Unit 10

The Combination of MIRR method is used by the Excel MIRR function and uses which of the following?

-A reinvestment rate for compounding -Discounting all cash OUTFLOWS to time 0 -A financing rate for discounting -Compounding cash inflows to the end of the project

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

-MIRR -NPV

Which of the following present problems when using the IRR method?

-Mutually exclusive projects -Non-conventional cash flows

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

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%

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%?

NPV=-$95+(107/1.06)=$5.94

Which of the following is a disadvantage of the payback period rule?

Requires an arbitrary cutoff point.

The Internal Rate of Return is a function of___.

a project's cash flows

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

accepts

The Average Accounting Return is defined as:

average net income/average book value

The NPV is _______ if the required to return is less than the IRR, and it is _______ if the required return is greater than the IRR.

positive, negative

The present value of the future cash inflows are divided by the __ to calculate the profitability index.

initial investment

Higher cash flows earlier in a project's life are ___ valuable than higher cash flows later on.

MORE

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

required return

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

Which of the following are reasons why IRR continues to be used in practice?

-It is easier to communicate information about a proposal with an IRR -The IRR of a proposal can be calculated without knowing the appropriate discount rate -Businesspeople refer to talk about rates of return

Which of the following is a disadvantage of the Profitability Index?

Cannot rank mutually exclusive projects

True or False; An advantage of the AAR is that it is based on book values, not market values.

False

The Management of Premium Manufacturing Company is evaluating two forklift systems to use in its plant that produces the towers for a windmill power farm. The costs and the cash flows from these systems are shown below. If the company uses a 12 percent discount rate for all projects, determine which forklift system should be purchased using the net present value (NPV) approach

Otis Forklifts

Capital budgeting is probably the most important of the three key areas of concern to the financial manager because ___.

it defines the business of the firm

The payback period can lead to foolish decisions if it is used too literally because

it ignored cash flows after thee cutoff date

If a firm is evaluating two possible projects, both of which require the use of the same production facilities, these projects would be considered ___.

mutually exclusive

In capital budgeting, _________ determines the dollar value of a project to the company.

net present value

The basic NPV investment rule is:

-If the NPV is equal to zero, acceptance or rejection of the project is a matter of indifference. -Accept a project if the NPV is greater than zero -Reject a project if its NPV is less than zero

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 -Time value of money principles are ignored -Cash flows received after the payback period 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 discount rate in Excel is entered is decimal, or as a percentage with a percent sign. -The range of cash flows specified in Excel begins with cashflow #1, not cashflow 0. -With the Excel NPV function, Cashflow #0 must be handled outside the NPV function. -The Excel NPV function is actually a PV function.

What is the profitability index for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in year one and $20 in year two if the discount rate is 12%?

=((80/1.12)+(20/1.12^2))/30 = 2.91

Some projects, such as mines, have cash outflows followed by cash inflows and cash outflows again, giving the project multiple internal rates of return.

True (Whenever subsequent cash flows are both negative and positive, multiple internal rates of return may occur)

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

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