tool when investment funds are limited

The Liberty Co. is considering two projects. Project A consists of building a wholesale book outlet on lot #169 of the Englewood Retail Center. Project B consists of building a sit-down restaurant on lot #169 of the Englewood Retail Center. When trying to decide whether to build the book outlet or the restaurant, management should rely most heavily on the analysis results from the _____ method of analysis. A. profitability index B. net present value C. payback D. internal rate of return E. accounting rate of return

B. net present value

The elements that cause problems with the use of the IRR in projects that are mutually exclusive are: A. the discount rate and scale problems. B. timing and scale problems. C. the discount rate and timing problems. D. scale and reversing flow problems. E. timing and reversing flow problems.

B. timing and scale problems.

If there is a conflict between mutually exclusive projects due to the IRR, one should: A. drop the two projects immediately. B. spend more money on gathering information. C. depend on the NPV as it will always provide the most value. D. depend on the AAR because it does not suffer from these same problems. E. None of the above

C. depend on the NPV as it will always provide the most value.

Accepting positive NPV projects benefits the stockholders because: A. it most easily understood valuation process. B. the value of the expected cashflows are equal to the cost. C. the value of the expected cashflows are greater than the cost. D. it is the most easily calculated

C. the value of the expected cashflows are greater than the cost

You are trying to determine whether to accept Project A or Project B. These projects are mutually exclusive. As part of your analysis, you should compute the incremental IRR by determining the: A. internal rate of return for the cash flows of each project. B. net present value of each project using the internal rate of return as the discount rate. C. discount rate that equates the discounted payback periods for each project. D. discount rate that makes the net present value of each project equal to one. E. internal rate of return for the differences in the cash flows of the two projects.

E. internal rate of return for the differences in the cash flows of the two projects.

If you want to review a project from a benefit-cost perspective, you should use the _______ method of analysis. A. net present value B. payback C. internal rate of return D. average accounting return E. profitability index

E. profitability index

The discounted payback rule may cause: A. projects with discounted payback periods in excess of the project's life to be accepted. B. the most liquid projects to be rejected in favor of less liquid projects. C. projects to be incorrectly accepted due to ignoring the time value of money. D. some projects with negative net present values to be accepted. E. some positive net present value projects to be rejected.

d. some positive net present value projects to be rejected.

When two projects both require the total use of the same limited economic resource, the projects are generally considered to be: A. marginally profitable. B. independent. C. acceptable. D. mutually exclusive. E. internally profitable.

mutually exclusive

The discount rate is referred to the ______ _________, since corporate investment in the project takes away the stockholders _________ to invest the same cash in a financial asset.

opportunity cost, opportunity

The length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment is called the A. net present value. B. internal rate of return. C. payback period. D. profitability index. E. discounted cash period.

payback period

No matter how many forms of investment analysis you do: A. the actual results from a project may vary significantly from the expected results. B. the internal rate of return will always produce the most reliable results. C. a project will never be accepted unless the payback period is met. D. the initial costs will generally vary considerably from the estimated costs. E. only the first three years of a project ever affect its final outcome

the actual results from a project may vary significantly from the expected results.

Which one of the following statements is correct concerning the payback period? A. An investment is acceptable if its calculated payback period is less than some pre-specified period of time. B. An investment should be accepted if the payback is positive and rejected if it is negative. C. An investment should be rejected if the payback is positive and accepted if it is negative. D. An investment is acceptable if its calculated payback period is greater than some pre-specified period of time. E. An investment should be accepted any time the payback period is less than the discounted payback period, given a positive discount rate

An investment is acceptable if its calculated payback period is less than some pre-specified period of time.

Which one of the following statements concerning net present value (NPV) is correct? A. An investment should be accepted if, and only if, the NPV is exactly equal to zero. B. An investment should be accepted only if the NPV is equal to the initial cash flow. C. An investment should be accepted if the NPV is positive and rejected if it is negative. D. An investment with greater cash inflows than cash outflows, regardless of when the cash flows occur, will always have a positive NPV and therefore should always be accepted. E. Any project that has positive cash flows for every time period after the initial investment should be accepted

An investment should be accepted if the NPV is positive and rejected if it is negative.

Which one of the following is the best example of two mutually exclusive projects? A. Planning to build a warehouse and a retail outlet side by side B. Buying sufficient equipment to manufacture both desks and chairs simultaneously C. Using an empty warehouse for storage or renting it entirely out to another firm D. Using the company sales force to promote sales of both shoes and socks E. Buying both inventory and fixed assets using funds from the same bond issue

C. Using an empty warehouse for storage or renting it entirely out to another firm

Problems Timing of cash flows within the payback period -Does not consider the timing of the cash flows within the payback period. Uses an arbitrary benchmark cutoff rate (payments after the payback period - ignores all cash flows occurring after the payback period. Because of the short term orientation of the payback period some valuable long term projects are likely to be rejected. Arbitrary standard for payback period - no comparable guide for choosing the payback cutoff date Advantages: Accounting information is usually available Easy to calculate

Payback period

The discounted payback period of a project will decrease whenever the: a. discount rate applied to the project is increased. b. initial cash outlay of the project is increased. c. number of cash inflows is increased. d. amount of each cash inflow is increased. e. costs of the fixed assets utilized in the project increase

d. amount of each cash inflow is increased

All else equal, the payback period for a project will decrease whenever the: a. initial cost increases. b. required return for a project increases. c. assigned discount rate decreases. d. cash inflows are adjusted such that they occur sooner. e. duration of a project is lengthened

d. cash inflows are adjusted such that they occur sooner.

All else constant, the net present value of a project increases when: a. the discount rate increases. b. each cash inflow is delayed by one year. c. the initial cost of a project increases. d. the rate of return decreases. e. all cash inflows occur during the last year of a project's life instead of periodically throughout the life of the project

the rate of return decreases *(NPV increases as rate of return decreases)