Chapter 11

Question 1

refers to long term assets used in production

Answer 1

capital

Question 2

plan that outlines projected expenditures during some future period

Answer 2

budget

Question 3

summary of planned investment in long term assets

Answer 3

capital budget

Question 4

process of planning expenditures on assets with cash flows that are expected to extend beyond 1 year

Answer 4

capital budgeting

Question 5

capital budgeting uses same concepts used in

Answer 5

security valuation

Question 6

stocks and bond exist in the security markets, and investors select from the available set
investors have no influence on the cash flows produced by their investments

Answer 6

security valuation

Question 7

firms, create capital budgeting projects
corporations have major influence on projects’ results

Answer 7

capital budgeting

Question 8

similarities of stock valuation and capital budgeting

Answer 8

1. forecast set of cash flows
2. find the present value of those flows
3. pv of the inflows > investment’s cost

Question 9

criteria for deciding to accept or reject projects

Answer 9

1. Net present value
2. Internal Rate of return
3. modified internal rate of return
4. regular payback
5. discounted payback

Question 10

a method of ranking investment proposals using the npv, which is equal ro the pv of future net cash flows, discounted at the cost of capital

Answer 10

NPV

Question 11

tells how much a project contributes to shareholder wealth

Answer 11

NPV

Question 12

high discount rate will lead to __ NPV

Answer 12

lower

Question 13

larger NPV = ____ project adds

Answer 13

more value

Question 14

NPV FORMULA

Answer 14

NPV = CF0 + CFN / (1+r )^N

Question 15

types of decision rules

Answer 15

1. independent projects
2. mutually exclusive projects

Question 16

projects whose cash flows are note affected by one another

Answer 16

independent project

Question 17

independent projects

Answer 17

NPV > 0 => Accept

Question 18

projects where if one project is accepted, the other must be rejected

Answer 18

Mutually exclusive projects

Question 19

mutually exclusive projects accept

Answer 19

• highest positive NPV
• if no project is positive - reject all

Question 20

it is the discount rate that forces the pv of inflows to equl the cost. (npv = 0)

Answer 20

internal rate of return

Question 21

if IRR>cost of fund

Answer 21

difference will be a bonus to a stockholders and cause stock price to rise

Question 22

independent projects accept

Answer 22

IRR > WACC

Question 23

mutually exclusive project accept

Answer 23

project with highest IRR

Question 24

a graph showing the relationship between a project’s NPV and fhe firm’s cost of capital

Answer 24

NPV Profiles

Question 25

npv profiles x and y axes

Answer 25

x axis - discount rate y axis - NPV

Question 26

the rate of return at which rhe NPVs of two projects are equal

Answer 26

crossover rate

Question 27

useful in capital budgeting analysis because it tells the investing company about the cost of capital at which both of the mutually exclusive projects are equally good

Answer 27

npv profiles

Question 28

limitations of IRR

Answer 28

1. unconventional cash flows 2. reinvestment assumption (npv calculation is based on the assumption that cash inflows can be reinvested at the projects risk adjusted wacc

Question 29

assumes that positive cash flows are reinvested at the firm's cost of capital and that negative cash flows are financed at the firm's financing cost

Answer 29

MIRR

Question 30

MIRR FORMULA

Answer 30

[nth root of FV (reinvestment rate)/ -PV (finance cost)] - 1

Question 31

evaluating true ratw of return

Answer 31

MIRR > IRR

Question 32

choosing among competing projects

Answer 32

NPV > IRR and MIRR

Question 33

the length of time required for an investment's net revenues to cover its cost

Answer 33

payback period

Question 34

payback formula

Answer 34

no. of years prior to full recovery + (unrecovered cost at start of year/CF during full recovery) assumes unifoem CF

Question 35

payback note

Answer 35

shorter the payback, better the project

Question 36

advantages of payback period

Answer 36

- easy to understand - adjust for uncerrainy of later CF - biased towards liquidity

Question 37

disadvantages if payback period

Answer 37

- ignores time value of money - requires an arbitrary cutoff point - ignores cf beyond the cutoff date - biased against long term projects, such as research and development, and new projects

Question 38

the length of time required for an investment's cash flows, discounted at the investment's cost of capital, to cover its costs

Answer 38

discounted payback

Question 39

it is used as part of capital budgeting to determine which projects to take on

Answer 39

discounted payback

Question 40

more accurate because discounted payback period factors in the

Answer 40

time value of money

Question 41

accept/reject decisions, large, sophisticated firms

Answer 41

all five measures

Question 42

provides direct measure of value the project adds to shareholder wealth

Answer 42

NPV

Question 43

measure profitability

Answer 43

IRR and MIRR

Question 44

contain information concerninf project's safety margin

Answer 44

percentage rate of return

Question 45

is better indicator to know projects' rates if return

Answer 45

MIRR

Question 46

provide indications if project's liquidity and risk

Answer 46

payback and discounted payback

Question 47

means relatively illiquid and riskier than one with a shorter payback

Answer 47

long payback

Question 48

it is the best single criterion, but all of the methods provide useful information and all are easy to calculate, thus all are used along with judgement and common sense

Answer 48

NET PRESENT VALUE