FIN360-c9

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 (50000+75000+90000)/3=71670. The average accounting return is 71670/350000=20.48%

A(n) _____ project does not rely on the acceptance or rejection of another project.

independent

The payback period rule ______ a project if it has a payback period that is less than or equal to a particular cutoff date.

suggest accepting

The point at which the NPV profile crosses the vertical axis is the:

sum of the cash flows of the project

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 spreadsheet function for calculating net present value is ____.

=NPV(rate,CF1, ..., CFn) + CF0

T/F Based on the discounted payback rule, an investment is acceptable if its discounted payback is less than some prespecified number of years.

True

T/F: IRR approach may lead to incorrect decision in comparison of two mutually exclusive projects.

True

T/F: The crossover rate is the rate at which the NPVs of two projects are equal.

True

Which of the following are advantage(s) of AAR?

easy to compute needed information is always available

This capital budgeting method allows lower management to make smaller, everyday financial decisions effectively

payback method

The amount of time needed for the cash flows from an investment to pay for its initial cost is the

payback period

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

required return

Which of the following are mutually exclusive investments?

- 2 different choices for the assembly lines that will make the same product - a restaurant or gas station on the same piece of land

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

- NPV - MIRR

The discounted payback period has which of these weaknesses?

-Exclusion of some cash flows -Loss of simplicity as compared to payback method -Arbitrary cutoff date

Which of the following projects is acceptable if the average accounting return is required to be at least 20%?

-Restaurant: Average Income = $450,00, Average Book Value = $2,180,000 -Book Store: Average Income = $140,000, Average Book Value = $600,000

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%

What is the PI for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in Year 1 and $20 in Year 2 if the discount rate is 12%?

=((80/1.12)+(20/1.12^2))/30=2.91

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

Accept

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.

T/F Investing more money in a project will always lead to greater profits.

False

T/F The MIRR function eliminates multiple IRRs and should replace NPV.

False

The profitability index is calculated by dividing the PV of the _____ cash flows by the initial investment.

Future

The most important alternative to NPV is the ____ method.

IRR

IRR continues to be very popular in practice, partly because:

It gives a rate of return rather than a dollar value

The point at which the NPV profile crosses the vertical axis is the:

Sum of the cash flows of the project

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

accepted

Payback period tells the time it takes to break even in an ____ sense. Discounted payback period tells the time it takes to break even in an ______ or financial sense.

accounting; economic

Captial _____ is the decision-making process for accepting and rejecting projects.

budgeting

The IRR rule can lead to bad decisions when ____ or ____.

cash flows are not conventional; projects are mutually exclusive

By ignoring time value, the payback period rule may accept projects with a _____ (positive/negative) NPV

negative

In capital budgeting, the net ______ determines the value of a project to the company.

present value

When cash flows are conventional, NPC is ____ if the discount rate is above the IRR.

Negative

What are the advantages of the payback period method for management?

-The payback period method is easy to use. -It allows lower level managers to make small decisions effectively. -The payback period method is ideal for minor projects.

Project Alpha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000.

Beta: The 2 projects have a crossover point above the horizontal axis, and Alpha crosses the vertical axis above beta. Because the cash flows are conventional, their NPV profiles cross only once, so alpha must have a steeper NPV profile, but beta must have a higher IRR.

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%?

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

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.

- net present value - internal rate of return

Arrange the steps involved in the discounted payback period in order starting with the first step.

-Discount the cash flows using the discount rate. -Add the discounted cash flows. -Accept if the discounted payback period is less than some pre-specified number of years.

The basic NPC investment rule is:

-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 -Reject a project if its NPV is less than zero

The IRR is the discount rate that makes the NPC of a project equal to ____.

zero

T/F: 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 (Whenever subsequent cash flows are both negative and positive, multiple internal rates of return may occur)

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

a target average accounting return

In which of the following scenarios would IRR always recommend the wrong decision?

start CF= 1000 End CF= -2000

The three attributes of NPC are that it:

uses cash flows, discounts the cash flows properly and uses all the cash flows of a project.