BUS 350 Principles of finacechapter 13 smartbok
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Why do firms purchase real assets in the form of capital equipment?
To create value for their customers
Which one of these capital budgeting techniques is preferred for most projects?
Net present value (NPV)
Which one of these methods best applies to a project when a firm is facing a time constraint?
Payback (PB)
Which of these affect the capital budgeting technique used to evaluate a project? Select all that apply.
Whether or not the firm must choose among various projects
Whether the project has normal or non-normal cash flows
The benchmark to be used for comparison purposes
Rate is the unit of measurement for which of these capital budgeting techniques? Select all that apply.
Profitability index (PI)
Modified internal rate of return (MIRR)
Internal rate of return (IRR)
What type of return are firms seeking when considering a real asset project?
Economic profit
True or false: For most projects, net present value is the generally preferred method for making capital budgeting decisions.
True
If a firm is concerned about capital constraints and needs to prioritize its projects, which budgeting technique should the firm use?
Profitability index (PI)
Which one of these factors affects the capital budgeting technique used to analyze a project?
Whether or not the time value of money is to be considered
Which of these capital budgeting techniques use time as their unit of measurement? Select all that apply.
Payback (PB)
Discounted payback (DPB)
Why do firms purchase real assets in the form of capital equipment?
To create value for their customers
Rate-based decision statistics provide a rate of return based on which one of these?
Each $1 of investment
Which one of these capital budgeting techniques is preferred for most projects?
Net present value (NPV)
An accept decision for an independent project does which one of these?
Has no affect on accept/reject decisions for other projects
Which one of these methods best applies to a project when a firm is facing a time constraint?
Payback (PB)
Which of these affect the capital budgeting technique used to evaluate a project? Select all that apply.
Whether or not the firm must choose among various projects
Whether the project has normal or non-normal cash flows
The benchmark to be used for comparison purposes
Rate is the unit of measurement for which of these capital budgeting techniques? Select all that apply.
Profitability index (PI)
Modified internal rate of return (MIRR)
Internal rate of return (IRR)
Rate-based decision statistics are popular because managers like to compare the expected rate of return to which one of these?
Borrowing rates
What does the term "mutually exclusive projects" imply?
Only one of the two or more projects can be accepted.
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If a firm is concerned about capital constraints and needs to prioritize its projects, which budgeting technique should the firm use?
Profitability index (PI)
Which steps are involved in the accept/reject decision process for mutually exclusive projects? Select all that apply.
Compare the statistic with the benchmark
Compute the project statistics
Identify the project with the best statistic
Which one of these factors affects the capital budgeting technique used to analyze a project?
Whether or not the time value of money is to be considered
Which of these capital budgeting techniques use time as their unit of measurement? Select all that apply.
Payback (PB)
Discounted payback (DPB)
Which one of these is the primary advantage of the payback method?
Easy to compute
Rate-based decision statistics provide a rate of return based on which one of these?
Each $1 of investment
An accept decision for an independent project does which one of these?
Has no affect on accept/reject decisions for other projects
Which of these steps are required when deciding whether or not an independent project should be accepted? Select all that apply.
Compute the statistic
Compare the statistic to the benchmark
Which of these affect the capital budgeting technique used to evaluate a project? Select all that apply.
Whether or not the firm must choose among various projects
Whether the project has normal or non-normal cash flows
The benchmark to be used for comparison purposes
Which one of these sets of cash flows meets the definition of normal cash flows?
-$500, $200, $300, $400.
Reason: Normal cash flows have all outflows occurring at the beginning of the set.
Which of these apply to the payback method? Select all that apply.
Easy to compute
Considers the total dollar cost of the initial investment
Rate-based decision statistics are popular because managers like to compare the expected rate of return to which one of these?
Borrowing rates
Which assumption is made by the payback statistic method?
The cash flows are normal.
What does the term "mutually exclusive projects" imply?
Only one of the two or more projects can be accepted.
A project has been assigned a maximum allowable payback period of 2.5 years. How is the reject decision expressed for this project?
PB > 2.5 years
Which steps are involved in the accept/reject decision process for mutually exclusive projects? Select all that apply.
Compare the statistic with the benchmark
Compute the project statistics
Identify the project with the best statistic
How are normal cash flows defined?
All cash outflows occur at the beginning
Which one of these is the primary advantage of the payback method?
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Easy to compute
A project has an initial cost of $900 and cash flows of $500, $800, and $200 over years 1 to 3, respectively. How is the payback period calculated?
PB = 1 + ($900 - $500)/$800
The payback method is based on which one of these assumptions?
The cash flows occur evenly throughout each time period.
Which one of these correctly states the accept rule for the payback statistic?
Accept any project that pays back within the maximum allowable period
Which of these steps are required when deciding whether or not an independent project should be accepted? Select all that apply.
Compute the statistic
Compare the statistic to the benchmark
Project A requires $22,500 in start-up costs. The cash flows for years 1 to 4 are $3,200, $7,800, $8,900, and $9,700, respectively. What is the payback statistic?
3.27 years.
Reason: PB = 3 + ($22,500 - $3,200 - $7,800 - $8,900)/$9,700 = 3.27 years
Which one of these sets of cash flows meets the definition of normal cash flows?
-$500, $200, $300, $400.
Reason: Normal cash flows have all outflows occurring at the beginning of the set.
What is the discounted payback method designed to compute?
The time period required to return the initial investment plus interest
A project has an initial cost of $500 and cash flows of $100, $150, and $600 for years 1 to 3, respectively. How is the payback period calculated?
PB = 2 + ($500 - $100 - $150)/$600
Which assumption is made by the payback statistic method?
The cash flows are normal.
A project has been assigned a maximum allowable payback period of 2.5 years. How is the reject decision expressed for this project?
PB > 2.5 years
A project has an initial cost of $13,000. The cash flows for years 1 to 3 are $8,000, $6,000, and $4,000, respectively. Management has set a maximum allowable payback period of 2 years. Should the project be accepted or rejected based on payback? Why?
Accept; The payback period of 1.83 years is less than the requirement.
Reason:
PB = 1 + ($13,000 - $8,000)/$6,000 = 1.83 years, which is less than the 2 year maximum allowable.
When is a cash flow not discounted when using the discounted payback method for project analysis?
When the cash flow occurs at time zero.
What is the key difference between discounted payback (DPB) and regular payback (PB)?
The time value of money is considered in DPB but not in PB.
A project has an initial cost of $900 and cash flows of $500, $800, and $200 over years 1 to 3, respectively. How is the payback period calculated?
PB = 1 + ($900 - $500)/$800
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8 percent. Should the project be accepted or rejected according to discounted payback (DPB) if the maximum allowable period is two years?
Rejected; DPB = 2.29 years.
Reason: DCF1 = $700/1.08 = $648.15; DCF2 = $1,100/1.082 = $943.07; DCF3 = $900/1.083 = $714.45; DPB = 2 + ($1,800 - $648.15 - $943.07)/$714.45 = 2.29 years
The payback method is based on which one of these assumptions?
The cash flows occur evenly throughout each time period.
How will the computation of a discounted payback (DPB) be affected if the discount rate is increased from 11 percent to 12 percent?
The discounted cash inflows for all time periods will decrease causing the DPB period to increase.
Which one of these correctly states the accept rule for the payback statistic?
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Accept any project that pays back within the maximum allowable period
A project has an initial cost of $5,200. The cash flows for years 1 to 3 are $2,800, $3,600, and $2,400, respectively. What is the discounted payback (DPB) at a discount rate of 12 percent?
1.94 years.
Reason: DCF1 = $2,800/1.12 = $2,500; DCF2 = $3,600/1.122 = $2,869.90; DPB = 1 + ($5,200 - $2,500)/
$2,869.90 = 1.94 years
Project A requires $22,500 in start-up costs. The cash flows for years 1 to 4 are $3,200, $7,800, $8,900, and $9,700, respectively. What is the payback statistic?
3.27 years.
Reason: PB = 3 + ($22,500 - $3,200 - $7,800 - $8,900)/$9,700 = 3.27 years
Which of these is a weakness of the payback method? Select all that apply.
The present value of the inflows is ignored.
All cash flows after the payback period are ignored.
Which of these statements represent differences between the discounted payback (DPB) and payback (PB)? Select all that apply.
Ease of computation
Length of maximum allowable period
Consideration of the time value of money
What should the decision be if the maximum allowable discount period is less than the discounted payback (DPB) statistic?
Reject the project
A project has an initial cash flow of -$6,300 and cash flows of $3,800 a year for two years. How is the discounted payback (DPB) computed if the discount rate is 9 percent?
DCF1= $3,800/1.09 = $3,486.24; DCF2= $3,800/1.092 = $3,198.38; DPB = 1 + ($6,300 - $3,486.24)/
$3,198.38
A project has an initial cost of $10,000. The cash flows for years 1 to 3 are $3,000, $4,000, and $5,000, respectively. What is the discounted payback (DPB) at a discount rate of 12%?
Does not exist
Which one of these is a weakness of the payback method?
The time value of money is ignored.
What is the key difference between discounted payback (DPB) and regular payback (PB)?
The time value of money is considered in DPB but not in PB.
What is the accept decision rule for discounted payback (DPB)?
Accept when the DPB is equal to or less than the maximum allowable period
How will the computation of a discounted payback (DPB) be affected if the discount rate is increased from 11 percent to 12 percent?
The discounted cash inflows for all time periods will decrease causing the DPB period to increase.
A project has an initial cost of $5,200. The cash flows for years 1 to 3 are $2,800, $3,600, and $2,400, respectively. What is the discounted payback (DPB) at a discount rate of 12 percent?
1.94 years.
Reason: DCF1 = $2,800/1.12 = $2,500; DCF2 = $3,600/1.122 = $2,869.90; DPB = 1 + ($5,200 - $2,500)/
$2,869.90 = 1.94 years
Which of these is a weakness of the payback method? Select all that apply.
