# Finance Chapter 8

 • The net present value is best defined as the difference between an investment’s MARKET VALUE and COST. • The process of valuing an investment by discontinuing its future cash flows is called DISCOUNTED CASH FLOW VALUATION • The period of time it takes an investment to generate sufficient cash flows to recover its initial cost is called the PAYBACK PERIOD The average net income/ Average book value Average accounting return Discount rate that causes the net present value of a project to equal zero Internal Rate of Return The net present value profile is a graphical relationship of an investment’s: Discount rate and net present value The possibility that more than one discount rate can cause the net present value of a project to equal zero is referred to as: Multiple rates of return A mutually exclusive investment decision is defined as a situation where: An investment in a project A prohbitis you from investing in project B The present value of an investment’s cash inflows divided by the investment’s initial cost is called the : Profitability index Which of the following indicate that a project will produce a return equal to or greater than the required rate of return for that project? A positive NPV & NPV of 0 The net present value rule states that you should accept a project if the NPV is POSITIVE The net present value: -Is highly dependent upon the discount rate applied to an investment-Is a measure of the value created by undertaking an investment. The overall best method used to evaluate investments is: NPV NPV is : equal to zero when the discount rate used is the IRR When NPV = 0 it implies that an invesment Has no expected impact on shareholders A project has a NPV of 2500 and an initial cash outlay of 2500. This project’s: Required return < IRR The president of a firm is most concerned with creating value for the firm’s shareholders. Given this concern, the best method he or she should use to evaluate all proposed projects: NPV Which statement correctly states payback rule? The rule is floawed because it ignores all cash flows after some arbitrary point in time. The payback rule works best in evaluating: low cost project which pays back slowly The payback rule: -Is biased towards short-term projects-Helps limit possibly losses-Is biased towards liquidity Payback ignores: Time value of money Which method can be applied without using an interest rate? Payback Which method is biased towards liquidity and requires and arbitrary cutoff date? Payback Which one of the following methods has the least value from a financial point of view? Average accounting return Angie is evaluating a proposed project and wants to answer two questions: FIRST what is the market value of the project? SECOND how much profit will the project produce in relation to its book value? To answer these questions, Angie should use which one of the following sets of investment analysis methods? NPV and Average accounting return The Average Accounting Return Ignores Time Value Which method is biased on net income rather than cash flows? Average accounting rate of return. What can be interpreted as the breakeven financing rate that leads to a profitable project? Internal Rate of Return The internal rate of return can lead to faulty decisions: IF two projects are mutually exclusive You are considering a project which has an internal rate of return that is equal to the required return. This means that : Project is returning the minimal amount that is acceptable to you. The internal rate of return IS the minimal rate that produces and accept decision given the NPV rule IF a project has an internal rate of return that exceeds the required discount rate, the project should be accepted because the NPV is positive. The internal rate of return is best used to evaluate: A project with all positive cash inflows after the initial cash outlay IF a project has a conventional cash flows and a net present value equal to 1, then the internal rate of return ____ the required rate of return MUST BE GREATER THAN This is statement best expresses two mutually exclusive investments: Building either a gas station or a restaurant on a corner lot When evaluating two mutually exclusive investments, the best method to use is the NPV You are using NPV profile to compare two projects. At the point where the NPV of the two projects intersect, the: Relevant discont rate is called the crossover rate. For a project with conventional cash flows, a profitability index greater than 1 means that the: NPV is positive If managers only invest in projects that have a profitability index greater than 1.0: The firm will increase in value If a project with conventional cash flows has a profitablity index equal to 1.0, the project: -Will pay back during the life of the project-Will have an internal rate of return that equals the project’s required rate or return. Which one of the following will reveal the amount of cash in today’s dollars that a project will return for each dollar originally invested? Profitability Index Project Selection ambiguity can arise if you rely on the internal rate of return instead of the NPV when: There are mulitple internal rates of return Decision rules from best to worst in terms of overall usefulness in capital budgeting analysis for a project with convetional cash flows: NPV, IRR, Payback, Average Accounting rate of return. Method most appropriate for a low-level manager, who has no financial training, to use when evaluating small projects: PAYBACK The payback method of analysis is the most beneficial in which one of the following situations: A firm has free cash which can be invested but must be returned in time to meet a bond obligation two years from now. Which of the following is correct concerning the rules related to project analysis: The IRR can lead to faulty decisions if two mutually exclusive projects are of different sizes.
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