The NPV Rule O is flawed due to a technical factor called the 'reinvestment rate assumption. O is carved into the limestone above the entrance to the New York Stock Exchange. O is the best criterion for making capital budgeting decisions. O is flawed because it does not measure the wealth created or destroyed by a potential project. provides the same information as the payback rule, but is harder to calculate.

The NPV Rule O is flawed due to a technical factor called the 'reinvestment rate assumption. O is carved into the limestone above the entrance to the New York Stock Exchange. O is the best criterion for making capital budgeting decisions. O is flawed because it does not measure the wealth created or destroyed by a potential project. provides the same information as the payback rule, but is harder to calculate.

Managerial Accounting: The Cornerstone of Business Decision-Making

7th Edition

ISBN:9781337115773

Author:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger

Publisher:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger

Chapter12: Capital Investment Decisions

Section: Chapter Questions

Problem 12MCQ: Using NPV, a project is rejected if it is a. equal to zero. b. negative. c. positive. d. equal to...

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Which of the following statements indicate a disadvantage of using the discounted payback period for capital budgeting decisions? Check all that apply. The discounted payback period does not take the project’s entire life into account. The discounted payback period does not take the time value of money into account. The discounted payback period is calculated using net income instead of cash flows.
The WACC is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that the WACC is only an appropriate discount rate for a project of average risk—in other words, a project that has the same beta as the company. If a project has less risk than the overall company risk, it should be evaluated with a lower discount rate; if a project is riskier than the overall company risk, it should be evaluated using a discount rate higher than the company WACC. Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. It has a before-tax cost of debt of 11.1%, and its cost of preferred stock is 12.2%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 14.7%.…
Which of the following is correct? • the shorter a projects payback period, the less desirable the project is normally considered to be by this criterion • one drawback of the payback criterion is that this method does not take account of cash flows beyond the payback period. • if a projects payback is postitive, then the project should be accepted because it must have a positive NPV • the regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem •one drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback.
Explain what a discounted cash flow method of making capital budgeting decisions is. Why are discounted cash flow methods superior to other methods? What are the risks related to using discounted cash flow methods? What a project profitability index? What does it measure? Why is it used? What is the primary criticism of the payback and simple rate of return methods of making capital budget decisions? What are the benefits in using these methods? Should companies continue to use these methods? Why or why not? What role, if any, should qualitative factors play in capital budgeting decisions? Explain your reasoning for your answer Discuss some of the major benefits to be gained from budgeting.
Why are interest charges not deducted when a project’s cash flows for use in a capital budgeting analysis are calculated? Most firms generate cash inflows every day, not just once at the end of the year. In capital budgeting, should we recognize this fact by estimating daily project cash flows and then using them in the analysis? If we do not, are our results biased? If so, would the NPV be biased up or down? Explain.
Which of the following statements is false? A. Net incomes are not cash flows. Financial Managers should focus on the cash flows when making capital budgeting decisions. B. Incremental earnings are the amount by which the firm's earnings are expected to change as a result of the investment decision. C. To the extend that overhead costs are fixed and will be incurred in any case, they are not incremental to the project and should be excluded in the capital budgeting analysis. D. Depreciation is not a cash expense paid by the firm. E. None of the above.
Option values are extinguished when they areexercised. How does this influence capital budgeting decisions? What considerations, or typesof analysis, might lead management to “take theplunge” and proceed with a project rather thankeep delaying it?
Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product? a. It is learned that land the company owns and would use for the new project, if it is accepted, could be sold to another firm. b. The cost of a study relating to the market for the new product that was completed last year. The results of this research were positive, and they led to the tentative decision to go ahead with the new product. The cost of the research was incurred and expensed for tax purposes last year. c. Revenues from an existing product would be lost as a result of customers switching to the new product. d. Shipping and installation costs associated with a machine that would be used to produce the new product. e. Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product. This space could be…
What are the principal objections to the use of the average rate of return method in evaluating capital investment proposals? Discuss the principal limitations of the cash payback method for evaluating capital investment proposals. What information does the cash payback period ignore that is included by the net present value method? Why would the cash payback method understate the value of a project with a large residual value? What are the major disadvantages of the use of the net present value method of analyzing capital investment proposals? Give examples of qualitative factors that should be considered in a capital investment analysis related to acquiring automated factory equipment.
Which of the following statement is true? O a. Sunk cost is not relevant in capital budgeting decision O b. Capital budgeting decisions are based on past OC. Capital budgeting decisions are short term in nature O d. Capital Budgeting decisions can be changed anytime
True or False: It is often impossible to forecast the cash flows from follow-on projects associated with a proposed capital investment; therefore, it is best for decision makers to ignore strategic value when making capital budgeting decisions.
Which are problems of the payback criterion? Check all that apply: It ignores cash flows after the cutoff date. It ignores the time value of money. It doesn't show the value created by a project. It doesn't fully reflect the risk of a project. It uses an arbitrary cutoff value. It is difficult to calculate.