Finance Ch. 8

The internal rate of return is unreliable as an indicator of whether or not an investment should be accepted given which one of the following? The investment is mutually exclusive with another investment of a different size.
Which one of the following statements is correct? The payback period ignores the time value of money.
Which one of the following is most closely related to the net present value profile? internal rate of return
Both Projects A and B are acceptable as independent projects. However, the selection of either one of these projects eliminates the option of selecting the other project. Which one of the following terms best describes the relationship between Project A and Project B? mutually exclusive
If an investment is producing a return that is equal to the required return, the investment’s net present value will be: IRR = RR = NPV zero zero
The net present value: decreases as the required rate of return increases.
Which one of the following statements is correct? If the internal rate of return equals the required return, the net present value will equal zero.
Which one of the following indicates that a project is expected to create value for its owners? Positive net present value
Which one of the following statements is correct? Assume cash flows are conventional. When the internal rate of return is greater than the required return, the net present value is positive.
The internal rate of return is the: discount rate that results in a zero net present value for the project.
NPV present value of all future cash inflows less the initial cash outlay. net value of the project in todays dollars+:-considers timing-considers risk-comparison of diff cash flows of levels of risk-gives absolute dollars-:based on estimates
Payback method provides the length of time required to “payback” or recover the firms initial outlay in a new project+:-easy to calc-screening method, good for small projects-May allow to see if cash flows are accurate-:-ignores time value and risk-biased against long-term projects
IRR rate of return of a project must earn so that the present value of future cash flows just equals the projects initial outlay+:-used by investores -easy to understand-able to compare diff cash flows and levels of risk-provides the max rr that will make the project accetable-easy comparison with rr-often usted with npv-:-possible multiple rates with unconventional cash flows-diff size projects may conflict with NPV-if projects are mutually exclusive may conflict with NPV
PI (profitability index) ratio of the present value benefits associated with the project to its cost. That is PI is the ratio of PV benefits the initial cost+:-consistent with TVM-incorporates risk with NPV-allow for the comparison of projects with different cash flows and levels of risk-allos the ranking of projects based on the PV of benefit per dollar upfront-: -difficult to accurately forecast the cash flows and the correct discount rate-problems of scale. may give conflicting results with mutually exclusive projects
if RR changes will IRR no because IRR is based off of cash flow not RR
NPV future is built in with cash flow and rr
NPV increases RR decreases
Capital rationing does not support the goal of the firm-firm is unable to raise the required financing-firm does not have enough qualified managers-company management may be pessimistic about economy-intangible reasons like managers fear debt
special issues with ranking 1. problem of scale (size disparity)2. Reinvestment decision and assumptions3. Unequal lives (projects with diff EUL)
Risk Adjusted Discount Rate (RADR) 1. Previously we assumed that we would use the same discount rate to evaluate all projects2. unrealistic: one discount rate does not fit all3. Each project should be evaluated on the basis of its individual risk
independent can choose all that have NPV greater than 0
mutually exclusive choose one

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