gyu mcps before final Flashcards
hen will NPV and IRR have different rankings when we evaluate two mutually exclusive projects? IRRA < IRRB.
a) Discount rate (k) < crossover rate
b) Discount rate (k) < IRRA
c) Discount rate (k) > crossover rate
d) Discount rate (k) > IRRB
a) Discount rate (k) < crossover rate
advantages of payback period
- Determines how long it takes for the project cash flows to add up to the investment
- Useful to gauge the possible liquidity impact of the project (how long is the firm’s capital tied up in the project)
- Easy to calculate, quick “back-of-the-envelope” type of calculation
advantages of the IRR
- Determines the rate of return at which the NPV = 0. Intuitively, it is the rate of return promised by the project
- Easy to interpret and compare to other projects
Malcolm, a very junior reporter, has asked for your help with his first article for a major national newspaper. He has provided you with the following excerpt from his article and would like your comments:
The BathGate Group, one of the few all-equity firms left in Canada, has recently built a widget-manufacturing plant in Whitby. The firm has invested $1 million and, according to our sources, the promised return on the investment (IRR) is over 27 percent! The shareholders of the firm must be ecstatic—they are currently only receiving a return of 10 percent. Just think—in 10 years the value of the plant is expected to be close to $11 million.
What is Malcolm assuming about the reinvestment rate? Does it make sense?
Malcolm is assuming that the investors (or the company) will be able to reinvest any cash generated by the project at 27%.
If the investors required a return of 10%, it would seem unlikely that they will be able to find another project that pays 27% with the same risk.
For example, investors require 10% for a project with a risk of X.
Malcolm is assuming that the investors can find another project with risk X that returns 27%. This is unlikely.
Malcolm, a very junior reporter, has asked for your help with his first article for a major national newspaper. He has provided you with the following excerpt from his article and would like your comments:
The BathGate Group, one of the few all-equity firms left in Canada, has recently built a widget-manufacturing plant in Whitby. The firm has invested $1 million and, according to our sources, the promised return on the investment (IRR) is over 27 percent! The shareholders of the firm must be ecstatic—they are currently only receiving a return of 10 percent. Just think—in 10 years the value of the plant is expected to be close to $11 million.
Are the shareholders necessarily happy with this decision?
Malcolm is assuming that the risk of the project is the same as the risk of the firm. If the risk is much higher, which is likely given the high promised rate of return, the investors may be very unhappy. For example, if they require a return of 30% for projects with a comparable level of risk, then they will be very unhappy with the firm accepting a project that is only expected to return 27%.
The internal rate of return (IRR) is:
a) the opportunity cost of the capital invested in the project.
b) the discount rate that sets the FV of future CFs equal to the initial cash outlay.
c) the discount rate that makes the NPV greater than zero for a given set of cash flows.
d) the economic rate of return of a given project
d) the economic rate of return of a given project
What is the discounted payback period of a project whose profitability index is higher than 1?
a) Less than the project lifetime
b) Equal to the project lifetime
c) Greater than the project lifetime
d) Not enough information to answer the question
a) Less than the project lifetime
what type of costs are R and D costs?
sunk costs
do not include in the¡he initial cost (C0)
Which of the following items is not included in the calculation of the ending (or terminal) cash flow (ECFn)?
a) Salvage value
b) Change in inventory levels
c) Change in accounts receivable levels
d) Operating cash flows
d) Operating cash flows
Which of the following statements is false?
a) CCA recapture occurs when the salvage value is greater than the ending UCC for the asset or asset class.
b) Capital gains occur when the salvage value is greater than the original cost of the asset.
c) CCA recapture is taxable.
d) A terminal loss occurs when the salvage value is greater than the ending UCC for the asset or asset class.
d) A terminal loss occurs when the salvage value is greater than the ending UCC for the asset or asset class.
irms A and B are competing for a project. The potential client has provided the following information on a hypothetical project: initial cost is $500,000; building renovation is $600,000; and the building cannot be rented due to the project (currently the building is vacant). Firm B has made the following statement to the board of directors:
We have conducted an extensive analysis of the project and have concluded that your decision should consider the initial cost of $500,000 only. The $600,000 spent on renovations will not affect future cash flow; therefore we can ignore it. The potential rental revenue should be ignored also, as the building is currently empty and therefore is not a cost of this project.
The board of directors has asked for your comments on firm B’s statement.
Firm B is partially correct
To evaluate any project, we have to ignore sunk costs (the $600,000 is a sunk cost) and take into account opportunity costs (i.e., projects foregone) in determining the incremental costs
Therefore, the analysis should take into account the initial costs and the foregone rents, but not the $600,000 sunk renovation costs
costs we should not include in the capital budgeting decisions
dividends and interest payments
sucks costs
extexnelaties
