ADMS 3530 - Connect #6 PDF

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Connect #6 1. When companies spend large amounts of money in the hope of generating more cash at a later date, that outlay is called a ______________ expenditure. Ans: Capital 2. The expected future payoff from a project is discounted by the rate of return offered by comparable investment alternatives. This discount rate is also called _____. Ans: the opportunity cost of capital 3. The discount rate used for calculating the NPV of an investment is determined by the _____ of the investment. Ans: risk 4. When calculating the net present value (NPV), the present value of the nth cash flow is calculated by dividing the nth cash flow by 1 plus the _____ rate raised to the nth power. Ans: discount 5. True or false: When choosing among mutually exclusive projects, choose the one that offers the highest net present value (NPV). Ans: True 6. Capital expenditures can be made for ___________ assets, such as research and testing costs for the development of a new drug. Ans; intangible 7. The opportunity cost of capital is best described as _____. Ans: the expected rate of return given up by investing in a project 8. Which of the following investment criteria tends to lead to the same decisions as net present value? Ans: internal rate of return 9. Since a risky dollar is worth less than a safe one, cash flows generated by more risky investments should be discounted at ____________ cash flows generated by less risky investments. Ans: a higher rate than 10. A firm plans to invest $10,000,000 in a new factory that will generate annual cash flows of $3,000,000 for the firm for 5 years and then be scrapped. If the appropriate opportunity cost of capital for this investment is 8.0%, what will be its net present value (NPV)? (Round your answer to the nearest dollar.) Ans: 1,978,130 Reason:

$1,978,130 = −10,000,000 + $3 million / (1.08) + $3 million / (1.08)2 + $3 million / (1.08)3 + $3 million / (1.08)4 + $3 million / (1.08)5 OR: Calculator: CF0 = -10,000,000 , CO1 = 3,000,000 FO1 =5, i=8%, NPV = 1,978,130 11. If two projects (investments), A and B, are said to be mutually exclusive, then we know that a firm _____. Ans: must choose to invest in either A or B, but not both 12. In addition to net present value, which of the following criteria can be used when making investment decisions? (Select all that apply.) payback treasury bill rate of return internal rate of return discounted payback 13. What is the net present value (NPV) of a project with an initial investment of $95, a cash flow of $107 at the end of Year 1, and a discount rate of 6%? (Round your answer to two decimal places.) Ans: $5.94; Reason: NPV = −$95 + ($107 / 1.06) = $5.94 14. True or false: The payback rule states that a project should be accepted if its payback period is greater than a specified cutoff period. Ans: FALSE 15. When choosing among mutually exclusive projects, a firm needs to choose the one that _____. Ans: offers the highest net present value (NPV) 16. The _____ is the number of periods before the present value of prospective cash flows equals or exceeds the initial investment. Ans: discounted payback 17. The ______________ rule states that a firm should invest in any project whose rate of return is greater that the opportunity cost of capital. Ans: internal rate of return 18. The payback period for a project can best be defined as _____. Ans: the length of time until you recover your initial investment 19. True or false: The rate of return is the discount rate at which a project's net present value equals zero. Ans: TRUE 20. The capital budgeting method that involves calculating the length of time before a project starts giving a positive net present value is called the _____. Ans: discounted payback period

21. Internal rate of return (IRR) is also known as _____. Ans: discounted cash flow rate of return 22. The internal rate of return rule specifies that a firm should select any project whose rate of return is _____ the firm's _____. Ans: higher than; opportunity cost of capital 23. Which of the following statements about the relationship between NPV and rate of return are true? (Check all that apply.) When the project rate of return is greater than the firm's opportunity cost of capital, the project's net present value (NPV) is less than zero. When the project rate of return is less than the firm's opportunity cost of capital, the project's net present value (NPV) is greater than zero. When the project rate of return is greater than the firm's opportunity cost of capital, the project's net present value (NPV) is greater than zero. When the project rate of return is less than the firm's opportunity cost of capital, the project's net present value (NPV) is less than zero. 24. A firm plans to invest $400,000 in a new high-efficiency furnace that will reduce its energy bill by $100,000 in years 1 and 2, $75,000 in years 3, 4, and 5, and $50,000 in years 6 through 10. Calculate the project's internal rate of return. (Use your financial calculator.) Ans: 13.07%; plug percentage until you get NPV close to initial investment 25. The internal rate of return (IRR) is best defined as _____. Ans: the discount rate at which the net present value (NPV) equals zero 26. The rate of return that is equal to the return offered by equivalent-risk investments is called the ______________. Ans: opportunity cost of capital 27. One limitation of __________ is that it favours projects with large early cash inflows.. Ans: Internal rate of return 28. Identify the decision rule for investment timing. Ans: Choose the investment date that produces the highest net present value (NPV) today. 29. Find the internal rate of return for project with an initial outlay of 350,000 in year 0; cash inflows of $16,000 for years 1 and 2; and cash inflow of $466,000 in year 3. (Use your financial calculator.)

Ans: 12.96%; plug percentage that gives NPV closest to ZERO 30. Which of the following is the correct definition of equivalent annual cost? Ans: It is the cost per period with the same present value as the cost of buying and operating a machine. 31. _______________ is the rate that depends only on a project's own cash flows. Ans: Internal rate of return 32. Managers should avoid replacing old machines unless the ________ of a new machine is lower. Ans: equivalent annual cost 33. Projects that often have a higher net present value can have _______ internal rates of return, in contrast to projects who have high cash inflows early but which do not last a long time. Ans: lower 34. Investment timing decisions always involves a choice among ________ investments. Ans: mutually exclusive 35. Capital ______ occurs when there is a limit set on the amount of funds available for investment. Ans: RATIONING 36. When faced with mutually-exclusive projects with different lives, it is best to calculate the ________________ instead of net present value. Ans: equivalent annual cost 37. The best approach to solving replacement decisions is to calculate the ___________ of the new machine and the old machine. Ans: equivalent annual cost 38. When a company is experiencing hard capital rationing, it needs to select the package of projects that will maximize overall ___________ within the budget. Ans: net present value 39. When a firm's capital is rationed, management should pick the projects that give the highest net present value per dollar of investment. This ratio is called the ______ index. Ans: PROFITABILITY

40. With _______ capital rationing, a firm's top management, not investors, imposes limits on capital spending. Ans: SOFT 41. The profitability index should only be used to select projects when funds are __________. Ans: limited 42. When a company's new projects are limited by the amount of funds it can raise, then it is said to be experiencing _______ capital rationing. Ans: Hard 43. Which of the following capital investment criteria is consistent with maximizing the value of the firm? Ans: Net present value (NPV) 44. Profitability index is calculated as the ratio of _____. Ans: net present value to initial investment 45. When funds are not rationed, a firm should use which criteria to chose projects? Ans: Net present value 46. Which of the following is the one of the few situations when NPV fails as a decision rule? Ans: When the firm faces capital rationing...