Financial Management Chapter 10
CHAPTER 10
ANSWERS TO REVIEW QUESTIONS
9-1 Once the relevant cash flows have been developed, they must be analyzed to determine whether the projects are acceptable or to rank the projects in terms of acceptability in meeting the firm 's goal.
9-2 The payback period is the exact amount of time required to recover the firm 's initial investment in a project. In the case of a mixed stream, the cash inflows are added until their sum equals the initial investment in the project. In the case of an annuity, the payback is calculated by dividing the initial investment by the annual cash inflow.
9-3 The weaknesses of using the payback period are 1) no explicit consideration of shareholders ' wealth; 2) failure to take fully into account the time factor of money; and 3) failure to consider returns beyond the payback period and, hence, overall profitability of projects.
9-4 Net present value computes the present value of all relevant cash flows associated with a project. For conventional cash flow, NPV takes the present value of all cash inflows over years 1 through n and subtracts from that the initial investment at time zero. The formula for the net present value of a project with conventional cash flows is:
NPV = present value of cash inflows - initial investment
9-5 Acceptance criterion for the net present value method is if NPV > 0, accept; if NPV < 0, reject. If the firm undertakes projects with a positive NPV, the market value of the firm should increase by the amount of the NPV.
9-6 The internal rate of return on an investment is the discount rate that would cause the investment to have a net present value of zero. It is found by solving the NPV equation given below for the value of k that equates the present value of cash inflows with the initial investment.
9-7 If a project 's internal rate of return is greater than the firm 's cost of capital, the project should be accepted; otherwise, the project should be rejected. If the
ANSWERS TO REVIEW QUESTIONS
9-1 Once the relevant cash flows have been developed, they must be analyzed to determine whether the projects are acceptable or to rank the projects in terms of acceptability in meeting the firm 's goal.
9-2 The payback period is the exact amount of time required to recover the firm 's initial investment in a project. In the case of a mixed stream, the cash inflows are added until their sum equals the initial investment in the project. In the case of an annuity, the payback is calculated by dividing the initial investment by the annual cash inflow.
9-3 The weaknesses of using the payback period are 1) no explicit consideration of shareholders ' wealth; 2) failure to take fully into account the time factor of money; and 3) failure to consider returns beyond the payback period and, hence, overall profitability of projects.
9-4 Net present value computes the present value of all relevant cash flows associated with a project. For conventional cash flow, NPV takes the present value of all cash inflows over years 1 through n and subtracts from that the initial investment at time zero. The formula for the net present value of a project with conventional cash flows is:
NPV = present value of cash inflows - initial investment
9-5 Acceptance criterion for the net present value method is if NPV > 0, accept; if NPV < 0, reject. If the firm undertakes projects with a positive NPV, the market value of the firm should increase by the amount of the NPV.
9-6 The internal rate of return on an investment is the discount rate that would cause the investment to have a net present value of zero. It is found by solving the NPV equation given below for the value of k that equates the present value of cash inflows with the initial investment.
9-7 If a project 's internal rate of return is greater than the firm 's cost of capital, the project should be accepted; otherwise, the project should be rejected. If the