Finance 325 Chapter 9. NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA

Which of the following are the advantages of AAR?

-Needed information is usually available. -Is easy to compute.

When cash flows are conventional, NPV is ____.

-Positive for discount rates below the IRR. -Equal to zero when the discount rate equals the IRR. -Negative for discount rates about the IRR.

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

-Projects are mutually exclusive -Cash flows are not conventional

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

-Restaurant: Average income= $450,000, Average book value= $2,180,000 -Book store: Average income= $140,000. Average book value = $600,000

Which of the following are weaknesses of the payback method?

-Time value of money -Cash flows received after the payback period are ignored -The cutoff date is arbitrary

The three attributes of NPV are that it:

-Uses all the cash flows of a project. -Discounts the cash flows properly. -Uses cash flows.

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

Zero

Capital ____ is the decision-making process for accepting and rejecting projects.

Budgeting

Which of the following are mutually exclusive investments?

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

The discounted payback period has which of these weaknesses?

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

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 U.S. and Canada?

-Internal rate of return -Net present value

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

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

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

-MIRR -NPV

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

1. Discount the cash flows using the discount rate 2. Add the discounted cash flows 3. Accept if discounted payback period is less than some pre-specified number of years.

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

Future

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

Independent

The present value of all cash flows (after the initial investment is divided by the ____ to calculate the profitability index.

Initial Investment

The present value of all cash flows (after the initial investment) is divided by the ____ to calculate the profitability index.

Initial Investment

The most important alternative to NPV is the ____ method.

Internal rate of return

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

Internal rate of return

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

It gives a rate of return rather than a dollar value.

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

Present Value

Project Aplha's NPV profile crosses the vertical axis at $230,000. Project Beta's NPV profile crosses the vertical axis at $150,000. If projects Alpha and Beta have conventional cash flows, are mutually exclusive and the NPV profiles cross at 15% (where the NPVs are positive), which of the projects has a higher internal rate of return?

Project Beta

If the IRR is greater than the ___ ___, we should accept the project.

Required Return

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

Required return

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

Starting cash flow: 1000 Ending cash flow: -2000

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

Suggests accepting

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

Sum of the cash flows of the project

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 percent?

$5.94

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

2.91

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%

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%

The spreadsheet function for calculating net present value is ____.

=NPV()

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

A target average accounting return

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

Accept

A project should be ____ if it's 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 ____ of financial sense.

Accounting; Economic

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.

NPV ____ cash flows properly.

Discounts

True or false: Investing more money in a project is a guarantee of a greater profits.

False

True or false: The MIRR function eliminates multiple IRRs and should replace NPV.

False

True or false: The discounted payback rule has an objective benchmark to use in decision making.

False

By ignoring time value, the payback period rule may accept projects with a ____ NPV.

Negative

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

Negative

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

True or false: IRR approach may lead to incorrect decisions in comparison of two mutually exclusive projects.

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 crossover rate is the rate at which the NPVs of the two project are equal.

True