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Questions and Answers
Multiple internal rates of return can occur when there is (are):
Multiple internal rates of return can occur when there is (are):
The ______ measures the present value return for each dollar of initial investment.
The ______ measures the present value return for each dollar of initial investment.
The payback method is at best a crude measure of the risk of a project because it fails to consider the ______ of a project's returns.
The payback method is at best a crude measure of the risk of a project because it fails to consider the ______ of a project's returns.
variability
According to the profitability index criterion, a project is acceptable if its profitability index is
According to the profitability index criterion, a project is acceptable if its profitability index is
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The payback period of an investment is defined as:
The payback period of an investment is defined as:
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The advantages of the payback approach include all of the following except:
The advantages of the payback approach include all of the following except:
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The disadvantages of the payback approach include:
The disadvantages of the payback approach include:
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One weakness of the internal rate of return approach is that:
One weakness of the internal rate of return approach is that:
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The relationship between NPV and IRR is such that:
The relationship between NPV and IRR is such that:
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When a project has multiple internal rates of return:
When a project has multiple internal rates of return:
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The profitability index (PI) approach:
The profitability index (PI) approach:
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In the case of mutually exclusive projects, NPV and PI are likely to yield conflicting decisions when:
In the case of mutually exclusive projects, NPV and PI are likely to yield conflicting decisions when:
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The objective in solving capital rationing problems is to:
The objective in solving capital rationing problems is to:
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Which of the following is not a technique to handle the capital rationing problem?
Which of the following is not a technique to handle the capital rationing problem?
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In order to compensate for inflation in capital budgeting procedures, it is necessary to:
In order to compensate for inflation in capital budgeting procedures, it is necessary to:
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If a net present value analysis for a normal project gives an NPV greater than zero, an internal rate of return calculation on the same project would yield an internal rate of return ______ the required rate of return for the firm.
If a net present value analysis for a normal project gives an NPV greater than zero, an internal rate of return calculation on the same project would yield an internal rate of return ______ the required rate of return for the firm.
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When two or more normal projects are under consideration, the profitability index, the net present value, and the internal rate of return methods will yield identical accept/reject signals.
When two or more normal projects are under consideration, the profitability index, the net present value, and the internal rate of return methods will yield identical accept/reject signals.
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The net present value method assumes that the cash flows over the life of the project are reinvested at
The net present value method assumes that the cash flows over the life of the project are reinvested at
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The internal rate of return method assumes that the cash flows over the life of the project are reinvested at:
The internal rate of return method assumes that the cash flows over the life of the project are reinvested at:
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In the absence of capital rationing, the_____ method is normally superior to the____ method when choosing among mutually exclusive investments.
In the absence of capital rationing, the_____ method is normally superior to the____ method when choosing among mutually exclusive investments.
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Generally, the____ is considered to be a more realistic reinvestment rate than the______. .
Generally, the____ is considered to be a more realistic reinvestment rate than the______. .
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The profitability index is the ratio of the___ to the____ .
The profitability index is the ratio of the___ to the____ .
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With the net present value approach, all net cash flows are discounted at the
With the net present value approach, all net cash flows are discounted at the
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If the net present value of an investment project is positive then the:
If the net present value of an investment project is positive then the:
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The “value additivity principle” means that the
The “value additivity principle” means that the
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The internal rate of return does not take into account the
The internal rate of return does not take into account the
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The net present value method assumes that cash flows are reinvested at the____ , whereas the internal rate of return method assumes that cash flows are reinvested at the____ .
The net present value method assumes that cash flows are reinvested at the____ , whereas the internal rate of return method assumes that cash flows are reinvested at the____ .
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All of the following are reasons why a firm may face capital rationing except:
All of the following are reasons why a firm may face capital rationing except:
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Which of the following would increase the net present value of a project?
Which of the following would increase the net present value of a project?
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The reason for a postaudit is to
The reason for a postaudit is to
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A capital expenditure project has an expected 20 percent internal rate of return and a $10,000 net present value. It has one cash flow sign change.
A capital expenditure project has an expected 20 percent internal rate of return and a $10,000 net present value. It has one cash flow sign change.
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When dealing with cash flows, the is computed by trial and error.
When dealing with cash flows, the is computed by trial and error.
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The____ is interpreted as the____ for each dollar of initial investment.
The____ is interpreted as the____ for each dollar of initial investment.
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The____ of an investment is the period of time for the_____ to equal the initial cash outlay.
The____ of an investment is the period of time for the_____ to equal the initial cash outlay.
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The profitability index would be_____ if the present value of the net cash flows (NCF) over the life of a project were ____.
The profitability index would be_____ if the present value of the net cash flows (NCF) over the life of a project were ____.
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Which of the following investment decision rules (if any) assumes that the cash flows generated are reinvested over the life of the project at the firm’s cost of capital?
Which of the following investment decision rules (if any) assumes that the cash flows generated are reinvested over the life of the project at the firm’s cost of capital?
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The____ approach takes into account both the magnitude and timing of cash flows over the entire life of a project in measuring its economic desirability.
The____ approach takes into account both the magnitude and timing of cash flows over the entire life of a project in measuring its economic desirability.
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Real options in capital budgeting can be classified in all of the following ways except:
Real options in capital budgeting can be classified in all of the following ways except:
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There are many reasons why a firm can earn above-normal profits. These reasons include all of the following except:
There are many reasons why a firm can earn above-normal profits. These reasons include all of the following except:
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Generally, the existence of a(n)____ option reduces the downside risk of a project and should be considered in project analysis.
Generally, the existence of a(n)____ option reduces the downside risk of a project and should be considered in project analysis.
