Chapter 5 Net Present Value and Other Investment Rules

The difference between the present value of an investment's future cash flows and its initial cost is the:

• net present value.

• internal rate of return.

• payback period.

• profitability index.

• discounted payback period.

If a project is assigned a required rate of return of zero, then:

• the timing of the project's cash flows has no bearing on the value of the project.

• the project will always be accepted.

• the project will always be rejected.

• whether the project is accepted or rejected will depend on the timing of the cash flows.

• the project can never add value for the shareholders.

Which statement concerning the net present value (NPV) of an investment or a financing project is correct?

• A financing project should be accepted if, and only if, the NPV is exactly equal to zero.

• An investment project should be accepted only if the NPV is equal to the initial cash flow.

• Any type of project should be accepted if the NPV is positive and rejected if it is negative.

• Any type of project with greater total cash inflows than total cash outflows, should always be accepted.

• An investment project that has positive cash flows for every time period after the initial investment should be accepted.

All else constant, the net present value of a typical investment project increases when:

• the discount rate increases.

• each cash inflow is delayed by one year.

• the initial cost of a project increases.

• the required rate of return decreases.

• all cash inflows occur during the last year instead of periodically throughout the project's life.

Proposed projects should be accepted when those projects:

• create value for the owners of the firm.

• have a positive rate of return.

• return the initial cash outlay within the life of the project.

• have required cash inflows that exceed the actual cash inflows.

• have an initial cost that exceeds the present value of the future cash flows.

If a project has a net present value equal to zero, then:

• the initial cost of the project exceeds the present value of the project's subsequent cash flows.

• the internal rate of return exceeds the discount rate.

• the project produces cash inflows that exceed the minimum required inflows.

• any delay in receiving the projected cash inflows will cause the project's NPV to be negative.

• the discount rate exceeds the internal rate of return.

Net present value:

• cannot be relied upon when deciding between two mutually exclusive projects.

• rule for project acceptance must be modified when comparing projects of varying sizes.

• is less commonly used in business than the profitability index method of analysis.

• is not as widely used in practice as payback and discounted payback.

• provides the means for considering the risks associated with a specific project.

A project has an initial cost of $26,000, a discount rate of 11.7 percent, a life of 5 years, and an NPV of $11,216. Given this, you know that the project is expected to earn a return:

• equal to 11.7 percent of $26,000 plus an additional $11,216

• of $11,216 in total.

• equal to 11.7 percent of $37,216 (= $26,000 + 11,216)

• of 11.7 percent of $11,216.

• of $26,000 minus $11,216

When a firm commences a positive net present value project, you know:

• the project will pay back within the required payback period.

• the present value of the expected cash flows is equal to the project's cost.

• the inherent risks within the project have been ignored.

• that all the projected cash flows will occur as expected.

• the stockholders' value in the firm is expected to increase.

The net present value method of capital budgeting analysis does all of the following except:

• incorporate risk into the analysis.

• consider all relevant cash flow information.

• discount all future cash flows to their current value.

• consider the initial cost of the project.

• provide a specific anticipated rate of return.