Chapter 9

Question 1

Which of the following statements is FALSE?

a) The IRR can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital.

b) The IRR investment rule states you should turn down any investment opportunity where the IRR is less than the opportunity cost of capital.

c) It is possible that an IRR does not exist for an investment opportunity.

d) The profitability index can be easily adapted for determining the correct investment decisions when multiple resource constraints exist.

Answer 1

D

Question 2

Which of the following statements is FALSE?
A. If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.
B. The internal rate of return (IRR) can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital.
C. In general, the difference between the cost of capital and the internal rate of return (IRR) is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision.
D. If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate.

Answer 2

A

Question 3

Net Present Value calculation

Answer 3

NPV=PV(benefits)-PV (cost)

Question 4

The NPV Decision Rule

Answer 4

• Accept positive-NPV projects
  -Reject negative NPV projects

Question 5

NPV profile

Answer 5

The graph of a project’s NPT over a range of discount rates

Question 6

internal rate of return (IRR)

Answer 6

The interest rate that sets the net present value of the cash flows equal to zero

Question 7

payback investment rule

Answer 7

only projects that payback their initial investment within a prespecified period are undertaken

Question 8

Payback period

Answer 8

The amount of time until the cash flows from the project offset the initial investment. The time it takes to pay back the initial investment.

Question 9

Weakness of the payback rule

Answer 9

• ignores the time value of money
• ignores cash-flows after the payback period
• Lacks a decision criterion grounded in economics

Question 10

Mutually Exclusive Projects

Answer 10

• Pick the project with the highest NPV