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Capital expenditures levels tend______(in real terms) during periods of relatively high inflation than during low inflation times.
Capital expenditures levels tend______(in real terms) during periods of relatively high inflation than during low inflation times.
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Entrepreneurial firms with a net worth of less than $1 million tend to prefer the____method for evaluating capital expenditures.
Entrepreneurial firms with a net worth of less than $1 million tend to prefer the____method for evaluating capital expenditures.
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Which of the following statements about comparing capital budget techniques is/are correct?
I. The payback period is easy to understand and helps the firm identify how long it will be unable to use the initial investment for other projects.
II. Mutually exclusive projects allow a firm to do other like projects (mutually exclusive) simultaneously as long as the budget restraints are met.
Which of the following statements about comparing capital budget techniques is/are correct? I. The payback period is easy to understand and helps the firm identify how long it will be unable to use the initial investment for other projects. II. Mutually exclusive projects allow a firm to do other like projects (mutually exclusive) simultaneously as long as the budget restraints are met.
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Which of the following statements about comparing the techniques of net present value (npv) and internal rate of return (irr) is/are correct?
I. The net present value assumes that all cash flows are reinvested at the cost of capital and is therefore realistic.
II. The internal rate of return is stated as a percent and is therefore easy to communicate to decision-makers who may not understand the fine points of finance.
Which of the following statements about comparing the techniques of net present value (npv) and internal rate of return (irr) is/are correct? I. The net present value assumes that all cash flows are reinvested at the cost of capital and is therefore realistic. II. The internal rate of return is stated as a percent and is therefore easy to communicate to decision-makers who may not understand the fine points of finance.
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In comparing the techniques of net present value and internal rate of return:
In comparing the techniques of net present value and internal rate of return:
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In considering the payback period:
In considering the payback period:
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In considering the payback method,
In considering the payback method,
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The payback method has all of the following advantages EXCEPT:
The payback method has all of the following advantages EXCEPT:
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A firm’s capital expenditures may be limited due to externally imposed constraints. All of the following are
external constraints EXCEPT:
A firm’s capital expenditures may be limited due to externally imposed constraints. All of the following are external constraints EXCEPT:
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The payback period can be considered justified on the basis of:
The payback period can be considered justified on the basis of:
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The choice to accept or reject projects based on the payback period is:
The choice to accept or reject projects based on the payback period is:
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Real options in capital budgeting can be classified. The classification that means that the project is delayed and can be termed “waiting to invest” is:
Real options in capital budgeting can be classified. The classification that means that the project is delayed and can be termed “waiting to invest” is:
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A weakness of the payback period is that it disregards:
A weakness of the payback period is that it disregards:
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When two or more mutually exclusive alternative investments have , neither the net present value nor the internal rate of return method yields reliable accept-reject information unless the projects are evaluated for an equal period of time.
When two or more mutually exclusive alternative investments have , neither the net present value nor the internal rate of return method yields reliable accept-reject information unless the projects are evaluated for an equal period of time.
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Study Notes
Capital Budgeting Decision Criteria and Real Option Considerations
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Multiple internal rates of return can occur when there is more than one sign change in the pattern of cash flows over a project's life.
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The profitability index measures the present value return for each dollar of initial investment.
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The payback method is a crude measure of risk as it doesn't consider variability in a project's returns.
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A project is acceptable under the profitability index criterion if its profitability index is greater than 1.
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The payback period is the time required for cumulative cash flows to equal the initial outlay.
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The advantages of the payback approach include ease of computation and consideration of liquidity.
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Disadvantages of the payback approach include ignoring cash flows after the payback period and failing to incorporate the time value of money.
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The internal rate of return approach may fail to give a straightforward decision-making criterion and implicitly assumes reinvestment at the firm's cost of capital.
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NPV and IRR are likely to yield conflicting decisions when projects are significantly different in size.
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Projects with a profitability index greater than 1 are considered acceptable.
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The objective in solving capital rationing problems is to maximize the net present value of the projects that are accepted.
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Capital rationing methods include linear programming and goal programming, but not ranking according to payback.
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To compensate for inflation, constant dollar estimates of costs and revenues are used in capital budgeting.
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The profitability index approach does not consider the timing of cash flows.
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NPV and PI are likely to yield conflicting decisions when projects differ significantly in size.
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The objective in solving capital rationing problems is maximizing the NPV of the acceptable projects.
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Methods to handle capital rationing include linear and goal programming, not ranking by payback period.
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Net present value analysis, if positive, indicates a project will generate an acceptable return.
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The internal rate of return method assumes reinvestment at the computed internal rate of return.
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In the case of mutually exclusive projects, NPV and PI may yield conflicting decisions if projects have significant size differences.
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A project is acceptable if its net present value is greater than zero.
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When selecting among mutually exclusive projects, the net present value method is generally superior to the internal rate of return method.
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The profitability index is the ratio of the present value of future net cash flows to the initial investment.
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The payback period is the time required for the cumulative cash flows to equal the initial investment outlay.
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The profitability index is a useful criterion for capital budgeting decisions in the presence of capital rationing.
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Methods to handle capital rationing include linear and goal programming, but not ranking by payback period.
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Inflation must be considered when performing capital budgeting calculations.
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The value additivity principle states that the value of a firm increases when an independent project is added.
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The profitability index should be used to solve capital rationing problems to maximize the returns per dollar of investment, particularly when different sized investments produce conflicting results with NPV.
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Description
Explore the essential criteria for capital budgeting decisions, including internal rates of return, profitability index, and payback methods. This quiz also delves into the advantages and disadvantages of these financial decision-making topics. Test your understanding of these principles and their impact on project evaluations.
