Chapter 7 Flashcards
Which of the following statements is false?
A) About 75% of firms surveyed used the NPV rule for making investment decisions.
B) If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate.
C) To decide whether to invest using the NPV rule, we need to know the cost of capital.
D) NPV is positive only for discount rates greater than the internal rate of return.
D
Which of the following statements is false?
A) In general, the difference between the cost of capital and the IRR is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision.
B) The IRR can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital.
C) If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate.
D) If the cost of capital estimate is more than the IRR, the NPV will be positive.
D
Which of the following statements is false?
A) The IRR investment rule will identify the correct decision in many, but not all, situations.
B) By setting the NPV equal to zero and solving for r, we find the IRR.
C) If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate.
D) The simplest investment rule is the NPV investment rule.
D
When using the internal rate of return (IRR) investment rule, we compare
A) the average return on the investment opportunity to returns on all other investment opportunities in the market.
B) the average return on the investment opportunity to returns on other alternatives in the market with equivalent risk and maturity.
C) the NPV of the investment opportunity to the average return on the investment opportunity.
D) the average return on the investment opportunity to the risk-free rate of return.
B
The internal rate of return rule can result in the wrong decision if the projects being compared have A) differences in scale. B) differences in timing. C) differences in NPV. D) A and B are correct.
D
Which of the following statements is false?
A) It is possible that an IRR does not exist for an investment opportunity.
B) If the payback period is less than a pre-specified length of time you accept the project.
C) The internal rate of return (IRR) investment rule is based upon the notion that if the return on other alternatives is greater than the return on the investment opportunity you should undertake the investment opportunity.
D) It is possible that there is no discount rate that will set the NPV equal to zero.
C
Which of the following statements is false?
A) The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea.
B) An IRR will always exist for an investment opportunity.
C) A NPV will always exist for an investment opportunity.
D) In general, there can be as many IRRs as the number of times the project’s cash flows change sign over time.
B
Which of the following statements is false?
A) In general, the IRR rule works for a stand-alone project if all of the project’s positive cash flows precede its negative cash flows.
B) There is no easy fix for the IRR rule when there are multiple IRRs.
C) The payback rule is primarily used because of its simplicity.
D) No investment rule that ignores the set of alternative investment alternatives can be optimal.
A
Which of the following statements is false?
A) Problems can arise using the IRR method when the mutually exclusive investments have different cash flow patterns.
B) The IRR is affected by the scale of the investment opportunity.
C) Multiple incremental IRRs might exist.
D) The incremental IRR rule assumes that the riskiness of the two projects is the same.
B
Which of the following statements is false?
A) The incremental IRR investment rule applies the IRR rule to the difference between the cash flows of the two mutually exclusive alternatives.
B) When a manager must choose among mutually exclusive investments, the NPV rule provides a straightforward answer.
C) The likelihood of multiple IRRs is greater with the regular IRR rule than with the incremental IRR rule.
D) Problems can arise using the IRR method when the mutually exclusive investments have differences in scale.
C
Which of the following statements is false?
A) When using the incremental IRR rule, you must keep track of which project is the incremental project and ensure that the incremental cash flows are initially positive and then become negative.
B) Picking one project over another simply because it has a larger IRR can lead to mistakes.
C) Problems arise using the IRR method when the mutually exclusive investments have differences in scale.
D) When the risks of two projects are different, only the NPV rule will give a reliable answer.
A
Which of the following statements is false?
A) The incremental IRR need not exist.
B) If a change in the timing of the cash flows does not affect the NPV, then the change in timing will not impact the IRR.
C) Although the incremental IRR rule can provide a reliable method for choosing among projects, it can be difficult to apply correctly.
D) When projects are mutually exclusive, it is not enough to determine which projects have positive NPVs.
B
Consider two mutually exclusive projects A & B. If you subtract the cash flows of opportunity B from the cash flows of opportunity A, then you should
A) take opportunity A if the regular IRR exceeds the cost of capital.
B) take opportunity A if the incremental IRR exceeds the cost of capital.
C) take opportunity B if the regular IRR exceeds the cost of capital.
D) take opportunity B if the incremental IRR exceeds the cost of capital.
B
You are trying to decide between three mutually exclusive investment opportunities. The most appropriate tool for identifying the correct decision is A) NPV. B) Profitability index. C) IRR. D) Incremental IRR.
A
Which of the following statements is false?
A) If there is a fixed supply of resource available, you should rank projects by the profitability index, selecting the project with the lowest profitability index first and working your way down the list until the resource is consumed.
B) Practitioners often use the profitability index to identify the optimal combination of projects when there is a fixed supply of resources.
C) If there is a fixed supply of resources available, so that you cannot undertake all possible opportunities, then simply picking the highest NPV opportunity might not lead to the best decision.
D) The profitability index is calculated as the NPV divided by the resources consumed by the project.
A
