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Finance 3040, Chapter 8
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Key Concepts:
Terms in this set (24)
Opportunity cost of capital
The return that shareholders could expect to earn by investing in the financial markets.
For a project with a positive NPV
The IRR must be greater than 0.
the decision rule for net present value is to
Accept all projects with positive net present values.
If a project's NPV is calculated to be negative
The project should be reject by the project manager.
A decrease in the disocount rate will
Increase the NPV of a project.
NPV
Net Present Value
Shareholders face an opportunity cost in the amount of
The project's NPV when a manger does not accept a positive-NPV project.
The NPV of a specific project will decrease
As the discount rate is increased.
Net present value will be zero
When a project's internal rate of return equals its opportunity cost of capital.
Firms that make investment decisions based on the payback rule
May be biased toward rejecting projects with long lives.
If the IRR for a project is 15%, then the project's NPV would be
Negative at a discount rate of 20%
When projects are mutually exclusive, you should chose
The project with the highest NPV
In simple cases when hard capital rationing exists, projects
May be evaluated by a profitability index
Use of a profitability index to evaluate
Mutually exclusive projects in the absence of capital rationing can result in misguided selections.
The profitability index selects projects based on the
Largest return per dollar invested.
Profitability index, internal rate of return, and net present value all
Are investment criteria that take the time value of money into consideration.
When calculating a project's payback period, cash flows
Are not discounted at all.
Profitability Index
Th ratio of net present value to initial investment.
"Gold Standard" of investmennt
Net Present Value Rule
Payback Period tends to improperly
Reject long-lived projects.
If a project's expected rate of return exceeds its opportunity cost of capital
One would expect the project to have a positive NPV
If two projects offer the same positive NPV, then
They add the same amount of value to the firm.
According to the NPV rule, all projects should be accepted if NPV
Is positive when discounted at the internal rate of return.
The equivalent annual cost of a project decreases
As the opporutnity cost of capital decreases.
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