The present value of the inflows is ignored.
All cash flows after the payback period are ignored.
Which of these statements represent differences between the discounted payback (DPB) and payback (PB)? Select all that apply.
Ease of computation
Length of maximum allowable period
Consideration of the time value of money
Which of these are weaknesses of the discounted payback (DPB) method? Select all that apply.
May cause an incorrect decision when comparing mutually exclusive projects
Works only for projects with normal cash flows
Ignores cash flows after the payback period
What should the decision be if the maximum allowable discount period is less than the discounted payback (DPB) statistic?
Reject the project
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A project has an initial cash flow of -$6,300 and cash flows of $3,800 a year for two years. How is the discounted payback (DPB) computed if the discount rate is 9 percent?
DCF1= $3,800/1.09 = $3,486.24; DCF2= $3,800/1.092 = $3,198.38; DPB = 1 + ($6,300 - $3,486.24)/
$3,198.38
A project has an initial cost of $10,000. The cash flows for years 1 to 3 are $3,000, $4,000, and $5,000, respectively. What is the discounted payback (DPB) at a discount rate of 12%?
Does not exist
Which one of these sets of cash flows for time periods 0 to 4, respectively, best illustrates a situation where the payback method is affected by a weakness? Assume the maximum allowable period is 3 years.
-$500, $100, $100, $100, $3,500
What does the net present value (NPV) of a project represent?
The expected increase in wealth from accepting a project
Which one of these is a weakness of the payback method?
The time value of money is ignored.
What value should be used to discount the cash flow that occurs in time period N when computing a net present value?
(1 + i)N
Project A has a 5-year life and a payback period of 2.9 years. Project B has a 3-year life and a payback period of 2.8 years. The projects are mutually exclusive. The maximum allowable period is 3 years. The payback method will select project B. Why might this be an incorrect decision?
The cash flows after the payback period for Project A may be significantly higher than those of Project B.
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8 percent. Should the project be accepted or rejected according to discounted payback (DPB) if the maximum allowable period is two years?
Rejected; DPB = 2.29 years.
Reason: DCF1 = $700/1.08 = $648.15; DCF2 = $1,100/1.082 = $943.07; DCF3 = $900/1.083 = $714.45; DPB = 2 + ($1,800 - $648.15 - $943.07)/$714.45 = 2.29 years
Which one of these statements is correct?
A zero NPV indicates a project's discounted cash inflows equal the discounted cash outflows.
Which one of these sets of cash flows for years 0 to 3, respectively, best illustrates a weakness of the payback (PB) method? Assume the maximum allowable payback period is 3 years.
-$300, $100, $100, $100
What is the definition of net present value (NPV)?
NPV is a technique that generates a decision rule based on the total discounted values of a project's lifetime cash flows.
In the NPV formula, what does CF0 represent?
The cash flow at time zero, or the project start-up costs
True or false: The benchmark value for net present value (NPV) is 1.
False
Which of these are weaknesses of the payback (PB) method of analysis? Select all that apply
Can cause incorrect decisions when projects are mutually exclusive
Ignores the time value of money
Ignores cash flows after the payback period
What does a positive net present value (NPV) represent?
A project more than covers all of its necessary costs
Which one of these sets of cash flows for time periods 0 to 4, respectively, best illustrates a situation where the payback method is affected by a weakness? Assume the maximum allowable period is 3 years.
-$500, $100, $100, $100, $3,500
Which of these statements is (are) correct? Select all that apply.
A negative NPV project might be acceptable if the discount rate can be lowered.
A negative NPV project should be rejected at the given discount rate.
What does the net present value (NPV) of a project represent?
The expected increase in wealth from accepting a project
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A project requires $23,400 in initial costs. The cash inflows for years 1 to 3 are $12,000, $0, and $18,000 respectively. The discount rate is 14 percent. Based on NPV, should the project be accepted or rejected and why?
Reject because the NPV is negative; NPV = -$724.20
Why is the NPV benchmark zero?
A zero NPV means a project can cover its costs as well as its required return.
Project A has a 5-year life and a payback period of 2.9 years. Project B has a 3-year life and a payback period of 2.8 years. The projects are mutually exclusive. The maximum allowable period is 3 years. The payback method will select project B. Why might this be an incorrect decision?
The cash flows after the payback period for Project A may be significantly higher than those of Project B.
Which one of these statements is correct?
A zero NPV indicates a project's discounted cash inflows equal the discounted cash outflows.
A project has an initial cash outflow of $600 followed by cash inflows of $200, $200, $400, and $500 over
years 1 to 4, respectively. The discount rate is 9 percent. Which one of these correctly represents part of the calculator input for computing the NPV?
F1 = 2
What is the accept decision rule for NPV?
Accept a project if it has a zero or positive NPV.
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8 percent. Should the project be accepted or rejected according to discounted payback (DPB) if the maximum allowable period is two years?
Rejected; DPB = 2.29 years.
Reason: DCF1 = $700/1.08 = $648.15; DCF2 = $1,100/1.082 = $943.07; DCF3 = $900/1.083 = $714.45; DPB = 2 + ($1,800 - $648.15 - $943.07)/$714.45 = 2.29 years
True or false: The benchmark value for net present value (NPV) is 1.
False
Which of these are weaknesses of the discounted payback (DPB) method? Select all that apply.
May cause an incorrect decision when comparing mutually exclusive projects
Works only for projects with normal cash flows
Ignores cash flows after the payback period
A project has an initial cost of $950 and produces cash inflows of $300, $400, and $400 over years 1 to 3,
respectively. The discount rate is 12 percent. What is the NPV?
-$78.55.
Reason: CF0 = -950; CF1 = 300; F1 = 1; CF2 = 400; F2 = 2; I = 12; NPV = -78.55
A project has an initial cost of $400 and cash inflows of $500 in year one and $300 in year two. Which of these correctly illustrates part of the calculator input?
F1 = 1
Which one of these is an advantage of the net present value (NPV) method?
NPV can be used with both independent and mutually exclusive projects.
Which of these statements is (are) correct? Select all that apply.
A negative NPV project might be acceptable if the discount rate can be lowered.
A negative NPV project should be rejected at the given discount rate.
What is the internal rate of return (IRR)?
The implicit expected geometric average of a project's rate of return
A project requires $23,400 in initial costs. The cash inflows for years 1 to 3 are $12,000, $0, and $18,000 respectively. The discount rate is 14 percent. Based on NPV, should the project be accepted or rejected and why?
Reject because the NPV is negative; NPV = -$724.20
What is the NPV if the IRR equals the required return?
Zero
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8%. What is the NPV?
$505.67.
Reason: CF0 = -1850; CF1 = 700; F1 = 1; CF2 = 1100; F2 = 2; CF3=900; F3 = 1; I = 8; NPV = -505.67
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Project A has a 5-year life and a payback period of 2.9 years. Project B has a 3-year life and a payback period of 2.8 years. The projects are mutually exclusive. The maximum allowable period is 3 years. The payback method will select project B. Why might this be an incorrect decision?
The cash flows after the payback period for Project A may be significantly higher than those of Project B.
Which one of these is a situation that creates internal rate of return (IRR) problems?
Non-normal cash flows
Explain the disadvantage of the net present value (NPV) method
Uninformed managers may compare the NPV value to the cost of the project rather than to the benchmark value of zero.
Which of these defines the internal rate of return (IRR)? Assume the cash flows are normal. Select all that apply.
The interest rate that causes the NPV to equal zero.
The interest rate that causes NPV to equal (-1)(Cash flow at time 0)
Which one of these statements is correct for a project with normal cash flows?
NPV is positive only when IRR > Required return
A project has an initial cost of $950 and produces cash inflows of $300, $400, and $400 over years 1 to 3,
respectively. The discount rate is 12 percent. What is the NPV?
-$78.55.
Reason: CF0 = -950; CF1 = 300; F1 = 1; CF2 = 400; F2 = 2; I = 12; NPV = -78.55
To solve for the IRR statistic, set NPV equal to:
Zero
The internal rate of return (IRR) should not be used in which one of these situations?
Choosing among mutually exclusive projects
How can the IRR benchmark best be described?
The rate required by investors to compensate for a project's level of risk
Which one of these is an advantage of the net present value (NPV) method?
NPV can be used with both independent and mutually exclusive projects.
When does the IRR decision rule indicate rejection for projects with normal cash flows?
IRR < Required return
What is the internal rate of return (IRR)?
The implicit expected geometric average of a project's rate of return
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8%. What is the NPV?
$505.67.
Reason: CF0 = -1850; CF1 = 700; F1 = 1; CF2 = 1100; F2 = 2; CF3=900; F3 = 1; I = 8; NPV = -505.67
What is the NPV if the IRR equals the required return?
Zero
A project requires $28,900 in initial fixed assets and is expected to produce cash inflows of $0, $19,600, and $13,400 for years 1 to 3, respectively. How are the cash inflows input into a financial calculator?
CF0 = -28900; CF1 = 0; CF2 = 19600; CF3 = 13400
Why is the IRR formula set equal to zero?
By definition, IRR is the interest rate that makes the summation of the present values of all the cash flows equal zero.
A project costs $46,200 to implement and has expected cash flows of $6,800, $22,500, and $28,700 for years 1 to 3, respectively. What must the required rate of return be for the NPV to equal zero?
10.14 percent.
Reason: CF0 = -46200; CF1 = 6800; CF2 = 22500; CF3 = 28700; IRR; CPT; IRR = 10.14
Which one of these is the IRR benchmark?
required rate of return
A project has cash flows of -$400, $200, $200, -$100, $300, and -$50. How many x-axis intersection points will the NPV profile for this project have?
Four.
Reason: There are four sign changes, so there will be four intersection points and four IRRs.
