FINA 3313 ch 9

What is the profitability index for Project A with a cost of capital of 8%? YearProject AProject B0($42,000.00)($45,000.00)1$14,000.00$28,000.002$14,000.00$12,000.003$14,000.00$10,000.004$14,000.00$10,000.005$14,000.00$10,000.00

1.33

The Internal Rate of Return (IRR) is the discount rate that equates the NPV of an investment opportunity with $0

True

The multiple IRR problem occurs when the signs of a project's cash flows change more than once. True False

tRUE

Capital rationing may be beneficial to a firm if it:

weeds out proposals with weaker or biased NPVs.

What is the internal rate of return for a project with an initial outlay of $10,000 that is expected to generate cash flows of $2,000 per year for 6 years

5.47

Compute the payback period for a project that requires an initial outlay of $248,607 that is expected to generate $40,000 per year for 9 years.

6.22

the financing decision

Find the right kind of debt for your firm and the right mix of debt and equity to fund your operations

Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function.

Mutually Exclusive

The "gold standard" of investment criteria refers to: Payback Period IRR EVA NPV Profitabilty Index

NPV

The multiple IRR problem occurs when the signs of a project's cash flows change more than once.

True

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $291 at the end of the next three years and then $1,988 per year for the three years after that. If the discount rate is 2.36% then what is the NPV?

1141.78

What is the NPV of a project that costs $100,000.00 and returns $50,000.00 annually for three years if the opportunity cost of capital is 9.5%?

25,445.34

What are advantages of payback period? Does not require discount rate Does not require complex calculations Does not require all CFs, Does not fully adjust for TVM Measures Liquidity, Easy to communicate

Does not require discount rate Does not require complex calculations Measures Liquidity, Easy to communicate

It should not usually be clear whether we are describing independent or mutually exclusive projects in the following chapters because when we only describe one project then it can be assumed to be independent True False

False

The disadvantages of the IRR period method is that it Requires complex calculations Adjusts for TVM and therefore risk (in comparing to hurdle rate that adjusts for risk) Requires a lot of data (estimates of all CFs) Only works for normal cash flows Does not require a discount rate (for calculation)

Requires complex calculations Requires a lot of data (estimates of all CFs) Only works for normal cash flows

List steps of the capital budgeting process

Step 1 Proposal generation Step 2 Review and analysis Step 3 Decision making Step 4 Implementation Step 5 follow up

Which of the following statements is correct for a project with a negative NPV? The cost of capital exceeds the IRR IRR exceeds the cost of capital. The discount rate exceeds the cost of capital. Accepting the project has an indeterminate effect on shareholders.

The cost of capital exceeds the IRR

Net present value (NPV) is a sophisticated capital budgeting technique; found by adding a project's initial investment from the present value of its cash inflows discounted at a rate equal to the firm's cost of capital

false

the divident decision

if you cant find investments that make your minimum aceptable rate return cash to owners

The investment decision

invest in assets that earn a return greater than the minimum acceptable hurdle rate

The primary purpose of capital budgeting is to:

maximize shareholders wealth

Your firm has a potential project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $900 at the end of the next three years and then $1400 per year for the three years after that. If the discount rate is 8% then what is the PI? Answer in % format with 2 number after the decimal point

103.67

You are considering the following three mutually exclusive projects. The required rate of return for all three projects is 14%. Year A B C 0 $ (1,000) $(5,000) $(50,000) 1 $ 300 $ 1,700 $ 0 2 $300 $ 1,700 $15,000 3 $ 600 $1,700 $ 28,500 4 $300 $1,700 $ 33,000 What is the IRR of the best project? % terms to 2 decimal places w/o % sign

14.23 when NPV are equal go with lower IRR

NPV assumes intermediate cash flows are reinvested at the cost of equity, while IRR assumes that they are reinvested at the cost of capital

Flase