Chapter 12

Question 1

what are measures to evaluate capital budget projects

Answer 1

NPV, IRR, MIRR

Question 2

what is NPV

Answer 2

sum of all PV’s of all CFs or net gain in wealth

it is direct measure of dollar benefit

Question 3

what does a projects NPV have to be to accept it

Answer 3

positive

Question 4

what is NPV dependent on

Answer 4

the cost of capital

Question 5

what is the IRR

Answer 5

the discount rate that forces PV inflows to equal cash and your NPV to equal 0

Question 6

What does IRR measure

Answer 6

how much rate of return a project will give you

Question 7

If IRR > r, then…

Answer 7

the projects return is greater than its costs

Question 8

what is the reason IRR and NPV might not give us the same decision

Answer 8

non-normal cash flows
mutually exclusive projects

Question 9

what are normal cash flows

Answer 9

cash flow signs start negative then are followed by a positive

Question 10

what are non normal cash flows

Answer 10

two or more of the cash flows change from positive or negative

Question 11

what are mutually exclusive projects

Answer 11

if you choose one you can’t choose the other

Question 12

what are independent projects

Answer 12

two projects that are not mutally exclusive

Question 13

what is the crossover point

Answer 13

the point where two mutually exclusive projects have the same r and NPV

Question 14

what are two reasons NPV profiles cross

Answer 14

• size difference of CF
• timing difference of CF

Question 15

is NPV always the most important

Answer 15

yes

Question 16

when is IRR unreliable

Answer 16

where there is non conventional cash flows and when projects are mutually exclusive

Question 17

What is MIIR

Answer 17

the modified internal rate of return is the discount rate that causes the PV of costs to grow to a project terminal value

also avoids multiple rate of return problem

Question 18

what is the terminal value

Answer 18

FV of cash inflows

Question 19

what does MIRR assume

Answer 19

that cash flows are reinvested at WAAC

Question 20

Is MIRR or IRR better?

Answer 20

MIRR because it correctly assumes reinvestment at opportunity cost and gives managers a better rate of return comparison

Question 21

what is the profitibility index?

Answer 21

the present value of future cash flows divided by the initial cost

Question 22

what does a profitability of 1.1 suggest

Answer 22

that for every $1 of investment, an additional 10 cents of value is created

Question 23

what is the payback period

Answer 23

the number of years that is required to recover a projects cost

“how long it takes to get money back”

Question 24

what are strengths of payback

Answer 24

1. provide an indication of the risk and liquidity of a project
2. easy to calculate and understand

Question 25

what are weaknesses of payback

Answer 25

• ignore the TVM
• ignores CF’s occurring after the payback period
• No specification of acceptable payback

Question 26

what does PI measure

Answer 26

profitability relative to the cost of the project

• shows project risk

Question 27

what does payback measure

Answer 27

risk and liquidity

Question 28

what do discounted paybacks use

Answer 28

discounted CFs