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Based on IRR, when should an independent project with normal cash flows be accepted?
IRR > or = to the cost of capital
A project has an initial cost of $51,000 and cash inflows of $15,600, $21,400, $21,400, and $10,400 for years 1 to 4, respectively. The required return is 12.5 percent. Should the project be accepted or rejected
based on IRR and why?
Accept; The IRR is 13.76 percent.
A project is acceptable if it graphs at the x-axis intersection point on a NPV profile graph. Where else can the project graph and be acceptable? Assume normal cash flows.
To the left of and above the x-axis intersection point
A project has an initial cost of $38,000 and expected annual cash inflows of $14,500 for 5 years. How are the cash flows input into a financial calculator?
CF0 = --38000; CF1 = 14500; F1 = 5
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8%. What is the IRR?
22.29%
Reason: CF0 = -1850; CF1 = 700; F1 = 1; CF2 = 1100; F2 = 2; CF3=900; F3 = 1; I = 8; IRR = 22.29%
Why should the internal rate of return (IRR) not be used as the decision technique for projects with non-
normal cash flows?
Non-normal cash flows produce multiple IRRs so the accept/reject decision is questionable.
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When does the IRR decision rule indicate rejection for projects with normal cash flows?
IRR < Required return
The NPV profile graphs NPV as a function of what?
cost of capital
NPV assumes all cash inflows are reinvested at which rate?
Cost of capital, i
A project requires $28,900 in initial fixed assets and is expected to produce cash inflows of $0, $19,600, and $13,400 for years 1 to 3, respectively. How are the cash inflows input into a financial calculator?
CF0 = -28900; CF1 = 0; CF2 = 19600; CF3 = 13400
A project costs $46,200 to implement and has expected cash flows of $6,800, $22,500, and $28,700 for years 1 to 3, respectively. What must the required rate of return be for the NPV to equal zero?
10.14 percent.
Reason: CF0 = -46200; CF1 = 6800; CF2 = 22500; CF3 = 28700; IRR; CPT; IRR = 10.14
Which of the following do you require in order to calculate the NPV of a project?
Discount rate
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Which one of these best describes the NPV profile given non-normal cash flows?
The profile will switch from downward-sloping to upward-sloping at least once.
How are non-normal cash flows modified for MIRR purposes? Select all that apply.
All cash inflows are moved to the end of the project
All cash outflows are moved to time zero.
Based on IRR, when should an independent project with normal cash flows be accepted?
IRR > or = to the cost of capital
A project requires $7,800 of fixed assets. The expected cash flows are -$800 in year 1, $5,600 in year 2, and $7,600 in year 4. How are the cash flows modified prior to computing the MIRR if the cost of capital is 12 percent?
CF0 = -$7,800 + (-$800/1.12)
CF4 = ($5,600 × 1.122) + $7,600
IRR assumes all cash inflows are reinvested at which rate?
IRR
A project has an initial cost of $38,000 and expected annual cash inflows of $14,500 for 5 years. How are the cash flows input into a financial calculator?
CF0 = --38000; CF1 = 14500; F1 = 5
A Modified Internal Rate of Return (MIRR) is a rate of return on the Blank______, not the Blank______.
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modified set of cash flows; project's actual cash flows
In order to use the IRR to make a decision on whether to accept or reject the project you require the appropriate Blank______.
discount rate
Which of these requires modification so MIRR can be applied to non-normal cash flows?
All cash outflows that occur at any time other than time zero
A project has an initial cost of $300 and cash flows of $200, $500, and -$100 for years 1 to 3, respectively. Illustrate how the cash flows are modified prior to computing the MIRR. The cost of capital is 11 percent.
CF0 = -$300 + (-$100/1.113)
CF3 = ($200 × 1.112) + ($500 × 1.11)
You are considering two mutually exclusive projects, A and B. Which of these options do you have? Select all that apply.
Accept A, reject B
Reject both A and B
Accept B, reject A
NPV assumes all cash inflows are reinvested at which rate?
Cost of capital, i
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The cash flows for a project are: Time 0 = -$1,200; Time 1 = $400; Time 2 = $1,500; Time 3 = -$200. What
is the MIRR if the cost of capital is 9 percent?
15.93 percent.
Reason: CF0 = -$1,200 + (-$200/1.093); CF3 = ($400 × 1.092) + ($1,500 × 1.09); Calculator; CF0 = -1354.44; CF1 = 0, F1 = 2; CF2 = 2110.24; IRR; CPT; MIRR = 15.93
Which of the following do you require in order to calculate the NPV of a project?
Discount rate
How are non-normal cash flows modified for MIRR purposes? Select all that apply.
All cash inflows are moved to the end of the project
All cash outflows are moved to time zero.
You are considering three mutually exclusive projects. Which one of these options is immediately eliminated as a possible decision?
Accepting more than one project
IRR assumes all cash inflows are reinvested at which rate?
IRR
You are considering two mutually exclusive projects, projects A and B. The crossover point of the NPV profiles for these projects occurs in the first quadrant. The cost of capital is equal to the IRR of "A - B" cash flows. What should your accept decision be?
Accept either project A or B, but not both
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A Modified Internal Rate of Return (MIRR) is a rate of return on the Blank______, not the Blank______.
modified set of cash flows; project's actual cash flows
Assume the NPV profiles of mutually exclusive projects A and B cross in the first quadrant. What do you know about these projects?
At some costs of capital, Project A will be acceptable while at other rates B will be acceptable.
In order to use the IRR to make a decision on whether to accept or reject the project you require the appropriate Blank______.
discount rate
What is the crossover rate?
The cost of capital which causes two projects to have the same NPV
Which of these requires modification so MIRR can be applied to non-normal cash flows?
All cash outflows that occur at any time other than time zero
Which one of these is a weakness of MIRR?
MIRR ignores project sizes.
You are considering two mutually exclusive projects, A and B. Which of these options do you have? Select all that apply.
Accept A, reject B
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Reject both A and B
Accept B, reject A
Which one of these causes two projects to be mutually exclusive?
Both projects require use of the same asset
Which of these statements applies to a NPV profile of two mutually exclusive projects, with normal, but differing cash flows? Select all that apply.
The profiles will cross at some point.
One profile will have a steeper slope than the other profile.
Both profiles will be downward-sloping.
How can a crossover rate between two mutually exclusive NPV profiles be defined?
The rate that causes the NPV of the differences in the cash flows of two projects to equal zero
Which of these are strengths of the MIRR process? Select all that apply.
Non-normal cash flows can be converted into normal cash flows.
The reinvestment rate assumption is more reasonable than in the IRR process.
How can the profitability index (PI) be defined?
Dollar return per dollar invested
What is the profitability index (PI) accept rule?
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Accept when PI > or = 1
A project has an initial cost of $105,700 and a NPV of $11,200. The discount rate is 11 percent. Should this project be accepted or rejected based on PI and why?
Accepted; PI > 1
The profitability index (PI) is most closely associated with which other decision method?
Net present value (NPV)
Which of these project PI's indicate a reject decision? Select all that apply.
0
0.9
What does a PI of 1.2 indicate about a project?
The project returns $1.20 for every $1 invested
A project has an initial cost of $10,000 and a NPV of -$700. The discount rate is 5%. Should this project be accepted or rejected based on PI and why?
Rejected; PI < 1
What do you know for certain about PI if the NPV is positive and non-zero?
PI > 1
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A project has an initial cost of $15,000 and a PI of 1.15. Which of these is correct? Select all that apply.
The project earns more in today's dollars than it costs.
The project is expected to earn an economic profit.
The project has a positive NPV.
Why do firms purchase real assets in the form of capital equipment?
To create value for their customers
Which one of these capital budgeting techniques is preferred for most projects?
Net present value (NPV)
Which one of these methods best applies to a project when a firm is facing a time constraint?
Payback (PB)
Which of these affect the capital budgeting technique used to evaluate a project? Select all that apply.
Whether or not the firm must choose among various projects
Whether the project has normal or non-normal cash flows
The benchmark to be used for comparison purposes
Rate is the unit of measurement for which of these capital budgeting techniques? Select all that apply.
Profitability index (PI)
Modified internal rate of return (MIRR)
Internal rate of return (IRR)
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What type of return are firms seeking when considering a real asset project?
Economic profit
True or false: For most projects, net present value is the generally preferred method for making capital budgeting decisions.
True
If a firm is concerned about capital constraints and needs to prioritize its projects, which budgeting technique should the firm use?
Profitability index (PI)
Which one of these factors affects the capital budgeting technique used to analyze a project?
Whether or not the time value of money is to be considered
Which of these capital budgeting techniques use time as their unit of measurement? Select all that apply.
Payback (PB)
Discounted payback (DPB)
Why do firms purchase real assets in the form of capital equipment?
To create value for their customers
Rate-based decision statistics provide a rate of return based on which one of these?
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Each $1 of investment
Which one of these capital budgeting techniques is preferred for most projects?
Net present value (NPV)
An accept decision for an independent project does which one of these?
Has no affect on accept/reject decisions for other projects
Which one of these methods best applies to a project when a firm is facing a time constraint?
Payback (PB)
Which of these affect the capital budgeting technique used to evaluate a project? Select all that apply.
Whether or not the firm must choose among various projects
Whether the project has normal or non-normal cash flows
The benchmark to be used for comparison purposes
Rate is the unit of measurement for which of these capital budgeting techniques? Select all that apply.
Profitability index (PI)
Modified internal rate of return (MIRR)
Internal rate of return (IRR)
Rate-based decision statistics are popular because managers like to compare the expected rate of return to which one of these?
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Borrowing rates
What does the term "mutually exclusive projects" imply?
Only one of the two or more projects can be accepted.
If a firm is concerned about capital constraints and needs to prioritize its projects, which budgeting technique should the firm use?
