Chapter 8 business finance

If a project with conventional cash flow has a payback period less than its life, can you definitively state the algebraic sign of the NPV? Why or why not?
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If a project with conventional cash flow has a payback period less than its life, can you definitively state the algebraic sign of the NPV? Why or why not?
A payback period less that the project's life means that the NPV is positive for a zero discount rate, but nothing more definitive can be said. For discount rates greater that zero, the payback period will still be less than the project's life, but the NPV may be positive, zero, or negative, depending on whether the discount rate is less than, equal to, or greater than the IRR
Suppose a project has conventional cash flows and a positive NPV. What do you know about its payback? Its profitability index? Its IRR?
The payback period must be less than the project life since NPV is positive.
The present value of the future cash inflows is greater than the initial investment cost, the PI must be greater than 1.
NPV is positive for discount rate than IRR must be greater than. required return.
Concerning Payback:
A) Describe how the payback period is calculated and describe the information this measure provides about a sequence of cash flows. What is the payback criterion decision rule?
Payback period is the break even point.
Is the point in time for the series of cash. flows when. the initial cash outlays are fully. recovered.
Rule is to accept projects that pay. back before this cutoff and reject projects that take longer to pay back
Concerning Payback:
B) What are the problems associated with using the payback period as a means of evaluating cash flows?
it ignores the time value of money
Concerning Payback:
C) What are the advantages of using the payback period to evaluate cash flows? Are there any any circumstances under which using payback might be appropriate? Explain
used because the analysis is straightforward and simple.
Appropriate analysis method for short-term projects where cash management is most important
Concerning AAR:
A) Describe how the average accounting return is usually calculated and describe the information this measure provides about a sequence of cash flows. What is the AAR criterion decision rule?
as an average measure of the accounting performance of a project over time
competed as some average. profit measure due to the. project divided by some average balance sheet value for the project
Concerning AAR:
B) what are the problems associated with using the AAR as a means of evaluating a project's cash flows? What underlying feature of AAR is most troubling to you from a financial perspective? Does the AAR have any. redeeming qualities?
Problems: the selection of a cutoff is arbitrary, and the time value of money is ignored.
The reliance on accounting number rather that relevant market data and the exclusion of time value of money. considerations are troubling.
Used in practice because the accounting information is usually available, the analysts often use accounting ratios to analyze firm performance, and managerial compensation is often tied to the attainment of certain target accounting ratio goals
Concerning NPV:
A) Describe how NPV is calculated, and describe the information this measure provides about a sequence of cash flows. What is the NPV criterion decision rule?
NPV is the sum of the present values of a project's cash flows.
The net increase or decrease in firm wealth due to the project.
The rule is to accept projects that have a positive NPV and reject projects with a negative NPV
Concerning NPV:
B) Why is NPV considered to be superior method of evaluating the cash flows from a project? Suppose the NPV for a project's cash flow is computed to be $2,500. What does this number represent with respect to the firm's shareholders?
It has no serious flaws
The wealth of the shareholder will increase by $2,500 if the project is accepted
Concerning IRR:
A) Describe how the IRR is calculated, and describe the information this measure provides about a sequence of cash flows. What is the IRR criterion. decision rule?
Is the discount rate that causes the NPV of a series of cash flows to be equal to zero.
Rule is to accept projects with IRRs greater than the discount rate and to reject projects with IRRs less that the discount rate