The payback period is the amount of time, rounded to the nearest year, which is required for a firm to recover the cost of a new asset.
Net present value is considered a sophisticated capital budgeting technique since it gives consideration to the time value of money.
The internal rate of return is the discount rate that equates the present value of the cash inflows of a project with its initial investment.
If the NPV of a project is zero, the IRR of that project will always be less than the firm's cost of capital.
The goal of the firm should be to use its budget to generate the highest possible internal rate of return for its cash inflows.
The NPV assumes that periodic cash inflows are invested at a rate equal to the firm's cost of capital.
A net present value profile is a graphical presentation of the NPV at various discount rates.
In reference to capital budgeting, risk is the chance that a project has a high degree of variability in the initial investment.
For conventional projects, the NPV and the IRR will always produce the same accept-reject decision.
The break-even cash inflow is the minimum level of cash inflow associated with a project to be acceptable.
The internal rate of return assumes that the periodic cash flows associated with a project will be reinvested at the project's IRR.
For stand-alone projects, the PI will always give the same accept/reject decision as NPV.
One of the weaknesses of the payback approach is that it assumes cash flows are reinvested at an interest rate which is generally too high.
One of the weaknesses of the IRR approach is multiple IRRs.
Theoretically, NPV is superior to all of the other decision methods.
One of the disadvantages of the payback methods (either regular or discounted) is that it considers all cash flows throughout the entire life of a project.
Assuming that the total cash flows are equal, the NPV of a project whose cash flows accrue relatively rapidly is more sensitive to changes in the discount rate than is the NPV of a project whose cash flows come in more slowly.
Other things held constant, an increase in the cost of capital discount rate will result in a decrease of a project's IRR.
The modified IRR (MIRR) always lead to the same capital budgeting decisions as the NPV methods.
If the IRR of normal Project X is greater than the IRR of mutually exclusive Project Y (also normal), we can conclude that the form will select X rather than Y if has a NVP > 0.
The ______ is the exact amount of time it takes the firm to recover its initial investment.
internal rate of return
net present value
payback period
certainty equivalent
A firm is evaluating a proposal which has an initial investment of $45,000 and has cash flows of $5,000 in year 1, $20,000 in year 2, $15,000 in year 3, and $10,000 in year 4. The payback period of the project is ____.
3.5 years
3 years
4 years
2.5 years
All of the following are examples of sophisticated capital budgeting techniques EXCEPT
annualized net present value
The _____ is the discount rate that equates the present value of the cash inflows with the initial investment.
cost of capital
average rate of return
opportunity cost
A firm with a cost of capital of 11% is evaluating four capital projects. The internal rate of return are as follows: Project / IRR 1 13% 2 10% 3 11% 4 15% The firm should
accept 4 and 1, and reject 2 and 3
accept 4, 1, and 3 and reject 2
accept 4 and reject 1,2,3
accept 3 and reject 1,2, and 4
The _____ is the minimum amount of return that must be earned on a project in order to leave the firm's value unchanged.
compound rate
discount rate
risk free interest rate
Project Initial Investment IRR NPV 1 $100,000 17% $50,000.00 2 $200,000 15% $10,000.00 3 $125,000 14% $30,000.00 4 $100,000 11% $(2,500.00) 5 $75,000 19% $25,000.00
Using the internal rate of return approach to ranking projects, which projects should the firm accept?
1,2,3, and 5
1,2, and 5
1,2, and 3
1,2,3,4, and 5
Using the net present value approach to ranking projects, which should be accepted?
A firm is evaluating an investment proposal which has an initial investment of $8,000 and a discounted cash flow valued at $6,000. The net present value of the investment is _____.
0
-$2,000
$2,000
$6,000
Comparing net present value and internal rate of return analysis _____.
always results in the same ranking of projects
always results in the same accept/reject decision
may result in differing ranking
both b and c are correct
Unlike the IRR criteria, the NPV approach assumes an interest rate equal to the _____.
market interest rate
project's internal rate of return
risk free rate of return
firm's cost of capital
Year Cash Inflow 1 $50,000 2 $65,000 3 $90,000
A firm has undertaken a project with an initial investment of $100,000. The firm's cost of capital is 14%. What is the NPV for the project?
$50,000
$32,486
$54,622
$76,549
A firm has undertaken a project with an initial investment of $100,000. The firm's cost of capital is 14%. What is the IRR for the project?
41%
46%
32%
22%
Initial investment: $75,000 Cost of capital: 14% Risk free rate: 6%
Year Cash Inflow Certainty Equivalent 1 $30,000 0.9 2 $35,000 0.8 3 $40,000 0.75
The certain cash inflow for year 1 is_____.
$31,800
$30,000
$27,000
Using the certainty equivalent method, the net present value for the project is _____.
$5,246
$581
$18,036
- $2,700
The objective of _____ is to select the group of projects that provide the highest overall net present value and does not require more dollars than are budgeted.
scenario analysis
simulation
capital rationing
sensitivity analysis
Mutually exclusive Cost of Capital 10% Project A Project B Length of cash inflows 5 7 NPV $12,000 $14000
What is the annualized net present value of project a and project b?
$3,165 and $2,876
$2,378 and $1,850
$2,986 and $4,197
$4,174 and $4,915
A project that has a coefficient of variation of zero is considered _____.
slightly risky
a bad investment
very risky
risk free
An increase in the risk adjusted discount rate will result in _____.
no change to the NPV
a decrease in the NPV
an increase in the NPV
an increase in the IRR
The amount by which the required discount rate exceeds the risk free rate is called the _____.
risk equivalent
risk premium
excess risk
market risk function
A major disadvantage of the payback period method is that it _____.
is useless as a risk indicator
ignores cash flows beyond the payback period
both
neither
If the NPV is negative, then which of the following must be true? The discount rate used is
equal to the internal rate of return
too high
greater than the IRR
too low
The internal rate of return of a capital investment
changes when the cost of capital changes
must exceed the cost of capital in order for the firm to accept the investment
is equal to the annual net cash flows divided by the project cost
is similar to the yield common stock
An insurance firm agrees to pay you $3,310 at the end of 20 years if you pay premiums of $100 per year at the end of each year of 20 years. Find the internal rate of return to the nearest whole percentage point.
9%
7%
5%
3%
You are considering the purchase of an investment that would pay you $5,000 per years 1-5, $3,000 per years 6-8, and $2,000 per year for years 9 and 10. if you require a 14% rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?
$15,819.27
$21,937.26
$32,415.85
$52,815.71