Profitability index (PI)
Which steps are involved in the accept/reject decision process for mutually exclusive projects? Select all that apply.
Compare the statistic with the benchmark
Compute the project statistics
Identify the project with the best statistic
Which one of these factors affects the capital budgeting technique used to analyze a project?
Whether or not the time value of money is to be considered
Which of these capital budgeting techniques use time as their unit of measurement? Select all that apply.
Payback (PB)
Discounted payback (DPB)
Which one of these is the primary advantage of the payback method?
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Easy to compute
Rate-based decision statistics provide a rate of return based on which one of these?
Each $1 of investment
An accept decision for an independent project does which one of these?
Has no affect on accept/reject decisions for other projects
Which of these steps are required when deciding whether or not an independent project should be accepted? Select all that apply.
Compute the statistic
Compare the statistic to the benchmark
Which of these affect the capital budgeting technique used to evaluate a project? Select all that apply.
Whether or not the firm must choose among various projects
Whether the project has normal or non-normal cash flows
The benchmark to be used for comparison purposes
Which one of these sets of cash flows meets the definition of normal cash flows?
-$500, $200, $300, $400.
Reason: Normal cash flows have all outflows occurring at the beginning of the set.
Which of these apply to the payback method? Select all that apply.
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Easy to compute
Considers the total dollar cost of the initial investment
Rate-based decision statistics are popular because managers like to compare the expected rate of return to which one of these?
Borrowing rates
Which assumption is made by the payback statistic method?
The cash flows are normal.
What does the term "mutually exclusive projects" imply?
Only one of the two or more projects can be accepted.
A project has been assigned a maximum allowable payback period of 2.5 years. How is the reject decision expressed for this project?
PB > 2.5 years
Which steps are involved in the accept/reject decision process for mutually exclusive projects? Select all that apply.
Compare the statistic with the benchmark
Compute the project statistics
Identify the project with the best statistic
How are normal cash flows defined?
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All cash outflows occur at the beginning
Which one of these is the primary advantage of the payback method?
Easy to compute
A project has an initial cost of $900 and cash flows of $500, $800, and $200 over years 1 to 3, respectively. How is the payback period calculated?
PB = 1 + ($900 - $500)/$800
The payback method is based on which one of these assumptions?
The cash flows occur evenly throughout each time period.
Which one of these correctly states the accept rule for the payback statistic?
Accept any project that pays back within the maximum allowable period
Which of these steps are required when deciding whether or not an independent project should be accepted? Select all that apply.
Compute the statistic
Compare the statistic to the benchmark
Project A requires $22,500 in start-up costs. The cash flows for years 1 to 4 are $3,200, $7,800, $8,900, and $9,700, respectively. What is the payback statistic?
3.27 years.
Reason: PB = 3 + ($22,500 - $3,200 - $7,800 - $8,900)/$9,700 = 3.27 years
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Which one of these sets of cash flows meets the definition of normal cash flows?
-$500, $200, $300, $400.
Reason: Normal cash flows have all outflows occurring at the beginning of the set.
What is the discounted payback method designed to compute?
The time period required to return the initial investment plus interest
A project has an initial cost of $500 and cash flows of $100, $150, and $600 for years 1 to 3, respectively. How is the payback period calculated?
PB = 2 + ($500 - $100 - $150)/$600
Which assumption is made by the payback statistic method?
The cash flows are normal.
A project has been assigned a maximum allowable payback period of 2.5 years. How is the reject decision expressed for this project?
PB > 2.5 years
A project has an initial cost of $13,000. The cash flows for years 1 to 3 are $8,000, $6,000, and $4,000, respectively. Management has set a maximum allowable payback period of 2 years. Should the project be accepted or rejected based on payback? Why?
Accept; The payback period of 1.83 years is less than the requirement.
Reason:
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PB = 1 + ($13,000 - $8,000)/$6,000 = 1.83 years, which is less than the 2 year maximum allowable.
When is a cash flow not discounted when using the discounted payback method for project analysis?
When the cash flow occurs at time zero.
What is the key difference between discounted payback (DPB) and regular payback (PB)?
The time value of money is considered in DPB but not in PB.
A project has an initial cost of $900 and cash flows of $500, $800, and $200 over years 1 to 3, respectively. How is the payback period calculated?
PB = 1 + ($900 - $500)/$800
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8 percent. Should the project be accepted or rejected according to discounted payback (DPB) if the maximum allowable period is two years?
Rejected; DPB = 2.29 years.
Reason: DCF1 = $700/1.08 = $648.15; DCF2 = $1,100/1.082 = $943.07; DCF3 = $900/1.083 = $714.45; DPB = 2 + ($1,800 - $648.15 - $943.07)/$714.45 = 2.29 years
The payback method is based on which one of these assumptions?
The cash flows occur evenly throughout each time period.
How will the computation of a discounted payback (DPB) be affected if the discount rate is increased from 11 percent to 12 percent?
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The discounted cash inflows for all time periods will decrease causing the DPB period to increase.
The discounted cash inflows for all time periods will decrease causing the DPB period to increase.
Which one of these correctly states the accept rule for the payback statistic?
Accept any project that pays back within the maximum allowable period
A project has an initial cost of $5,200. The cash flows for years 1 to 3 are $2,800, $3,600, and $2,400, respectively. What is the discounted payback (DPB) at a discount rate of 12 percent?
1.94 years.
Reason: DCF1 = $2,800/1.12 = $2,500; DCF2 = $3,600/1.122 = $2,869.90; DPB = 1 + ($5,200 - $2,500)/
$2,869.90 = 1.94 years
Project A requires $22,500 in start-up costs. The cash flows for years 1 to 4 are $3,200, $7,800, $8,900, and $9,700, respectively. What is the payback statistic?
3.27 years.
Reason: PB = 3 + ($22,500 - $3,200 - $7,800 - $8,900)/$9,700 = 3.27 years
Which of these is a weakness of the payback method? Select all that apply.
The present value of the inflows is ignored.
All cash flows after the payback period are ignored.
Which of these statements represent differences between the discounted payback (DPB) and payback (PB)? Select all that apply.
Ease of computation
Length of maximum allowable period
Consideration of the time value of money
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What should the decision be if the maximum allowable discount period is less than the discounted payback (DPB) statistic?
Reject the project
A project has an initial cash flow of -$6,300 and cash flows of $3,800 a year for two years. How is the discounted payback (DPB) computed if the discount rate is 9 percent?
DCF1= $3,800/1.09 = $3,486.24; DCF2= $3,800/1.092 = $3,198.38; DPB = 1 + ($6,300 - $3,486.24)/
$3,198.38
A project has an initial cost of $10,000. The cash flows for years 1 to 3 are $3,000, $4,000, and $5,000, respectively. What is the discounted payback (DPB) at a discount rate of 12%?
Does not exist
Which one of these is a weakness of the payback method?
The time value of money is ignored.
What is the key difference between discounted payback (DPB) and regular payback (PB)?
The time value of money is considered in DPB but not in PB.
What is the accept decision rule for discounted payback (DPB)?
Accept when the DPB is equal to or less than the maximum allowable period
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How will the computation of a discounted payback (DPB) be affected if the discount rate is increased from 11 percent to 12 percent?
The discounted cash inflows for all time periods will decrease causing the DPB period to increase.
A project has an initial cost of $5,200. The cash flows for years 1 to 3 are $2,800, $3,600, and $2,400, respectively. What is the discounted payback (DPB) at a discount rate of 12 percent?
1.94 years.
Reason: DCF1 = $2,800/1.12 = $2,500; DCF2 = $3,600/1.122 = $2,869.90; DPB = 1 + ($5,200 - $2,500)/
$2,869.90 = 1.94 years
Which of these is a weakness of the payback method? Select all that apply.
The present value of the inflows is ignored.
All cash flows after the payback period are ignored.
Which of these statements represent differences between the discounted payback (DPB) and payback (PB)? Select all that apply.
Ease of computation
Length of maximum allowable period
Consideration of the time value of money
Which of these are weaknesses of the discounted payback (DPB) method? Select all that apply.
May cause an incorrect decision when comparing mutually exclusive projects
Works only for projects with normal cash flows
Ignores cash flows after the payback period
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What should the decision be if the maximum allowable discount period is less than the discounted payback (DPB) statistic?
Reject the project
A project has an initial cash flow of -$6,300 and cash flows of $3,800 a year for two years. How is the discounted payback (DPB) computed if the discount rate is 9 percent?
DCF1= $3,800/1.09 = $3,486.24; DCF2= $3,800/1.092 = $3,198.38; DPB = 1 + ($6,300 - $3,486.24)/
$3,198.38
A project has an initial cost of $10,000. The cash flows for years 1 to 3 are $3,000, $4,000, and $5,000, respectively. What is the discounted payback (DPB) at a discount rate of 12%?
Does not exist
Which one of these sets of cash flows for time periods 0 to 4, respectively, best illustrates a situation where the payback method is affected by a weakness? Assume the maximum allowable period is 3 years.
-$500, $100, $100, $100, $3,500
What does the net present value (NPV) of a project represent?
The expected increase in wealth from accepting a project
Which one of these is a weakness of the payback method?
The time value of money is ignored.
What value should be used to discount the cash flow that occurs in time period N when computing a net present value?
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(1 + i)N
Project A has a 5-year life and a payback period of 2.9 years. Project B has a 3-year life and a payback period of 2.8 years. The projects are mutually exclusive. The maximum allowable period is 3 years. The payback method will select project B. Why might this be an incorrect decision?
The cash flows after the payback period for Project A may be significantly higher than those of Project B.
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8 percent. Should the project be accepted or rejected according to discounted payback (DPB) if the maximum allowable period is two years?
Rejected; DPB = 2.29 years.
