Ch7: NPV and Other Investment Rules

Question 1

Positive NPV benefits

NPV

Answer 1

the stockholders

Question 2

NPV raises the value of the firm

NPV

Answer 2

correct

Question 3

Discount rate is referred as opportunity cost

NPV

Answer 3

because it takes away the stockholders opportunity to invest in market

Question 4

Earnings shouldn’t be used in capital budgeting because they don’t represent cash

NPV

Answer 4

correct

Question 5

BIG companies use Payback method for small investment projects

PAYBACK

Question 6

NPV : uses cash flow, all relevant cash flows, and discounts them

Answer 6

correct

Question 7

Payback vs NPV

PAYBACK

Answer 7

payback know results faster vs NPV takes long time

Question 8

payback: firms with limited access to capital market use this method

PAYBACK

Question 9

Accpet < arbtitrrary limit set by company

payback

Question 10

PAYBACK: key terms

Answer 10

No value of money
no discouting
creating value to company - doesn’t care
Shoudn’t consider as primary criteria

Question 11

Big-ticket decisions , use NPV
small projects, use payback

PAYBACK

Question 12

Discounted payback: Discount the cashflows and do cut-off
It is poor compromise between the payback and NPV

Answer 12

yes

Question 13

AAR: Average accounting return
Total net income / Total investment

AAR

Answer 13

Total investment with depreciation. (500 + 400 + 300 + 200 + 100 + 0) / 6. For 5 years, it will be 5 +1.

Question 14

If company set AAR > 20 then 20 AAR will be rejected.

AAR

Answer 14

yes

Question 15

AAR drawbacks:

AAR

Answer 15

1. They use accounting data like netincome, book value.
2. They don’t take account of timing
3. No right target rate
4. Ignores time value of money
5. Not on cashflows and market values

Question 16

AAR will be used by some managers to select projects that are profitable in the near term even if they are not good long term

AAR

Answer 16

yes

Question 17

At which NPV becomes zero.

IRR

Answer 17

try with different discount rates and see where NPV becomes zero. That i

Question 18

Accept IRR > Discount Rate

IRR

Question 19

NPV will be positive for all discount rates < IRR

IRR

Question 20

IRR doesn’t use any external rates to calculate

IRR

Answer 20

yes

Question 21

Pros & Cons

Answer 21

Time value of money: yes
Creating value for the firm: yes
Decision criteria: Maybe
Adjust for risk: Yes