FINN 3120 Chapter 8: Reading Questions
The Combination MIRR method is used by the Excel MIRR function and uses which of the following?
-A financing rate for discounting -Discounting all cash outflows to time 0 -A reinvestment rate for compounding -Compounding cash inflows to the end of the project
Which of the following are reasons why IRR continues to be used in practice?
-The IRR of a proposal can be calculated without knowing the appropriate discount rate. -Businesspeople prefer to talk about rates of return. -It is easier to communicate information about a proposal with an IRR.
Which of the following are methods of calculating the MIRR of a project?
-The Reinvestment Approach -The Combination Approach -The Discounting Approach
Which of the following are weaknesses of the payback method?
-The cutoff date is arbitrary. -Cash flows received after the payback period are ignored. -Time value of money principles are ignored.
Specifying variables in the Excel NPV function differs from the manner in which they are entered in a financial calculator in which of the following ways?
-The range of cash flows specified in Excel begins with Cashflow 1, not Cashflow 0. -The discount rate in Excel is entered as a decimal, or as a percentage with a percent sign. -With the Excel NPV function, Cashflow 0 must be handled outside the NPV function. -The Excel NPV function is actually a PV function.
The basic NPV investment rule is:
-accept a project if the NPV is greater than zero. -if the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference -reject a project if its NPV is less than zero.
Which of the following present problems when using the IRR method?
-mutually exclusive projects -non-conventional cash flows
In general, NPV is ___.
-negative for discount rates above the IRR -equal to zero when the discount rate equals the IRR -positive for discount rates below the IRR
The spreadsheet function for calculating net present value is ______.
=NPV(rate,CF1, ..., CFn) + CF0
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.
True or false: The IRR is easy to use because you only need to know the appropriate discount rate.
False
True or false: The payback period takes into consideration the time value of money.
False
True or false: The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its future cost.
False
True or false: The profitability index rule for an independent project states that, if a project has a positive NPV, then the present value of the future cash flows must be smaller than the initial investment.
False
_______ is a measure of how much value is created or added by undertaking an investment.
Net Present Value
Which of the following is a disadvantage of the payback period rule?
Requires an arbitrary cutoff point
True or false: A project with non-conventional cash flows will produce two or more IRRs.
True
True or false: When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus the discount rate raised to the nth power.
True
The internal rate of return is a function of ____.
a project's cash flows
A project should be __________ if its NPV is greater than zero.
accepted
One of the weaknesses of the payback period is that the cutoff date is a(n) ______ standard.
arbitrary
The Profitability Index is also called the __________ ratio.
cost-benefit
The profitability index is calculated by dividing the PV of the _________ cash inflows by the initial investment.
future
A(n) ______ project does not rely on the acceptance or rejection of another project.
independent
The profitability index (PI) is calculated by dividing the present value of an investment's future cash flows by its _____ _____.
initial cost
The present value of the future cash inflows are divided by the ______ to calculate the profitability index.
initial investment
If a firm is evaluating two possible projects, both of which require the use of the same production facilities, and taking one project means that we cannot take the other, these projects would be considered _______________.
mutually exclusive
In capital budgeting, ______ determines the dollar value of a project to the company.
net present value
One of the flaws of the payback period method is that cash flows after the cutoff date are ___.
not considered in the analysis
The ______ method evaluates a project by determining the time needed to recoup the initial investment.
payback
The __________ is best suited for decisions on relatively small, minor projects while ______ is more appropriate for large complex projects.
payback period; NPV
Internal rate of return (IRR) must be compared to the ________ in order to determine the acceptability of a project.
required return
When calculating NPV, the present value of the nth cash flow is found by dividing the nth cash flow by 1 plus ______ rate raised to the nth power.
the discount
The IRR is the discount rate that makes NPV equal to ______.
zero