| International Rate of Return | The discount rate at which NPV equals zero |
| The discount rate used to value capital investments is often referred to as ________. | Opportunity Cost of Capital |
| A positive NPV investment _______________ which a negative NPV investment ____________________ | builds shareholder value; destroys shareholder value |
| Since a risky dollar is worth less than a safe one, returns for risky projects must be ____________ than those of a risk-free investment. | higher |
| What is the NPV of a project with an initial investment of $95, a cash flow in one year of $107, and a discount rate of 6%? (Be sure to record initial investment as a negative number.) | $5.94 |
| If two projects (investments) A and B are said to be mutually exclusive then we know that the firm ______________ | must choose to invest in either A or B, but not both |
| When choosing mutually exclusive projects, choose the one that offers the ____________________ | highest NPV |
| A project has an initial investment of $125,000 and cash flows of $50,000 per year for 3 years. What is the project’s internal rate of return (IRR)? | 9.7% |
| A projects IRR measures the _________ whereas the opportunity cost of capital is equal to the _________________. | profitability of a project; return offered by equivalent-risk investment in the capital market. |
| Under which situations should the IRR decision rule be avoided? | Mutually Exclusive ProjectsMultiple Rates of ReturnA project NPV does not decline smoothly as discount rate increases |
| The NPV rule states that managers increase shareholder wealth by: | accepting all projects with a positive NPV |
| A project with an initial investment of $5 million and cash flows for 6 years of $1.5 million per year. What is the project’s internal rate of return (IRR)? | 19.9% |
| Profitability Index (PI) Formula | NPV/Initial Investment |
| When the firm’s budget is limited, then the firm should select the project with the ______________ | highest PI ratio |
| The limit set on the amount of funds available for investment is referred to as: | capital rationing |
| Capital rationing that is imposed by top management of a firm is called ___________ rationing. _____________ rationing occurs when a firm cannot raise the money it needs from outside sources. | Soft, Hard |
| In simple cases of capital rationing, the _____________ can tell a firm which projects to accept | Profitability index (PI) |
| What are problems that managers may encounter when deciding between mutually exclusive projects? | When equipment should be replacedThe choice between short and long-lived equipmentThe timing of investments |
| Making the choice to invest today or to postpone that investment to a future date is a choice between mutually exclusive projects. When making this choice, what is the correct criterion to use? | Choose the investment date that produces the highest NPV today |
| The cash flow per period with the same present value as the cost of buying and operating a machine is called the: | Equivalent annual annuity |
| Equivalent annual annuity formula | (PV of costs)/(# of years annuity factor) |
| When comparing investments in assets with different lives you should: | select the project with the lowest equivalent annual annuity of costs |
| A machine that costs $20,000 today has annual operating costs of $1,500, $1,600, $1,700, and $1,800 in each of the next four years. The discount rate is 10 percent. The PV of costs is _________ and the equivalent annual annuity is __________. | $25,192.61; $7,947.53 |
| what are the Investment criterion methods most used by firms | NPVIRR |
| The IRR rule specifies that a firm should select any project whose IRR is ___________ the firm’s ____________ | higher than; opportunity cost of capital |
| What are three limitations of the Payback Rule for accepting projects? | Gives equal weight to all cash flows arriving before the cutoff period Biases the firm against long-term projects in favor of short-term onesDoes not consider cash flows after the payback period |
| What capital budgeting decision method finds the present value of each cash flow before calculating a payback period? | Discounted payback period |
| True or False: the payback rule states that a project should be accepted if its payback period is greater than a specified cutoff period | False: payback period is LESS than a specified cutoff period |
| The payback period for a project can best be defined as: | the length of time before you can recover you initial investment |
| The rate of return rule states that a firm should invest in any project offering a rate of return that is higher than the: | opportunity cost of capital |
| Which of the following is the capital investment decision criterion that will always lead management to make the value-maximizing choice? | NPV |
| True or false: when choosing among mutually exclusive projects, choose the one that offers the highest NPV | True |
| When evaluating a single project for acceptance, the NPV and IRR decision rules will give the same result when ______________ | the graph of NPV versus discount rate declines smoothly as discount rate increases |
