FIN 5352 Texas State University
A small project has cash flows of −$10 and $45, and a large project has cash flows of −$30 and $70. What is the incremental NPV at a discount rate of 10%?
$2.73 The answer is the NPV of the difference in cash flows between the two projects. In this case, the time 0 cash flow difference is (−$30−(−$10) = −$20), and the second cash flow difference is $70−$45 = 25. NPV = −$20+ (25/1.10) = $2.73. You can also take the difference in the NPVs of the two projects.
In general, NPV is ___.
Equal to zero when the discount rate equals the IRR Negative for Discount Rates above the IRR Positive for Discount Rates below the IRR
A project that results in the firm receiving funds first and pays out funds later should not be accepted.
False
True or false: A firm evaluating two mutually exclusive projects can accept both projects.
False
True or false: The scale of a project is never a concern when using IRR.
False
______ cash flows earlier in a project's life are more valuable than ______ cash flows later on.
Higher; higher Higher; lower
The _____ (IRR/NPV) rule summarizes the information about a project in a single rate of return. This single rate gives people a simple way of discussing the rate of return of projects. (Enter abbreviation only.)
IRR
The discount rate that makes the NPV of an investment equal to zero is ______.
IRR
Which of the following techniques eliminates the multiple IRR problem?
MIRR
The dollar difference in value between mutually exclusive projects can be found by calculating the _________ of the incremental cash flows.
NPV
Which of the following always provides a way to evaluate investment opportunities correctly?
NPV
The PI rule for an independent project is to ______ the project if the PI is greater than 1.
accept
For a project with a positive initial cash flow followed by negative cash flows, we should ___.
accept if the IRR is less than R
If the IRR is greater than the discount rate, we should ___.
accept the project
According to the basic IRR rule, we should ____ a project if the IRR is ____ than the discount rate.
accept; greater reject; less
A project with a positive NPV should be ______.
accepted
The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.
accepts
The property of value ______ implies that the contribution of any project to a firm's value is simply the NPV of the project.
additivity
The value of a firm is simply the combined value of the firm's projects, divisions, and entities owned by the firm. This property is called value _____.
additivity
The discounted payback period has an ______ cutoff period.
arbitrary
Capital ______ is the decision-making process for accepting and rejecting projects.
budgeting
What is the decision-making process for accepting or rejecting projects?
capital budgeting
Two mutually exclusive projects can be correctly evaluated by ____.
comparing the incremental IRR to the discount rate comparing the NPVs of the two projects examining the NPV of the incremental cash flows
The payback period method allows upper management to evaluate the ___________ abilities of lower management.
decision-making
Net present value is the ______ between the sum of the present value of all future cash flows and the ______ cost.
difference; initial
Internal rate of return (IRR) must be compared to the ______ rate in order to determine the acceptability of a project.
discount
We can evaluate two mutually exclusive projects by comparing the incremental IRR to the ___.
discount rate
Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?
discounted payback period
NPV ______ cash flows properly
discounts
The discounted payback period ______ account for the time value of money, and the payback period ______ account for the time value of money.
does; does not
The discounted payback period has which of these weaknesses?
exclusion of some cash flows arbitrary cutoff date loss of simplicity as compared to the payback method
Accept a project if its NPV is ______ zero.
greater than
The movie industry frowns upon NPV analysis because their cash flows are ______ to predict.
hard
When evaluating a project with an initial cash inflow followed by cash outflows, the NPV will _____ as the discount rate rises.
increase
A way to evaluate mutually exclusive projects is to analyze the ____ cash flows.
incremental
The problems with scale in the profitability index can be corrected by using ______ analysis.
incremental
Two mutually exclusive projects can be correctly evaluated by comparing the _____IRR to the discount rate.
incremental
Using ____ cash flows corrects the problems of scale in the profitability index.
incremental
Using _____ cash flows corrects the problems of scale in the profitability index.
incremental
A(n) ______ project does not rely on the acceptance or rejection of another project.
independent
If a project relies on the acceptance or rejection of another project, it is not an ______ project.
independent
When choosing a capital budgeting technique, the ______ may play an important role in the choice.
industry
The NPV of a project's cash flows is divided by the ______ to calculate the profitability index.
initial investment
IRR refers to ______.
internal rate of return
The most important alternative to NPV is the ______ method.
internal rate of return
The IRR ______ to distinguish between investing or financing.
is unable
A dollar received 1 year from today has ______ value than a dollar received today.
less
The PI rule for an independent project is to decline the project if the PI is _____ than 1.
less
The payback method works well for companies with ______ cash.
limited
The profitability index is preferred to the NPV rule when funds are ______.
limited
A project with an initial cash outflow followed by a cash inflow and then a cash outflow ____.
may have multiple rates of return
Higher cash flows earlier in a project's life are ______ valuable than higher cash flows later on.
