Chap 7 NPV Flashcards
Why is a dollar received today worth more than a dollar received in the future?
Today’s dollar can be invested, yielding a greater amount in the future
According to the basic investment rule for NPV, a firm should ___.
- -accept a project if the NPV is greater than zero
- -reject a project if NPV is less than zero
- -be indifferent towards accepting a project if NPV is equal to zero.
THE IRR allows a manager to summarize the information about a project in a ___ rate of return.
single
What is the PI for a project with an initial cash outflow of $30 and subsequent cash inflows of $80 in Y1 and $20 Y2 if the dicount rate is 12%?
2.91
In general, NPV is___.
- negative for discount rates above the IRR.
- equal to zero when the discount rate equals the IRR
- positive for discount rates below the IRR
The discount rate is often referred to as ___.
an opportunity cost.
Arrange the steps involved in the discounted payback period in order starting with the first step.
- Discount the cash flows using the discount rate.
- Add the discounted cash flows.
- Accept if the discounted payback period is less than some pre-specified number of years.
What is NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%?
5.94
Accept a project if its NPV is ___ zero.
greater than
What does value additivity mean for a firm?
- The value of a firm is simply the combined value of a firm’s projects, divisions, and entities owned by the firm.
- The NPV values of individual projects can be added together.
The incremental IRR is used to account for the problem of ___ when evaluating project cash flows.
scale
The three attributes of NPV are that it:
- uses cash flows.
- discounts the cash flow properly
- uses all the cash flows of a project
Which of these are weaknesses of the AAR method of project analysis?
- arbitrary target rate
- use of accounting values rather than cash flows
- no account of timing
According to the basic IRR rule, we should ___ a project if the IRR is ___ than the discount rate.
- reject; less
- accept; greater
Internal rate of return (IRR) must be compared to the __ rate in order to determine the acceptability of a project.
discount
A firm evaluating two mutually exclusive projects can __.
- reject both projects
- reject one of the projects
- accept one of the projects
Accepting a positive NPV project will __ the stockholders by __ the value of the firm.
benefit; increasing
Capital rationing requires a company to ___.
limit their investments
What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?
9.70%
A project requires $240 of equipment that will be depreciated straight-line over the 3-year project life. What is the average investment for AAR purposes??
($240+160+80+0)/4=$120
NPV___ cash flows properly.
discounts
When cash flows are conventional, NPV is ___ if the discount rate is above the IRR.
negative
The decision rule for a project for which the first cash flow is an inflow and subsequent cash flows are negative states that we should __ the project when the IRR is ___ than the discount rate.
- accept; less
- reject; greater
Which of the following are weaknesses of the payback method?
- time value of money principles are ignored
- cash flows received after the payback period are ignored
- the cutoff date is arbitrary
According to Graham and Harvey’s 1999 survey of 392 CFOs, which two capital budgeting methods are most used by firms in the US and Canada?
- NPV
- IRR
The average accounting return is calculated as the average net income from a project divided by the __.
average book value of the investment
NPV, but not IRR, can be used in which of these situations?
- multiple changes in cash flow signs
- multiple internal rates of return
A firm evaluating two mutually exclusive projects can accept both projects. T/F
FALSE
The NPV of a project’s cash flows is divided by the ___ to calculate the profitability index.
initial investment
we can evaluate two mutually exclusive projects by comparing the incremental IRR to the
discount rate
The problems with scale in the profitability index can be corrected by using ___ analysis.
incremental
The discount rate assigned to a project reflects the ___.
- risk of the project
- opportunity cost to the investor
The discounted payback period has which of these weaknesses?
- Exclusion of some cash flows
- Arbitrary cutoff date
- Loss of simplicity as compared to the payback methodd
How does the timing and the size of cash flows affect the payback method? Assume the project does pay back within the project’s lifetime.
-An increase in the size of the first cash inflow will decrease the payback period, all else held constant.
NPV accounts for the size of the project, elliminating the effects of ___.
scale
A project with a cash outflow followed by three cash inflows will always have ___ internal rate of return.
one
Which set of cash flows may have multiple internal rates of return?
- -50,40,30,-5
- 20,-5,10,-40
Two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing.T/F
TRUE
When evaluating mutually exclusive projects, the profitability index has a problem with __.
scale
Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?
-discounted payback period
The property of value __ implies that the contribution of any project to a firm’s value is simply the NPV of the project.
additivity
If a project has multiple internal rates of return, which of the following methods should be used?
- MIRR
- NPV