Reason: DCF1 = $700/1.08 = $648.15; DCF2 = $1,100/1.082 = $943.07; DCF3 = $900/1.083 = $714.45; DPB = 2 + ($1,800 - $648.15 - $943.07)/$714.45 = 2.29 years
Which one of these statements is correct?
A zero NPV indicates a project's discounted cash inflows equal the discounted cash outflows.
Which one of these sets of cash flows for years 0 to 3, respectively, best illustrates a weakness of the payback (PB) method? Assume the maximum allowable payback period is 3 years.
-$300, $100, $100, $100
What is the definition of net present value (NPV)?
NPV is a technique that generates a decision rule based on the total discounted values of a project's lifetime cash flows.
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In the NPV formula, what does CF0 represent?
The cash flow at time zero, or the project start-up costs
True or false: The benchmark value for net present value (NPV) is 1.
False
Which of these are weaknesses of the payback (PB) method of analysis? Select all that apply
Can cause incorrect decisions when projects are mutually exclusive
Ignores the time value of money
Ignores cash flows after the payback period
What does a positive net present value (NPV) represent?
A project more than covers all of its necessary costs
Which one of these sets of cash flows for time periods 0 to 4, respectively, best illustrates a situation where the payback method is affected by a weakness? Assume the maximum allowable period is 3 years.
-$500, $100, $100, $100, $3,500
Which of these statements is (are) correct? Select all that apply.
A negative NPV project might be acceptable if the discount rate can be lowered.
A negative NPV project should be rejected at the given discount rate.
What does the net present value (NPV) of a project represent?
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The expected increase in wealth from accepting a project
A project requires $23,400 in initial costs. The cash inflows for years 1 to 3 are $12,000, $0, and $18,000 respectively. The discount rate is 14 percent. Based on NPV, should the project be accepted or rejected and why?
Reject because the NPV is negative; NPV = -$724.20
Why is the NPV benchmark zero?
A zero NPV means a project can cover its costs as well as its required return.
Project A has a 5-year life and a payback period of 2.9 years. Project B has a 3-year life and a payback period of 2.8 years. The projects are mutually exclusive. The maximum allowable period is 3 years. The payback method will select project B. Why might this be an incorrect decision?
The cash flows after the payback period for Project A may be significantly higher than those of Project B.
Which one of these statements is correct?
A zero NPV indicates a project's discounted cash inflows equal the discounted cash outflows.
A project has an initial cash outflow of $600 followed by cash inflows of $200, $200, $400, and $500 over
years 1 to 4, respectively. The discount rate is 9 percent. Which one of these correctly represents part of the calculator input for computing the NPV?
F1 = 2
What is the accept decision rule for NPV?
Accept a project if it has a zero or positive NPV.
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A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8 percent. Should the project be accepted or rejected according to discounted payback (DPB) if the maximum allowable period is two years?
Rejected; DPB = 2.29 years.
Reason: DCF1 = $700/1.08 = $648.15; DCF2 = $1,100/1.082 = $943.07; DCF3 = $900/1.083 = $714.45; DPB = 2 + ($1,800 - $648.15 - $943.07)/$714.45 = 2.29 years
True or false: The benchmark value for net present value (NPV) is 1.
False
Which of these are weaknesses of the discounted payback (DPB) method? Select all that apply.
May cause an incorrect decision when comparing mutually exclusive projects
Works only for projects with normal cash flows
Ignores cash flows after the payback period
A project has an initial cost of $950 and produces cash inflows of $300, $400, and $400 over years 1 to 3,
respectively. The discount rate is 12 percent. What is the NPV?
-$78.55.
Reason: CF0 = -950; CF1 = 300; F1 = 1; CF2 = 400; F2 = 2; I = 12; NPV = -78.55
A project has an initial cost of $400 and cash inflows of $500 in year one and $300 in year two. Which of these correctly illustrates part of the calculator input?
F1 = 1
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Which one of these is an advantage of the net present value (NPV) method?
NPV can be used with both independent and mutually exclusive projects.
Which of these statements is (are) correct? Select all that apply.
A negative NPV project might be acceptable if the discount rate can be lowered.
A negative NPV project should be rejected at the given discount rate.
What is the internal rate of return (IRR)?
The implicit expected geometric average of a project's rate of return
A project requires $23,400 in initial costs. The cash inflows for years 1 to 3 are $12,000, $0, and $18,000 respectively. The discount rate is 14 percent. Based on NPV, should the project be accepted or rejected and why?
Reject because the NPV is negative; NPV = -$724.20
What is the NPV if the IRR equals the required return?
Zero
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8%. What is the NPV?
$505.67.
Reason: CF0 = -1850; CF1 = 700; F1 = 1; CF2 = 1100; F2 = 2; CF3=900; F3 = 1; I = 8; NPV = -505.67
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Project A has a 5-year life and a payback period of 2.9 years. Project B has a 3-year life and a payback period of 2.8 years. The projects are mutually exclusive. The maximum allowable period is 3 years. The payback method will select project B. Why might this be an incorrect decision?
The cash flows after the payback period for Project A may be significantly higher than those of Project B.
Which one of these is a situation that creates internal rate of return (IRR) problems?
Non-normal cash flows
Explain the disadvantage of the net present value (NPV) method
Uninformed managers may compare the NPV value to the cost of the project rather than to the benchmark value of zero.
Which of these defines the internal rate of return (IRR)? Assume the cash flows are normal. Select all that apply.
The interest rate that causes the NPV to equal zero.
The interest rate that causes NPV to equal (-1)(Cash flow at time 0)
Which one of these statements is correct for a project with normal cash flows?
NPV is positive only when IRR > Required return
A project has an initial cost of $950 and produces cash inflows of $300, $400, and $400 over years 1 to 3,
respectively. The discount rate is 12 percent. What is the NPV?
-$78.55.
Reason: CF0 = -950; CF1 = 300; F1 = 1; CF2 = 400; F2 = 2; I = 12; NPV = -78.55
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To solve for the IRR statistic, set NPV equal to:
Zero
The internal rate of return (IRR) should not be used in which one of these situations?
Choosing among mutually exclusive projects
How can the IRR benchmark best be described?
The rate required by investors to compensate for a project's level of risk
Which one of these is an advantage of the net present value (NPV) method?
NPV can be used with both independent and mutually exclusive projects.
When does the IRR decision rule indicate rejection for projects with normal cash flows?
IRR < Required return
What is the internal rate of return (IRR)?
The implicit expected geometric average of a project's rate of return
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8%. What is the NPV?
$505.67.
Reason: CF0 = -1850; CF1 = 700; F1 = 1; CF2 = 1100; F2 = 2; CF3=900; F3 = 1; I = 8; NPV = -505.67
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What is the NPV if the IRR equals the required return?
Zero
A project requires $28,900 in initial fixed assets and is expected to produce cash inflows of $0, $19,600, and $13,400 for years 1 to 3, respectively. How are the cash inflows input into a financial calculator?
CF0 = -28900; CF1 = 0; CF2 = 19600; CF3 = 13400
Why is the IRR formula set equal to zero?
By definition, IRR is the interest rate that makes the summation of the present values of all the cash flows equal zero.
A project costs $46,200 to implement and has expected cash flows of $6,800, $22,500, and $28,700 for years 1 to 3, respectively. What must the required rate of return be for the NPV to equal zero?
10.14 percent.
Reason: CF0 = -46200; CF1 = 6800; CF2 = 22500; CF3 = 28700; IRR; CPT; IRR = 10.14
Which one of these is the IRR benchmark?
required rate of return
A project has cash flows of -$400, $200, $200, -$100, $300, and -$50. How many x-axis intersection points will the NPV profile for this project have?
Four.
Reason: There are four sign changes, so there will be four intersection points and four IRRs.
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Based on IRR, when should an independent project with normal cash flows be accepted?
IRR > or = to the cost of capital
A project has an initial cost of $51,000 and cash inflows of $15,600, $21,400, $21,400, and $10,400 for years 1 to 4, respectively. The required return is 12.5 percent. Should the project be accepted or rejected
based on IRR and why?
Accept; The IRR is 13.76 percent.
A project is acceptable if it graphs at the x-axis intersection point on a NPV profile graph. Where else can the project graph and be acceptable? Assume normal cash flows.
To the left of and above the x-axis intersection point
A project has an initial cost of $38,000 and expected annual cash inflows of $14,500 for 5 years. How are the cash flows input into a financial calculator?
CF0 = --38000; CF1 = 14500; F1 = 5
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8%. What is the IRR?
22.29%
Reason: CF0 = -1850; CF1 = 700; F1 = 1; CF2 = 1100; F2 = 2; CF3=900; F3 = 1; I = 8; IRR = 22.29%
Why should the internal rate of return (IRR) not be used as the decision technique for projects with non-
normal cash flows?
Non-normal cash flows produce multiple IRRs so the accept/reject decision is questionable.
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When does the IRR decision rule indicate rejection for projects with normal cash flows?
IRR < Required return
The NPV profile graphs NPV as a function of what?
cost of capital
NPV assumes all cash inflows are reinvested at which rate?
Cost of capital, i
A project requires $28,900 in initial fixed assets and is expected to produce cash inflows of $0, $19,600, and $13,400 for years 1 to 3, respectively. How are the cash inflows input into a financial calculator?
CF0 = -28900; CF1 = 0; CF2 = 19600; CF3 = 13400
A project costs $46,200 to implement and has expected cash flows of $6,800, $22,500, and $28,700 for years 1 to 3, respectively. What must the required rate of return be for the NPV to equal zero?
10.14 percent.
Reason: CF0 = -46200; CF1 = 6800; CF2 = 22500; CF3 = 28700; IRR; CPT; IRR = 10.14
Which of the following do you require in order to calculate the NPV of a project?
Discount rate
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Which one of these best describes the NPV profile given non-normal cash flows?
The profile will switch from downward-sloping to upward-sloping at least once.
