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What does a Profitability Index (PI) greater than 1 indicate?

The investment is expected to generate more value than its cost. (correct)

The investment is expected to generate less value than its cost.

The investment will not generate any cash flow.

The investment is expected to generate a return equal to its cost.

Which approach to calculating the Modified Internal Rate of Return (MIRR) involves considering both negative and positive cash flows?

Capital Budgeting Approach

Combination Approach (correct)

Discounting Approach

Reinvestment Approach

Why might firms use multiple evaluation measures in capital budgeting?

To assess investment reliability under uncertainty. (correct)

To simplify decision making.

To avoid the complexity of cash flow projections.

To create a standard measure for all investments.

What is a limitation of using the Profitability Index (PI) in project evaluation?

It can mislead comparisons between mutually exclusive projects. Signup and view all the answers

In the context of capital budgeting, which of the following is NOT a common procedure?

Return on Equity (ROE) Signup and view all the answers

What is the primary issue with the NPV function in most spreadsheets?

It functions as a Present Value function instead of a true NPV function. Signup and view all the answers

How is the payback period defined?

The time required for an investment to generate cash flows sufficient to recover its initial cost. Signup and view all the answers

What is a significant limitation of the payback rule?

It ignores the time value of money and does not discount future cash flows. Signup and view all the answers

Why is the payback period rule seen as advantageous in some scenarios?

It allows for quick decision-making in small investments. Signup and view all the answers

What does the discounted payback period take into account that the regular payback period does not?

The time value of money by summing discounted cash flows. Signup and view all the answers

What limitation does the payback rule have regarding risk consideration?

It treats all projects as having the same level of risk. Signup and view all the answers

In the context of the payback rule, what does the term 'arbitrary cutoff' refer to?

The subjective choice of a payback period limit. Signup and view all the answers

What key insight about liquidity does the payback rule highlight?

Small businesses prioritize quick cash recovery over larger investments. Signup and view all the answers

What does the net present value (NPV) measure?

The difference between an investment's market value and its cost Signup and view all the answers

Which of the following is a step in estimating net present value?

Estimate start-up costs, which are known and predictable Signup and view all the answers

If the net present value of an investment is less than zero, what does it indicate?

The investment decreases the firm's value Signup and view all the answers

Which of the following is a shortcoming of the payback rule?

It disregards cash flows that occur after the payback period Signup and view all the answers

What is a significant advantage of the internal rate of return (IRR) criterion?

It accounts for the overall profitability of an investment Signup and view all the answers

Which aspect of capital budgeting involves predicting whether an investment will create value?

Calculating present value of future cash flows Signup and view all the answers

What issue may arise when using spreadsheet functions for capital budgeting decisions?

Users may use incorrect inputs leading to flawed calculations Signup and view all the answers

What is the modified internal rate of return (MIRR) primarily focused on?

Adjusting the assumptions behind the traditional IRR Signup and view all the answers

What is the key feature of the discounted payback period compared to the ordinary payback period?

It accounts for the time value of money. Signup and view all the answers

Which statement is TRUE regarding the relationship between discounted payback period and NPV?

If a project pays back on a discounted basis, it must have a positive NPV. Signup and view all the answers

What is one major disadvantage of using the discounted payback period?

It does not consider cash flows beyond the cutoff date. Signup and view all the answers

How is the average accounting return (AAR) defined?

An investment’s average net income divided by its average book value. Signup and view all the answers

What is a critical disadvantage of using AAR for investment decisions?

It ignores the time value of money. Signup and view all the answers

What does the internal rate of return (IRR) represent?

The discount rate that reduces NPV to zero. Signup and view all the answers

When should an investment be rejected based on IRR?

If the IRR is below the required return. Signup and view all the answers

Which of the following advantages applies to the discounted payback period?

It is easy to understand and includes the time value of money. Signup and view all the answers

What does IRR represent in the context of investment calculations?

The discount rate at which NPV equals zero Signup and view all the answers

What is a major problem associated with using IRR for non-conventional cash flows?

It can lead to multiple IRRs for the same project. Signup and view all the answers

How can MIRR improve upon the shortcomings of IRR?

By offering a single rate of return through consistent cash flow treatment. Signup and view all the answers

What is indicated when IRR is higher than the required return?

The investment may be worth considering. Signup and view all the answers

In the case of mutually exclusive investments, what issue arises from relying solely on IRR?

It can produce conflicting investment rankings. Signup and view all the answers

Which of the following best describes the NPV profile?

A graph plotting the relationship between NPV and discount rates. Signup and view all the answers

What does the Reinvestment Approach for calculating MIRR involve?

Compounding all cash flows to the project's end. Signup and view all the answers

When cash inflows occur before cash outflows, what can be misleading about the IRR?

It provides an inflated estimate of return. Signup and view all the answers

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Questions and Answers

What does a Profitability Index (PI) greater than 1 indicate?

Which approach to calculating the Modified Internal Rate of Return (MIRR) involves considering both negative and positive cash flows?

Why might firms use multiple evaluation measures in capital budgeting?

What is a limitation of using the Profitability Index (PI) in project evaluation?

In the context of capital budgeting, which of the following is NOT a common procedure?

What is the primary issue with the NPV function in most spreadsheets?

How is the payback period defined?

What is a significant limitation of the payback rule?

Why is the payback period rule seen as advantageous in some scenarios?

What does the discounted payback period take into account that the regular payback period does not?

What limitation does the payback rule have regarding risk consideration?

In the context of the payback rule, what does the term 'arbitrary cutoff' refer to?

What key insight about liquidity does the payback rule highlight?

What does the net present value (NPV) measure?

Which of the following is a step in estimating net present value?

If the net present value of an investment is less than zero, what does it indicate?

Which of the following is a shortcoming of the payback rule?

What is a significant advantage of the internal rate of return (IRR) criterion?

Which aspect of capital budgeting involves predicting whether an investment will create value?

What issue may arise when using spreadsheet functions for capital budgeting decisions?

What is the modified internal rate of return (MIRR) primarily focused on?

What is the key feature of the discounted payback period compared to the ordinary payback period?

Which statement is TRUE regarding the relationship between discounted payback period and NPV?

What is one major disadvantage of using the discounted payback period?

How is the average accounting return (AAR) defined?

What is a critical disadvantage of using AAR for investment decisions?

What does the internal rate of return (IRR) represent?

When should an investment be rejected based on IRR?

Which of the following advantages applies to the discounted payback period?

What does IRR represent in the context of investment calculations?

What is a major problem associated with using IRR for non-conventional cash flows?

How can MIRR improve upon the shortcomings of IRR?

What is indicated when IRR is higher than the required return?

In the case of mutually exclusive investments, what issue arises from relying solely on IRR?

Which of the following best describes the NPV profile?

What does the Reinvestment Approach for calculating MIRR involve?

When cash inflows occur before cash outflows, what can be misleading about the IRR?

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