FINA 3313 Chapter 9 Quizzes (Capital Budgeting Techniques)
The disadvantages of the IRR period method is that it
-Requires complex calculations -Only works for normal cash flows -Requires a lot of data (estimates of all CFs)
The financing decision
Find the right kind of debt for your firm and the right mix of debt and equity to fund your operations
The dividend decision
If you can't find investments that make your minimum acceptable rate, return the cash to owners of your business
What is the profitability index for Project A with a cost of capital of 8%? Year Project A Project B 0 ($42,000.00) ($45,000.00) 1 $14,000.00 $28,000.00 2 $14,000.00 $12,000.00 3 $14,000.00 $10,000.00 4 $14,000.00 $10,000.00 5 $14,000.00 $10,000.00
PI: 1.33
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
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 8.22%?
CF0=-100,000 C01=50,000 F01=3 CPT NPV I/Y= 8.22% Down Arrow NPV CPT NPV=28,345.05
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
False
NPV assumes intermediate cash flows are reinvested at the cost of equity, while IRR assumes that they are reinvested at the cost of capital
False
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
A: Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period) =300/1.14+300/1.14^2+600/1.14^3+300/1.14^4 =1076.61 NPV=Present value of inflows-Present value of outflows =1076.61-1000 =$76.61(Approx) B: Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period) =1700/1.14+1700/1.14^2+1700/1.14^3+1700/1.14^4 =4953.31 NPV=Present value of inflows-Present value of outflows =4953.31-5000 =-46.69(Approx)(Negative) C: Present value of inflows=cash inflow*Present value of discounting factor(rate%,time period) =15000/1.14^2+28500/1.14^3+33000/1.14^4 =50317.35 NPV=Present value of inflows-Present value of outflows =50317.35-50000 =$317.35(Approx) Hence C is the best project having highest NPV. Let irr be x% At irr,present value of inflows=present value of outflows. 50,000=15000/1.0x^2+28500/1.0x^3+33000/1.0x^4 Hence x=irr=14.23(Approx)
Which of the following statements is correct for a project with a negative NPV? A. The discount rate exceeds the cost of capital B. The cost of capital exceeds the IRR C. IRR exceeds the cost of capital D. Accepting the project has an indeterminate effect on shareholders.
B. The cost of capital exceeds the IRR
The "gold standard" of investment criteria refers to: A. Payback Period B. IRR C. NPV D. Eva E. Profitability index
C. NPV
Projects that compete with one another so that the acceptance of one eliminates from further consideration all other projects that serve a similar function. A. Dependent B. Independent C. Mutually inclusive D. Mutually exclusive
D. Mutually exclusive
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?
FV=0 PV=-10000 PMT=2000 N=6 CPT I = 5.47 Answer =5.47%
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
The Internal Rate of Return (IRR) is the discount rate that equates the NPV of an investment opportunity with $0
True
The investment decision
invest in assets that earn a rate greater than the minimum acceptable hurdle rate
What are advantages of payback period?
-Measures Liquidity, Easy to communicate -Does not require complex calculations -Does not require discount rate
Compute the payback period for a project that requires an initial outlay of $124,220 that is expected to generate $40,000 per year for 9 years.
3.1055 years
Your firm has a project that will cost $5,000 now to begin. The project will then generate after-tax cash flows of $305 at the end of the next three years and then $1,363 per year for the three years after that. If the discount rate is 3.49% then what is the NPV?
A. B C. D. Year. Cash Flow. Discount Factor at 3.49% Discount CF 0. (5,000) 1 (5,000) 1 305 0.966276935 294.7144652 2 305 0.933691115 284.7757901 3 305 0.902204189 275.1722776 4 1,363 0.871779098 1188.234911 5 1,363 0.842380035 1148.163988 6 1,363 0.813972398 1109.444379 =SUM(D2:D8) = ($699)
The primary purpose of capital budgeting is to: A. Maximize shareholders' wealth B. Maximize the budget C. Minimize the firm's costs D. Maximize the firm's profit
A. Maximize shareholders' wealth
The multiple IRR problem occurs when the signs of a project's cash flows change more than once. A. True B. False
A. True
Capital rationing may be beneficial to a firm if it: A. Weeds out proposals with weaker or biased NPV's B. Reduces a firm's interest expense C. Allows managers to select their favorite subjects D. Increases funds to be used for other purposes
A. Weeds out proposals with weaker or biased NPV's
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
CF0= -5,000 C01=900 FO1=3 CO2= 1400 FO2=3 NPVI=8 enter down arrow CPT NPV= 183.48 PI= (183.48+5,000)/5,000 PI= 1.03669 PI=103.67%
The multiple IRR problem occurs when the signs of a project's cash flows change more than once.
True