How are non-normal cash flows modified for MIRR purposes? Select all that apply.
All cash inflows are moved to the end of the project
All cash outflows are moved to time zero.
Based on IRR, when should an independent project with normal cash flows be accepted?
IRR > or = to the cost of capital
A project requires $7,800 of fixed assets. The expected cash flows are -$800 in year 1, $5,600 in year 2, and $7,600 in year 4. How are the cash flows modified prior to computing the MIRR if the cost of capital is 12 percent?
CF0 = -$7,800 + (-$800/1.12)
CF4 = ($5,600 × 1.122) + $7,600
IRR assumes all cash inflows are reinvested at which rate?
IRR
A project has an initial cost of $38,000 and expected annual cash inflows of $14,500 for 5 years. How are the cash flows input into a financial calculator?
CF0 = --38000; CF1 = 14500; F1 = 5
A Modified Internal Rate of Return (MIRR) is a rate of return on the Blank______, not the Blank______.
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modified set of cash flows; project's actual cash flows
In order to use the IRR to make a decision on whether to accept or reject the project you require the appropriate Blank______.
discount rate
Which of these requires modification so MIRR can be applied to non-normal cash flows?
All cash outflows that occur at any time other than time zero
A project has an initial cost of $300 and cash flows of $200, $500, and -$100 for years 1 to 3, respectively. Illustrate how the cash flows are modified prior to computing the MIRR. The cost of capital is 11 percent.
You are considering two mutually exclusive projects, A and B. Which of these options do you have? Select all that apply.
Accept A, reject B
Reject both A and B
Accept B, reject A
NPV assumes all cash inflows are reinvested at which rate?
Cost of capital, i
The cash flows for a project are: Time 0 = -$1,200; Time 1 = $400; Time 2 = $1,500; Time 3 = -$200. What
is the MIRR if the cost of capital is 9 percent?
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15.93 percent.
Reason: CF0 = -$1,200 + (-$200/1.093); CF3 = ($400 × 1.092) + ($1,500 × 1.09); Calculator; CF0 = -1354.44; CF1 = 0, F1 = 2; CF2 = 2110.24; IRR; CPT; MIRR = 15.93
Which of the following do you require in order to calculate the NPV of a project?
Discount rate
How are non-normal cash flows modified for MIRR purposes? Select all that apply.
All cash inflows are moved to the end of the project
All cash outflows are moved to time zero.
You are considering three mutually exclusive projects. Which one of these options is immediately eliminated as a possible decision?
Accepting more than one project
IRR assumes all cash inflows are reinvested at which rate?
IRR
You are considering two mutually exclusive projects, projects A and B. The crossover point of the NPV profiles for these projects occurs in the first quadrant. The cost of capital is equal to the IRR of "A - B" cash flows. What should your accept decision be?
Accept either project A or B, but not both
A Modified Internal Rate of Return (MIRR) is a rate of return on the Blank______, not the Blank______.
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modified set of cash flows; project's actual cash flows
Assume the NPV profiles of mutually exclusive projects A and B cross in the first quadrant. What do you know about these projects?
At some costs of capital, Project A will be acceptable while at other rates B will be acceptable.
In order to use the IRR to make a decision on whether to accept or reject the project you require the appropriate Blank______.
discount rate
What is the crossover rate?
The cost of capital which causes two projects to have the same NPV
Which of these requires modification so MIRR can be applied to non-normal cash flows?
All cash outflows that occur at any time other than time zero
Which one of these is a weakness of MIRR?
MIRR ignores project sizes.
Which of these cause two projects to be mutually exclusive? Select all that apply.
Both projects require use of the same machine. The combined cost of both projects exceeds the available funds. Market demand is limited to one product.
You are considering two mutually exclusive projects, A and B. Which of these options do you have? Select all that apply.
Accept A, reject B
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Reject both A and B
Accept B, reject A
Which one of these causes two projects to be mutually exclusive?
Both projects require use of the same asset
Which of these statements applies to a NPV profile of two mutually exclusive projects, with normal, but differing cash flows? Select all that apply.
The profiles will cross at some point.
One profile will have a steeper slope than the other profile.
Both profiles will be downward-sloping.
How can a crossover rate between two mutually exclusive NPV profiles be defined?
The rate that causes the NPV of the differences in the cash flows of two projects to equal zero
Which of these are strengths of the MIRR process? Select all that apply.
Non-normal cash flows can be converted into normal cash flows.
The reinvestment rate assumption is more reasonable than in the IRR process.
How can the profitability index (PI) be defined?
Dollar return per dollar invested
What is the profitability index (PI) accept rule?
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Accept when PI > or = 1
A project has an initial cost of $105,700 and a NPV of $11,200. The discount rate is 11 percent. Should this project be accepted or rejected based on PI and why?
Accepted; PI > 1
The profitability index (PI) is most closely associated with which other decision method?
Net present value (NPV)
Which of these project PI's indicate a reject decision? Select all that apply.
0
0.9
What does a PI of 1.2 indicate about a project?
The project returns $1.20 for every $1 invested
A project has an initial cost of $10,000 and a NPV of -$700. The discount rate is 5%. Should this project be accepted or rejected based on PI and why?
Rejected; PI < 1
What do you know for certain about PI if the NPV is positive and non-zero?
PI > 1
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A project has an initial cost of $15,000 and a PI of 1.15. Which of these is correct? Select all that apply.
The project earns more in today's dollars than it costs.
The project is expected to earn an economic profit.
The project has a positive NPV.
Why do firms purchase real assets in the form of capital equipment?
To create value for their customers
True or false: For most projects, net present value is the generally preferred method for making capital budgeting decisions.
True
Rate-based decision statistics provide a rate of return based on which one of these?
Each $1 of investment
Which of these apply to the payback method? Select all that apply.
Considers the total dollar cost of the initial investment
Easy to compute
What type of return are firms seeking when considering a real asset project?
economic profit
Which one of these correctly states the accept rule for the payback statistic?
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Accept any project that pays back within the maximum allowable period
Which one of these capital budgeting techniques is preferred for most projects?
net present value (NPV)
What is the discounted payback method designed to compute?
The time period required to return the initial investment plus interest
Rate-based decision statistics are popular because managers like to compare the expected rate of return to which one of these?
borrowing rates
A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8 percent. Should the project be accepted or rejected according to discounted payback (DPB) if the maximum allowable period is two years?
Rejected; DPB = 2.29 years
What does the term "mutually exclusive projects" imply?
Only one of the two or more projects can be accepted.
Which of these is a weakness of the payback method? Select all that apply.
All cash flows after the payback period are ignored.
The present value of the inflows is ignored.
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Which one of these is the primary advantage of the payback method?
easy to compute
A project has been assigned a maximum allowable payback period of 2.5 years. How is the reject decision expressed for this project?
PB > 2.5 years
When is a cash flow not discounted when using the discounted payback method for project analysis?
When the cash flow occurs at time zero
What is the definition of net present value (NPV)?
NPV is a technique that generates a decision rule based on the total discounted values of a project's lifetime cash flows.
What should the decision be if the maximum allowable discount period is less than the discounted payback (DPB) statistic?
reject the project
Which one of these is a weakness of the payback method?
time value of money is ignored
What does a positive net present value (NPV) represent?
A project more than covers all of its necessary costs
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What does the net present value (NPV) of a project represent?
The expected increase in wealth from accepting a project
Which one of these is an advantage of the net present value (NPV) method?
NPV can be used with both independent and mutually exclusive projects.
What is the accept decision rule for discounted payback (DPB)?
Accept when the DPB is equal to or less than the maximum allowable period
Which of these defines the internal rate of return (IRR)? Assume the cash flows are normal. Select all that apply.
The interest rate that causes the NPV to equal zero.
The interest rate that causes NPV to equal (-1)(Cash flow at time 0)
Why is the IRR formula set equal to zero?
By definition, IRR is the interest rate that makes the summation of the present values of all the cash flows equal zero.
What value should be used to discount the cash flow that occurs in time period N when computing a net present value?
(1 + i)N
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Which one of these statements is correct?
A zero NPV indicates a project's discounted cash inflows equal the discounted cash outflows.
How can the IRR benchmark best be described?
The rate required by investors to compensate for a project's level of risk
Explain the disadvantage of the net present value (NPV) method.
Uninformed managers may compare the NPV value to the cost of the project rather than to the benchmark value of zero.
Why should the internal rate of return (IRR) not be used as the decision technique for projects with non-
normal cash flows?
Non-normal cash flows produce multiple IRRs so the accept/reject decision is questionable.
What is the internal rate of return (IRR)?
The implicit expected geometric average of a project's rate of return
To solve for the IRR statistic, set NPV equal to
Zero
The NPV profile graphs NPV as a function of what?
cost of capital
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In the NPV formula, what does CF0 represent?
The cash flow at time zero, or the project start-up costs
How are non-normal cash flows modified for MIRR purposes? Select all that apply.
All cash outflows are moved to time zero.
All cash inflows are moved to the end of the project
Which one of these is the IRR benchmark?
required rate of return
You are considering two mutually exclusive projects, A and B. Which of these options do you have? Select all that apply.
Accept B, reject A
Accept A, reject B
Reject both A and B
A project has cash flows of -$400, $200, $200, -$100, $300, and -$50. How many x-axis intersection points will the NPV profile for this project have?
four
Which of these are strengths of the MIRR process? Select all that apply.
The reinvestment rate assumption is more reasonable than in the IRR process.
Non-normal cash flows can be converted into normal cash flows.
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A project is acceptable if it graphs at the x-axis intersection point on a NPV profile graph. Where else can the project graph and be acceptable? Assume normal cash flows.
To the left of and above the x-axis intersection point
The profitability index (PI) is most closely associated with which other decision method?
net present value (NPV)
Which of these requires modification so MIRR can be applied to non-normal cash flows?
