FIN 3113 Chapter 9 – Flashcards
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In capital budgeting, the net ______ determines the value of a project to the company.
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Present Value
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If NPV is positive, the project should be ______.
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Accepted
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If NPV is negative, the project should be _______.
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Rejected
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3 attributes of NPV are that it:
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uses all the cash flows of a project, uses cash flows, & discounts the cash flows properly.
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Length of time until the sum of the discounted cash flows is equal to the initial investment.
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Discounted payback period
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Capital budgeting method allows lower management to make smaller, everyday financial decisions effectively.
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Payback method
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Weaknesses of the payback method
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cash flows received after the payback period are ignored, time value of money principles are ignore, cutoff date is arbitrary
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Capital budgeting decision method finds the present value of each cash flow before calculating a payback period
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Discounted payback period
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Discounted payback rule has an objective benchmark to use in decision making. True/False
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False
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Payback period tells the time it takes to break even in an _________ sense.
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Accounting
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Discounted payback period tells the time it takes to break even in an _______or financial sense.
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Economic
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When cash flows are conventional, NPV is ______.
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Positive for discount rates below the IRR, equal to zero when the discount rate equals the IRR, and negative for discount rates above the IRR.
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The IRR rule can lead to bad decisions when _____ or ______.
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Projects are mutually exclusive, cash flows are not conventional.
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The point at which the NPV profile crosses the horizontal axis is the:
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Internal Rate of Return
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Mutually exclusive investment decisions
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a situation in which taking one investment prevents the taking of another.
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Mutually exclusive investments
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2 different choices for the assembly lines that will make the same product, & a restaurant or gas station on the same piece of land.
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Weaknesses of Discounted payback period
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Arbitrary cutoff date, exclusion of some cash flows, and loss of simplicity as compared to the payback method
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When cash flows are conventional, NPV is ________ if the discount rate is above the IRR.
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Negative
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The present value of all cash flows after the initial investment is divided by the _____to calculate the profitability index.
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initial investment
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Some projects, such as mines, have cash outflows followed by cash inflows, which are then followed by cash outflows, giving the project multiple rates of return.
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True
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If a project has multiple internal rates of return, which of the following methods should be used?
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NPV & MIRR
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According to the basic IRR rule, we should____
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reject a project if the IRR is less than the required return.
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The crossover rate is the rate at which the NPV's of 2 projects are equal.
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True
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IRR is 14%, if required return is 14%, the project's NPV is:
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Zero
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Budgeting methods are most used by the firms in the US and Canada
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IRR & NPV
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Point at which the NPV profile crosses the vertical axis is the:
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Sum of the cash flows of the project.
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Investing more money in a project is a guarantee of greater profits.
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False
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NPV accounts for the size of the project and eliminates the effects of _______
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Scale
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Decision making process for accepting and rejecting projects
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Capital budgeting
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An ______ project does not rely on the acceptance or rejection of another project
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Independent
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How does the timing and the size of cash flows affect the payback method?
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An increase in the size of the first cash inflow will decrease the payback method, all else held constant
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IRR is the discount rate that makes the NPV of a project equal to _______.
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zero
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Most important alternative to NPV is the ____ method.
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IRR
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Point at which the NPV profile crosses the horizontal axis is the:
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IRR
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IRR continues to be very popular in practice, partly because:
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gives a rate of return rather than a dollar value
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Amount of time needed for the cash flows from an investment to pay for its initial cost is the:
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payback period
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Profitability index is calculated by dividing the PV of the ______ CF by initial investment.
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Future
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Two challenges with the IRR approach when comparing 2 mutually exclusive projects are scale and cash flow timing.
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True
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The payback period rule ____ a project if it has a payback period that is less than or equal to a particular cutoff date.
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Suggests accepting