more
The discounted payback period method requires ______ steps than the payback period method.
more
A dollar today is worth ______ a dollar in the future because it can be reinvested.
more than
Projects with cash inflow and outflow change over time may have ______ IRR(s).
multiple
If the initial cash flow of a project is _____ and all remaining cash flows are positive, there can only be a single IRR.
negative
When cash flows are conventional, NPV is ______ if the discount rate is above the IRR.
negative
According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following two capital budgeting methods are most used by firms in the United States and Canada?
net present value internal rate of return
One of the flaws of the payback period method is that cash flows after the cutoff date are ___.
not considered in the analysis
When computing the IRR, the discount rate is ______.
not needed
A project with a cash outflow followed by three cash inflows will always have ____ internal rate of return.
one
The discount rate is often referred to as an ____ cost.
opportunity
This capital budgeting method allows lower management to make smaller, everyday financial decisions easily is ______.
payback method
Which of the following allows management to know if a correct decision was made sooner?
payback method
In capital budgeting, the net ______ is the value of a project to the company.
present value
According to Graham and Harvey's 1999 survey of 392 CFOs, which of the following capital budgeting techniques is least used?
profitability index
Which of the following is the best tool for ranking projects in the presence of capital rationing?
profitability index
A firm evaluating two mutually exclusive projects can ___.
reject one of the projects reject both projects accept one of the projects
A project with a negative NPV should be ______.
rejected
If a firm has a payback period of 3 years and a project has a payback period of 3.5 years, the project should be ______.
rejected
The discount rate is determined by the ______ of a project.
risk
When evaluating mutually exclusive projects, the profitability index has a problem with ___.
scale
Which of the following cause issues when comparing two mutually exclusive projects using IRR?
scale of cash flows timing of cash flows
The NPV _____ the initial investment, while the profitability index _____ the initial investment from the present value of all future cash flows.
subtracts; divides
The incremental IRR will make ______ decision as the incremental NPV when evaluating mutual exclusive projects.
the same
With mutually exclusive projects, the profitability index suffers from the same problem that the IRR rule does in that it fails to consider ____.
the size or scale of projects
True or false: The MIRR method eliminates multiple IRR problem and it is an alternative to the NPV method.
true
True or false: The crossover rate is the rate at which the NPVs of two projects are equal
true
The IRR is ______ to account for the scale of the project.
unable
The IRR is the discount rate that makes the NPV of a project equal to ______.
zero
The three attributes of NPV are that it ______.
1. uses all the cash flows of a project 2. uses cash flows 3. discounts the cash flows properly
A small project has cash flows of −$10 and $45, and a large project has cash flows of −$30 and $70. What is the incremental IRR?
25% −$30 − (−$10) + $70-451+IRR = $0. →IRR = $70-45$30-10 − 1 = 25%.
A project with a cash flow stream with three changes in sign can have ______ internal rate(s) of return.
3 or 2
Which of the following are true for a project with a negative initial cash flow followed by positive cash flows?
Accept if NPV is greater than zero. Reject if IRR is less than the market rate of financing.
How do the timing and the size of cash flows affect the payback method? Assume the project does payback within the project's lifetime.
An increase in the size of the first cash inflow will decrease the payback period, all else held constant.
Which of the following is true about projects with negative cash flow followed by positive cash flow and then another negative?
NPV can be used to make the correct accept/reject decision. The NPV decision rule is "Accept if NPV > 0."
You must know the discount rate to compute ____, while the discount rate is necessary to apply ___.
NPV, IRR
The ______ method is ideal for companies with limited funds that have a need for a quick turnaround of their capital.
Payback
According to the basic investment rule for NPV, a firm should ____.
a. accept a project if the NPV is greater than zero b. be indifferent toward accepting a project if NPV is equal to zero c. reject a project if NPV is less than zero
True or false: A project with an initial cash outflow followed by a cash inflow has an NPV that is negatively related to the discount rate.
True
True or false: Some projects, such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return.
True
True or false: The property of value additivity implies that the contribution of any project to a firm's value is simply the NPV of the project.
True
True or false: Two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing.
True
The internal rate of return is a function of ____.
a project's cash flows
The IRR rule summarizes the information about the project in ______.
a single rate of return
The incremental IRR is the rate that causes the incremental cash flows to have ______.
a zero NPV
Click and drag on elements in order Arrange the steps involved in the discounted payback period in order starting with the first step.
a. Discount the cash flows using the discount rate. b. Add the discounted cash flows. c. Accept if the discounted payback period is less than some pre-specified number of years.
What does value additivity mean for a firm?
a. The NPV values of individual projects can be added together. b. The value of a firm is simply the combined value of the firm's projects, divisions, and entities owned by the firm.
What are the advantages of the payback period method for management?
a. The payback period method is easy to use. b. It allows lower level managers to make small decisions effectively. c. The payback period method is ideal for minor projects.