All cash outflows that occur at any time other than time zero
You are considering three mutually exclusive projects. Which one of these options is immediately eliminated as a possible decision?
Accepting more than one project
Which one of these is a weakness of MIRR?
MIRR ignores project sizes.
What do you know for certain about PI if the NPV is positive and non-zero?
PI > 1
Which of these project PI's indicate a reject decision? Select all that apply.
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0
0.9
What is the profitability index (PI) accept rule?
Accept when PI > or = 1
Why do firms purchase real assets in the form of capital equipment?
To create value for their customers
Which one of these methods best applies to a project when a firm is facing a time constraint?
Payback (PB)
Rate-based decision statistics are popular because managers like to compare the expected rate of return to which one of these?
Borrowing rates
Reason:
Managers like to compare the expected rate of return to borrowing rates quoted by lenders
What does the term "mutually exclusive projects" imply?
Only one of the two or more projects can be accepted.
Which of these apply to the payback method? Select all that apply.
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Considers the total dollar cost of the initial investment
Easy to compute
What type of return are firms seeking when considering a real asset project?
Economic profit
If a firm is concerned about capital constraints and needs to prioritize its projects, which budgeting technique should the firm use?
Profitability index (PI)
Rate-based decision statistics provide a rate of return based on which one of these?
Each $1 of investment
A project has been assigned a maximum allowable payback period of 2.5 years. How is the reject decision expressed for this project?
PB > 2.5 years
Which one of these is the primary advantage of the payback method?
Easy to compute
Which of these statements represent differences between the discounted payback (DPB) and payback (PB)? Select all that apply.
Length of maximum allowable period
Ease of computation
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Consideration of the time value of money
What is the accept decision rule for discounted payback (DPB)?
Accept when the DPB is equal to or less than the maximum allowable period
Which one of these is a weakness of the payback method?
The time value of money is ignored.
Which one of these correctly states the accept rule for the payback statistic?
Accept any project that pays back within the maximum allowable period
What does the net present value (NPV) of a project represent?
The expected increase in wealth from accepting a project
In the NPV formula, what does CF0 represent?
The cash flow at time zero, or the project start-up costs
What is the key difference between discounted payback (DPB) and regular payback (PB)?
The time value of money is considered in DPB but not in PB.
What does a positive net present value (NPV) represent?
A project more than covers all of its necessary costs
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A project has an initial cost of $1,800 and cash flows of $700, $1,100, and $900 for years 1 to 3, respectively. The discount rate is 8 percent. Should the project be accepted or rejected according to discounted payback (DPB) if the maximum allowable period is two years?
Rejected; DPB = 2.29 years
Reason:
DCF1 = $700/1.08 = $648.15; DCF2 = $1,100/1.08^2 = $943.07; DCF3 = $900/1.08^3 = $714.45; DPB = 2 + ($1,800 - $648.15 - $943.07)/$714.45 = 2.29 years
Which of these is a weakness of the payback method? Select all that apply.
The present value of the inflows is ignored.
All cash flows after the payback period are ignored.
Why is the NPV benchmark zero?
A zero NPV means a project can cover its costs as well as its required return.
What is the definition of net present value (NPV)
NPV is a technique that generates a decision rule based on the total discounted values of a project's lifetime cash flows.
What value should be used to discount the cash flow that occurs in time period N when computing a net present value?
(1 + i)^N
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Which one of these is an advantage of the net present value (NPV) method?
NPV can be used with both independent and mutually exclusive projects.
Which one of these statements is correct?
A zero NPV indicates a project's discounted cash inflows equal the discounted cash outflows.
What should the decision be if the maximum allowable discount period is less than the discounted payback (DPB) statistic?
Reject the project
True or false: The benchmark value for net present value (NPV) is 1.
False
Which of these defines the internal rate of return (IRR)? Assume the cash flows are normal. Select all that apply.
The implicit expected geometric average of a project's rate of return
To solve for the IRR statistic, set NPV equal to
0
Explain the disadvantage of the net present value (NPV) method.
Uninformed managers may compare the NPV value to the cost of the project rather than to the benchmark value of zero.
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How can the IRR benchmark best be described?
The rate required by investors to compensate for a project's level of risk
Based on IRR, when should an independent project with normal cash flows be accepted?
IRR > or = to the cost of capital
A project has cash flows of -$400, $200, $200, -$100, $300, and -$50. How many x-axis intersection points will the NPV profile for this project have?
Four
Reason:
There are four sign changes, so there will be four intersection points and four IRRs.
Why is the IRR formula set equal to zero?
By definition, IRR is the interest rate that makes the summation of the present values of all the cash flows equal zero.
Which one of these is the IRR benchmark?
Required rate of return
When does the IRR decision rule indicate rejection for projects with normal cash flows?
IRR < Required return
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Given a set of normal cash flows, which shape does the NPV profile have?
Downward-sloping
Why should the internal rate of return (IRR) not be used as the decision technique for projects with non-
normal cash flows?
Non-normal cash flows produce multiple IRRs so the accept/reject decision is questionable.
How are non-normal cash flows modified for MIRR purposes? Select all that apply.
All cash outflows are moved to time zero.
All cash inflows are moved to the end of the project
You are considering three mutually exclusive projects. Which one of these options is immediately eliminated as a possible decision?
Accepting more than one project
A project is acceptable if it graphs at the x-axis intersection point on a NPV profile graph. Where else can the project graph and be acceptable? Assume normal cash flows.
To the left of and above the x-axis intersection point
Which one of these best describes the NPV profile given non-normal cash flows?
The profile will switch from downward-sloping to upward-sloping at least once.
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Which one of these is a weakness of MIRR?
MIRR ignores project sizes.
Which of these requires modification so MIRR can be applied to non-normal cash flows?
All cash outflows that occur at any time other than time zero
You are considering two mutually exclusive projects, A and B. Which of these options do you have? Select all that apply.
Accept B, reject A
Reject both A and B
Accept A, reject B
What do you know for certain about PI if the NPV is positive and non-zero?
PI > 1
What is the profitability index (PI) accept rule?
Accept when PI > or = 1
Which of these are strengths of the MIRR process? Select all that apply.
The reinvestment rate assumption is more reasonable than in the IRR process.
Non-normal cash flows can be converted into normal cash flows.
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How can the profitability index (PI) be defined?
Dollar return per dollar invested
Which of these project PI's indicate a reject decision? Select all that apply.
0
0.9
The profitability index (PI) is most closely associated with which other decision method?
Net present value (NPV)
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Related Documents
Related Questions
What is the typical discount rate used with the Net Present Value (NPV) when project risk is the same as firm risk?
Which capital budgeting methods should managers of firms use to evaluate a project? Why?
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Discuss the payback period, NPV (net present value), and IRR (internal rate of return) methods for capital budgeting analysis. What result does each method provide the user? What are the limitations of each of these methods? Which method would you find most useful in making the best investment decisions for your business and why?
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The cost of capital for a new project:
Multiple Choice
1.) is determined by the overall risk level of the firm.
2.) is dependent upon the source of the funds obtained to fund that project.
3.) is dependent upon the firm's overall capital structure.
4.) should be applied as the discount rate for all other projects considered by the firm.
5.) depends upon how the funds raised for that project are going to be spent.
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The duration of time within which the
investment made for the project will be
recovered by the net returns of the project is
known as
а.
Accounting rate of return method
b.
Payback period
С.
Net present value method
d.
Period of return
Capital budgeting is the process of evaluating
and selecting short-term investments that are
consistent with the firm's goal of maximizing
owners' wealth.
Select one:
True
False
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a. The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases.
b. An NPV profile graph shows how a project's payback varies as the cost of capital changes.
O c. An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital.
d. An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life.
e. We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV.
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Answer the following:
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a. Useful life of the project
b. The company's minimum required rate of return
c. The project's NPV
d. The project's annual cash flow
2. The payback criterion for capital investment decisionsa. is conceptually superior to the IRR criterion
b. takes into consideration the time value of money
c. gives priority to rapid recovery of cash
d. emphasizes the most profitable projects
3. What is an investor’s objective in financial statement analysis?a. To determine if the firm is risky
b. To determine the stability of earnings.
c. To determine changes necessary to improve future performance
d. To determine whether or not an investment is warranted by estimating a company’s future earnings stream
4. The current ratio isa. calculated by dividing current liabilities by current assets.…
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What is the connection between capital budgeting decisions and the enterprise’s cost of capital? Would an enterprise ever decide to embark on a project whose rate of return would be less than its cost of capital? Why or why not?
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Which of the statements below is TRUE regarding capital budgeting?
O A. Capital budgeting deals with how much to apportion spending on current assets.
O B. Projects with NPVS greater than the IRR should be accepted.
OC. We can find a project's NPV by simply taking the product of all of the project's undiscounted cash flows.
O D. Ceteris paribus, a lower cost of capital would increase a project's NPV.
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Explain what a discounted cash flow method of making capital budgeting decisions is. Why are discounted cash flow methods superior to other methods? What are the risks related to using discounted cash flow methods?
What a project profitability index? What does it measure? Why is it used?
What is the primary criticism of the payback and simple rate of return methods of making capital budget decisions? What are the benefits in using these methods? Should companies continue to use these methods? Why or why not?
What role, if any, should qualitative factors play in capital budgeting decisions? Explain your reasoning for your answer
Discuss some of the major benefits to be gained from budgeting.
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What is capital budgeting? Compare the advantages and disadvantages of various capital budgeting techniques. Do you think NPV is the best decision criterion and it can overcome the problems inherent in other methods? Justify your answer.
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How is the payback period used in capital budgeting?
