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FINC515 > Chap 7 NPV > Flashcards

Chap 7 NPV Flashcards

1
Q

Why is a dollar received today worth more than a dollar received in the future?

A

Today’s dollar can be invested, yielding a greater amount in the future

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2
Q

According to the basic investment rule for NPV, a firm should ___.

A
  • -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.
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3
Q

THE IRR allows a manager to summarize the information about a project in a ___ rate of return.

A

single

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4
Q

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%?

A

2.91

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5
Q

In general, NPV is___.

A
  • negative for discount rates above the IRR.
  • equal to zero when the discount rate equals the IRR
  • positive for discount rates below the IRR
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6
Q

The discount rate is often referred to as ___.

A

an opportunity cost.

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7
Q

Arrange the steps involved in the discounted payback period in order starting with the first step.

A
  1. Discount the cash flows using the discount rate.
  2. Add the discounted cash flows.
  3. Accept if the discounted payback period is less than some pre-specified number of years.
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8
Q

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%?

A

5.94

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9
Q

Accept a project if its NPV is ___ zero.

A

greater than

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10
Q

What does value additivity mean for a firm?

A
  • 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.
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11
Q

The incremental IRR is used to account for the problem of ___ when evaluating project cash flows.

A

scale

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12
Q

The three attributes of NPV are that it:

A
  • uses cash flows.
  • discounts the cash flow properly
  • uses all the cash flows of a project
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13
Q

Which of these are weaknesses of the AAR method of project analysis?

A
  • arbitrary target rate
  • use of accounting values rather than cash flows
  • no account of timing
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14
Q

According to the basic IRR rule, we should ___ a project if the IRR is ___ than the discount rate.

A
  • reject; less

- accept; greater

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15
Q

Internal rate of return (IRR) must be compared to the __ rate in order to determine the acceptability of a project.

A

discount

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16
Q

A firm evaluating two mutually exclusive projects can __.

A
  • reject both projects
  • reject one of the projects
  • accept one of the projects
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17
Q

Accepting a positive NPV project will __ the stockholders by __ the value of the firm.

A

benefit; increasing

18
Q

Capital rationing requires a company to ___.

A

limit their investments

19
Q

What is the IRR for a project with an initial investment of $250 and subsequent cash inflows of $100 per year for 3 years?

A

9.70%

20
Q

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??

A

($240+160+80+0)/4=$120

21
Q

NPV___ cash flows properly.

A

discounts

22
Q

When cash flows are conventional, NPV is ___ if the discount rate is above the IRR.

A

negative

23
Q

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.

A
  • accept; less

- reject; greater

24
Q

Which of the following are weaknesses of the payback method?

A
  • time value of money principles are ignored
  • cash flows received after the payback period are ignored
  • the cutoff date is arbitrary
25
Q

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?

A
  • NPV

- IRR

26
Q

The average accounting return is calculated as the average net income from a project divided by the __.

A

average book value of the investment

27
Q

NPV, but not IRR, can be used in which of these situations?

A
  • multiple changes in cash flow signs

- multiple internal rates of return

28
Q

A firm evaluating two mutually exclusive projects can accept both projects. T/F

A

FALSE

29
Q

The NPV of a project’s cash flows is divided by the ___ to calculate the profitability index.

A

initial investment

30
Q

we can evaluate two mutually exclusive projects by comparing the incremental IRR to the

A

discount rate

31
Q

The problems with scale in the profitability index can be corrected by using ___ analysis.

A

incremental

32
Q

The discount rate assigned to a project reflects the ___.

A
  • risk of the project

- opportunity cost to the investor

33
Q

The discounted payback period has which of these weaknesses?

A
  • Exclusion of some cash flows
  • Arbitrary cutoff date
  • Loss of simplicity as compared to the payback methodd
34
Q

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.

A

-An increase in the size of the first cash inflow will decrease the payback period, all else held constant.

35
Q

NPV accounts for the size of the project, elliminating the effects of ___.

A

scale

36
Q

A project with a cash outflow followed by three cash inflows will always have ___ internal rate of return.

A

one

37
Q

Which set of cash flows may have multiple internal rates of return?

A
  • -50,40,30,-5

- 20,-5,10,-40

38
Q

Two challenges with the IRR approach when comparing two mutually exclusive projects are scale and cash flow timing.T/F

A

TRUE

39
Q

When evaluating mutually exclusive projects, the profitability index has a problem with __.

A

scale

40
Q

Which capital budgeting decision method finds the present value of each cash flow before calculating a payback period?

A

-discounted payback period

41
Q

The property of value __ implies that the contribution of any project to a firm’s value is simply the NPV of the project.

A

additivity

42
Q

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

A
  • MIRR

- NPV

FINC515 (6 decks)

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