Chapter 9 Capital Budgeting Decision Models

9) Which
of the statements below is FALSE?

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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12)
Which of the statements below is FALSE?

A) 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 future 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
Discounted Payback Period method does not correct for the cash flow after the
recovery of the initial outflow.

13) Consider
the following four-year project. The initial outlay or cost is $180,000. The
respective cash inflows for years 1, 2, 3 and 4 are: $100,000, $80,000, $80,000
and $20,000. What is the discounted payback period if the discount rate is 11%?

A) About 1.667 years B) About 2.000
years C) About 2.135 years D) About 2.427 years

14) For
small-dollar decisions, a company usually establishes a short, arbitrary cutoff
date for handling the initial screening of many small-dollar opportunities.

15) By
switching to monthly cash flows, we cannot get a more accurate estimate of the
discounted payback period.

Comment: By switching to monthly cash
flows, we CAN GET a more accurate estimate of the discounted payback period.

16) The
Discounted Payback Period method is a modified payback period model that
considers how long it takes to recover the initial investment in current
dollars.

17) Describe
the shortcomings of the payback period model or method (without discounting).

Answer: The
payback period method ignores cash inflows after the initial outflow has been
recovered. Thus, this method is biased toward those projects that have higher
cash inflows for earlier years and against those with higher inflows for later
years. The payback period has a fundamental flaw from a finance perspective: it
fails to account for the time value of money. This problem can be easily
corrected by adjusting to a payback period model with discounting.

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18) Acme, Inc. is considering a
four-year project that has an initial outlay or cost of $80,000. The respective
future cash inflows for years 1, 2, 3 and 4 are: $40,000, $40,000, $30,000 and
$30,000. Acme uses the discounted payback period method and has a discount rate
of 12%. Will Acme accept the project if its payback period is two and one-half
years?

9.3 Net Present Value

1) The
capital budgeting decision model that utilizes all the discounted cash flow of
a project is the

________ model, which is one of the
single most important models in finance. A) net present value (NPV)

B) internal rate of return (IRR) C)
profitability index (PI)

D) discounted payback

2) The
net present value of an investment is ________.
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

3) In
the NPV Model, all cash flows are stated ________.

A) in
future value dollars, and the total inflow is “netted” against the
outflow to see if the net amount is positive or negative

B) in
present value or current dollars, and the outflow is “netted” against
the total inflow to see if the gross amount is positive or negative

C) in
present value or current dollars, and the total inflow is “netted”
against the initial outflow to see if the net amount is positive or negative

D) in
future dollars, and the initial outflow is “netted” against the total
inflow to see if the net amount is positive

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4)
In regard to the NPV method, which of the statements below is TRUE?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. Comment: In the NPV Model, if two
projects are being compared, the one with the highest POSITIVE NET PRESENT
VALUE is selected. In the NPV Model, the FUTURE cash flows are discounted at
the rate r, the cost of capital. In the NPV Model, ALL cash flows (including
the initial costs and future cash inflows) are stated in present value or
current dollars and the total inflow is “netted” against the outflow
to see if the net amount is positive or negative. 5)
Which of the statements below is FALSE?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 accepting of one project has no bearing on the
accepting or rejecting 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. Comment:
Two projects are INDEPENDENT if the accepting of one project has no bearing on
the accepting or rejecting of the other project.6) Projects
are mutually exclusive if picking one project eliminates the ability to pick
the other project. This mutually exclusive situation can arise for different
reasons. Which of the statements below is NOT one of these reasons? A) One project will always have a
negative NPV. B) There is a scarce resource
that both projects would need. C) There is need for only one
project, and both projects can fulfill that current need. D) By using funds for one project, there
are not enough funds available for the other project.
Comment:
Projects are mutually exclusive if picking one project eliminates the ability
to pick the other project even if BOTH PROJECTS HAVE POSITIVE net present values.
This mutually exclusive situation can arise for one of two reasons: there is
need for only one project, and both projects can fulfill that current need;
there is a scarce resource that both projects need, and by using it in one
project, it is not available for the second project.