Multiple Choice
As a measure of a project's risk
To determine the amount of funds that will be required in the
future
To measure the relationship between the project's return and
the company's cost of capital
None of the above
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1. In the context of capital budgeting, what is an opportunity cost?2. Given the choice, would a firm prefer to use MACRS depreciation or straight-line depreciation? Why?3. In our capital budgeting examples, we assumed that a firm would recover all of the working capital it invested in a project. Is this a reasonable assumption? When might it not be valid?4. Suppose a financial manager is quoted as saying, “Our firm uses the stand-alone principle. Because we treat projects like minifirms in our evaluation process, we include financing costs because they are relevant at the firm level.” Critically evaluate this statement.
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In considering the payback period, ____.
a.
it considers the time value of money in determining the maximum allowable time period
b.
it is based on cash flows both during and after the payback period
c.
it gives some indication of a project’s desirability from a liquidity viewpoint
d.
the maximum period allowed by a firm is a specific time period based on objective criteria
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Which methods of evaluating a capital investment project ignore the time value of money?
Multiple Choice
Net present volue and accounting rate of retum,
Accounting rate of return and internal rate of return.
Internal rate of return and payback perlod.
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now estimation
Capital budgeting analysis not only requires the evaluation of cash flows but also requires the understanding of the origin of those cash flows. Based
on your understanding of cash flows in a firm, answer the following questions:
The present value of
v can be used to determine the basis of a firm's value.
Ideally, capital budgeting analysis should take cash flows into account
Understanding the nature of projects
Capital budgeting analysis often involves decisions related to expansion projects and/or replacement projects. Based on your understanding of
expansion and replacement projects, answer the following:
If a clothing store opens a second retail location on the other side of town, this project would be considered
project.
What are sunk costs?
Alexander Industries owns a warehouse that it is not currently using. It could sell the warehouse for $300,000 or use the warehouse in a new project.
Should Alexander Industries include the value of the warehouse as part of the…
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Select all that are true with respect to the Cost of Capital.
Group of answer choices
The cost of capital is the discount rate to use when evaluating investment opportunities
There is one cost of capital for every firm, and that one rate should be used for evaluating all investment opportunities
The cost of capital for an asset is driven by an asset's riskiness
The cost of capital is driven by how we raise funds to pay for an investment opportunity
The cost of capital for a project is driven by the systematic risk of that project
When estimating the cost of capital for a project, it is the total risk of that project that matters
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Please describe NPV, IRR and their relationship.
How do you evaluate each for making an investment decision? That is, what is a favorable NPV and IRR for making an investment decision.
If you were developing a capital budgeting process at your employer, how would you prioritize your projects?
What is the NPV when IRR = WACC, IRR>WACC, and IRR<WACC?
There is a duplex for sale in Absecon for $700,000 at this time. It has 2 units that generate a total of $25,000 in gross rent. The property taxes are $4,000, commercial property insurance is $2,000, flood insurance is $1,000, and annual maintenance is $2,000. You expect to sell it in one year at a price growth of 0%. What is the NPV with a WACC of 10%.
Is the IRR greater or less than the WACC? Would you invest in this project and why?
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The decision process
Before making capital budgeting decisions, finance professionals often generate, review, analyze, select, and implement long-term investment
proposals that meet firm-specific criteria and are consistent with the firm's strategic goals.
Companies often use several methods to evaluate the project's cash flows and each of them has its benefits and disadvantages. Based on your
understanding of the capital budgeting evaluation methods, which of the following conclusions about capital budgeting are valid? Check all that apply.
O Managers have been slow to adopt the IRR, because percentage returns are a harder concept for them to grasp.
For most firms, the reinvestment rate assumption in the NPV is more realistic than the assumption in the IRR.
IRR
The discounted payback period improves on the regular payback period by accounting for the time value of money.
NPV
is the single best method to use when making capital budgeting decisions.
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The decision process
Before making capital budgeting decisions, finance professionals often generate, review, analyze, select, and implement long-term investment proposals that meet firm-specific criteria and are consistent with the firm’s strategic goals.
Companies often use several methods to evaluate the project’s cash flows and each of them has its benefits and disadvantages. Based on your understanding of the capital budgeting evaluation methods, which of the following conclusions about capital budgeting are valid? Check all that apply.
For most firms, the reinvestment rate assumption in the MIRR is more realistic than the assumption in the IRR.
The discounted payback period improves on the regular payback period by accounting for the time value of money.
Because the MIRR and NPV use the same reinvestment rate assumption, they always lead to the same accept/reject decision for mutually exclusive projects.
True or False: Sophisticated firms use only…
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The decision process
Before making capital budgeting decisions, finance professionals often generate, review, analyze, select, and implement long-term investment proposals that meet firm-specific criteria and are consistent with the firm’s strategic goals.
Companies often use several methods to evaluate the project’s cash flows and each of them has its benefits and disadvantages. Based on your understanding of the capital budgeting evaluation methods, which of the following conclusions about capital budgeting are valid? Check all that apply.
The discounted payback period improves on the regular payback period by accounting for the time value of money.
Managers have been slow to adopt the IRR, because percentage returns are a harder concept for them to grasp.
For most firms, the reinvestment rate assumption in the NPV is more realistic than the assumption in the IRR.
True or False: Sophisticated firms use only the NPV method in capital budgeting decisions.…
arrow_forward
Before making capital budgeting decisions, finance professionals often generate, review, analyze, select, and
implement long-term investment proposals that meet firm-specific criteria and are consistent with the firm's strategic
goals
Companies often use several methods to evaluate the project's cash flows and each of them has its benefits and
disadvantages. Based on your understanding of the capital budgeting evaluation methods, which of the following
conclusions about capital budgeting are valid? Check all that apply.
The discounted payback period improves on the regular payback period by accounting for the time value of
money
For most firms, the reinvestment rate assumption in the MIRR is more realistic than the assumption in the
IRR.
Managers have been slow to adopt the IRR, because percentage returns are a harder concept for them to
grasp
is the single best method to use when making capital budgeting decisions.
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Internal rate of return For the project shown in the following table, calculate the internal rate of return (IRR). Then indicate, for the project, the maximum cost of capital that the firm could have and still find the IRR acceptable.
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Related Questions
- What is the typical discount rate used with the Net Present Value (NPV) when project risk is the same as firm risk? Which capital budgeting methods should managers of firms use to evaluate a project? Why?arrow_forwardDiscuss the payback period, NPV (net present value), and IRR (internal rate of return) methods for capital budgeting analysis. What result does each method provide the user? What are the limitations of each of these methods? Which method would you find most useful in making the best investment decisions for your business and why?arrow_forwardDiscuss the connection between capital budgeting decisions and the enterprise’s cost of capital. Would an enterprise ever decide to embark on a project whose rate of return would be less than its cost of capital? Why or why not?arrow_forward
- The cost of capital for a new project: Multiple Choice 1.) is determined by the overall risk level of the firm. 2.) is dependent upon the source of the funds obtained to fund that project. 3.) is dependent upon the firm's overall capital structure. 4.) should be applied as the discount rate for all other projects considered by the firm. 5.) depends upon how the funds raised for that project are going to be spent.arrow_forwardThe duration of time within which the investment made for the project will be recovered by the net returns of the project is known as а. Accounting rate of return method b. Payback period С. Net present value method d. Period of return Capital budgeting is the process of evaluating and selecting short-term investments that are consistent with the firm's goal of maximizing owners' wealth. Select one: True Falsearrow_forwardWhich of the following statements is CORRECT? a. The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases. b. An NPV profile graph shows how a project's payback varies as the cost of capital changes. O c. An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital. d. An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life. e. We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV.arrow_forward
- Answer the following: 1. Calculating the payback period for a capital project requires knowing which of the following? a. Useful life of the project b. The company's minimum required rate of return c. The project's NPV d. The project's annual cash flow 2. The payback criterion for capital investment decisionsa. is conceptually superior to the IRR criterion b. takes into consideration the time value of money c. gives priority to rapid recovery of cash d. emphasizes the most profitable projects 3. What is an investor’s objective in financial statement analysis?a. To determine if the firm is risky b. To determine the stability of earnings. c. To determine changes necessary to improve future performance d. To determine whether or not an investment is warranted by estimating a company’s future earnings stream 4. The current ratio isa. calculated by dividing current liabilities by current assets.…arrow_forwardWhat is the connection between capital budgeting decisions and the enterprise’s cost of capital? Would an enterprise ever decide to embark on a project whose rate of return would be less than its cost of capital? Why or why not?arrow_forwardWhich of the statements below is TRUE regarding capital budgeting? O A. Capital budgeting deals with how much to apportion spending on current assets. O B. Projects with NPVS greater than the IRR should be accepted. OC. We can find a project's NPV by simply taking the product of all of the project's undiscounted cash flows. O D. Ceteris paribus, a lower cost of capital would increase a project's NPV.arrow_forward
- Explain what a discounted cash flow method of making capital budgeting decisions is. Why are discounted cash flow methods superior to other methods? What are the risks related to using discounted cash flow methods? What a project profitability index? What does it measure? Why is it used? What is the primary criticism of the payback and simple rate of return methods of making capital budget decisions? What are the benefits in using these methods? Should companies continue to use these methods? Why or why not? What role, if any, should qualitative factors play in capital budgeting decisions? Explain your reasoning for your answer Discuss some of the major benefits to be gained from budgeting.arrow_forwardWhat is capital budgeting? Compare the advantages and disadvantages of various capital budgeting techniques. Do you think NPV is the best decision criterion and it can overcome the problems inherent in other methods? Justify your answer.arrow_forwardHow is the payback period used in capital budgeting? Multiple Choice As a measure of a project's risk To determine the amount of funds that will be required in the future To measure the relationship between the project's return and the company's cost of capital None of the abovearrow_forward
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Recommended textbooks for you
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Managerial Accounting: The Cornerstone of Busines...
Accounting
ISBN:9781337115773
Author:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger
Publisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
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