Finance- Exam #2- Ch 9
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%?
$5.94 NPV=-$95+(107/1.06)
In capital budgeting, the net ____ determines the value of a project to the company
present value
Using the payback period rule will bias toward accepting which type of investment
short-term
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
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
T or F: the crossover rate is the rate at which the NPVs of two projects are equal.
true
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 the discounted payback period is less than some pre-specified number of years
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
Investing more money in a project is a guarantee of greater profits
False
T/F: the discounted payback rule has an objective benchmark to use in decision making.
False
An ___ project does not rely on the acceptance or rejection of another project.
Independent
In which of the following scenarios would IRR always recommend the wrong decision?
start CF= 1000 End CF= -2000
The spreadsheet function for calculating net present value is:
=NPV(CF1, ..., CFn) + CFO
If the IRR is greater than the ___ ___, we should accept the project.
required return
Capital ___ is the decision-making process for accepting and rejecting projects.
budgeting
Project alpha'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 NPV's are positive), which of the projects has a higher internal rate of return?
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.
The MIRR function eliminates multiple IRRs and should replace NPV
False
The point at which the NPV profile crosses the horizontal axis is the:
IRR
What capital budgeting method allows lower management to make smaller, everyday financial decisions effectively?
Payback method
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
The IRR rule can lead to bad decisions when __________ or _________.
-Cf's are not conventional -Projects are mutually exclusive
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 of the first cash inflow will decrease the payback period, all else held constant.
A project should be ___________ if its NPV is greater than zero.
accepted
NPV ______ cash flows properly
discounts
The profitability index is calculated by dividing the PV of the ___ cash inflows by the initial investment.
future
The most important alternative to NPV is the _______ method.
internal rate of return (IRR)
The amount of time needed for the cash flows from an investment to pay for its initial cost is the:
payback period
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%?
2.91 ((80/1.12)+(20/1.12^2))/30
The internal rate of return is a function of _____.
a project's cash flows
The PI rule for an independent project is to ___ the project if the PI is greater than 1.
Accept
T/F: IRR approach may lead to incorrect decisions in comparison of two mutually exclusive projects
true
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
When cash flows are conventional, NPV is ___
1. Positive for discount rates below the IRR 2. equal to zero when the discount rate equals the IRR 3. negative for discount rates above the IRR
What are the weaknesses of the discounted payback period?
1. loss of simplicity as compared to the payback method 2. exclusion of some cash flows 3. arbitrary cutoff date
IRR continues to be very popular in practice bc:
It gives rate or return rather than dollar value
If a project has multiple internal rates of return which of the following methods should be used
NPV IRR
The point at which the NPV profile crosses the vertical axis is the:
Sum of the cash flows of the project
What is the IRR for a project with an annual initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?
solve for I/Y =9.7%
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 easy to use -The payback period method is ideal for minor projects (It does not adjust for discount rate)
According to Graham and Harvey's 1999 survey of 392 CFOs (published in 2001), which of the following two capital budgeting methods are widely used by firms in the US and Canada?
-Net Present Value -Internal Rate of Return
