Exam 9: Capital Budgeting Decision Models

A) In the NPV model,if two projects are being compared,the one with the highest IRR is selected.
B) In the NPV model,the present cash flows are discounted at the rate r,the cost of capital.
C) In the NPV model,most future cash flows are stated in present value or current dollars and the inflow is "netted" against the outflow to see if the net amount is positive or negative.
D) In the NPV model,the net present value of an investment is the present value of all benefits (cash inflow) minus the present value of all costs (cash outflow) of the project.

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Using a financial calculator or software...

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A) crossover rate
B) internal rate of return
C) discount rate
D) yield to maturity

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A) We calculate the equivalent annual annuity by taking the NPV of the project and find the annuity stream that equates to the NPV,using the appropriate discount rate for the project and life of the project.
B) In dealing with mutually exclusive projects of unequal lives,we can compute the EAA for the NPV of the project over the life of the project.
C) One of the advantages of NPV over other decision models is that we can select the appropriate discount rate for each individual project and still compare the resulting NPVs across different projects.
D) By using the EAA approach for mutually exclusive projects,we overcome all potential problems.

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A) The IRR is less than 22.50%.
B) The IRR is about 19.16%.
C) The IRR is about 17.86%.
D) The IRR is over 25.50%.

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A) Yes,because it pays back in 25 months.
B) No,because it pays back in 28 months.
C) No,because it pays back in over 31 months.
D) No,because it pays back in over 35 months.

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A) Comparing mutually exclusive projects
B) Cumbersome computations not resolvable by the latest technology
C) Incorporates the IRR as the reinvestment rate for the future cash flows
D) Multiple IRRs

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A) the present value of all benefits (cash inflows)
B) the present value of all benefits (cash inflows) minus the present value of all costs (cash outflows) of the project
C) the present value of all costs (cash outflows) of the project
D) the present value of all costs (cash outflow) minus the present value of all benefits (cash inflow) of the project

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B

A) Sandstone accepts the project because the NPV is greater than $30,000.
B) Sandstone rejects the project because the NPV is less than -$4,000.
C) Sandstone rejects the project because the NPV is -$3,021.
D) Sandstone accepts the project because it has a positive NPV of over $28,000.

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Payback Period is simple and fast but economically unsound.It ignores all cash flow after the cutoff date and it ignores the time value of money. Discounted Payback Period incorporates the time value of money but still ignores cash flow after the cutoff date. Net Present Value is economically sound and properly ranks projects across various sizes,time horizons,and levels of risk,without exception for all independent projects. IRR provides a single measure (return)but has the potential for errors in ranking projects.It also can lead to incorrect selection of two mutually exclusive projects or incorrect acceptance or rejection of a project with more than a single IRR. Modified Internal Rate of Return,in general,corrects for most of,but not all,the problems of IRR and gives the solution in terms of a return. Profitability Index incorporates risk and return,but the benefits-to-cost ratio is actually just another way of expressing the NPV.

A) The NPV decision criterion is true when all projects are independent and the company has a sufficient source of funds to accept all positive NPV projects.
B) Two projects are mutually exclusive if the acceptance of one project has no bearing on the acceptance or rejection of the other project.
C) Projects are mutually exclusive if picking one project eliminates the ability to pick the other project.
D) If a company has constrained capital,then it can only take on a limited number of projects.

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A) The net present value decision model is an economically sound model when comparing different projects across a wide variety of products,services,and activities under capital constraint.
B) The greater the NPV of a project,the greater the "bag of money" for doing the project,and more money is better.If a company is short of capital,it would choose those projects that provide the largest "bag of money."
C) Despite all of the advantages of using the NPV model,it is inconsistent with the concept of the time-value-of-money.
D) By discounting all future cash flows to the present,adding up all inflows,and subtracting all outflows,we are determining the net present value of the project.

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A) the future value of the present cash outflows
B) the present value of the future benefits or cash inflows
C) the present value of the cash outflow
D) the investment

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A) In order to account for the time value of money with the Payback Period Model,the future cash flow needs to be restated in current dollars.
B) The Discounted Payback Period method is the time it takes to recover the initial investment in current dollars.
C) When we discount a future cash flow with our standard time-value-of-money concepts,we inherently assume that the entire cash flow was received at the end of the year.
D) The Payback Period method (with no discounting) is the dollar amount that it takes to recover the initial investment in current dollars.

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D

A) One way is to find a common life,without the need to extend the projects to the least common multiple of their lives.
B) One way is to find the present value factors and then compare them.
C) One way is to compare the lengths of the projects and take the project with the shortest life.
D) One way is to find a common life by extending the projects to the least common multiple of their lives.

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A) Leanard will probably reject this project because its IRR is about 39.74%,which is slightly below its hurdle rate.
B) Leanard will probably accept this project because its IRR is about 41.04%,which is slightly above its hurdle rate.
C) Leanard will accept this project because its IRR is about 41.50%.
D) Leanard will accept this project because its IRR is over 45.50%.

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