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An investment is acceptable if its NPV is _____. An investment is unacceptable if its NPV is ______. The NPV of an asset measures the ____ which accrues to the ____ of the firm if the asset is acquired. Thus, the use of the NPV rule is consistent with the financial manager's goal of maximizing the ____ of the firm's common stock.

A _____ is the impact that a given capital budgeting project might have on cash flows in another area of the firm. These changes in cash flows (are/are not) incremental cash flows for the project under construction

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Hubert Koch
Hubert KochLv2
28 Sep 2019

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Fill in the blank with the appropriate terms:

The IRR is that rate of return (or discount rate) which equals the (A)_____ of the future (B)_________ for an investment with its (C)_______. The IRR is the rat eof return which equales the NPV of an investment to (D)_______. An investment is (E) ________ if the IRR exceeds the rate of return that could be earned in the financial markets on investment of equal riskl an investment project is (F)_________ if the IRR is less than the relevant rate of return in the financial markets.

A (G)________ is the impact that a given capital budgeting project might have on cash flows in another areaof the firm. These changes in cash flos (H) (are/are not) incrementalcash flows for the project under construction.

NPV versus IRR Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation (BRC). Both projects require an annual return of 14 percent. Year Deepwater Fishing New Submarine Ride 0 −$850,000 −$1,650,000 1 320,000 810,000 2 470,000 750,000 3 410,000 690,000 As a financial analyst for BRC, you are asked the following questions: If your decision rule is to accept the project with the greater IRR, which project should you choose? Because you are fully aware of the IRR rule’s scale problem, you calculate the incremental IRR for the cash flows. Based on your computation, which project should you choose? To be prudent, you compute the NPV for both projects. Which project should you choose? Is it consistent with the incremental IRR rule?

1) Explain why the NPV of a relatively long-term project, defined as one for which a high percentage of its cash flows are expected in the distant future, is more sensitive to changes in the cost of capital than is the NPV of a short-term project.

b) When two mutually exclusive projects are being compared, explain why the short term project might be ranked higher under the NPV criterion if the cost of capital is high whereas the long-term project might be deemed better if the cost of capital is low. Would changes in the cost of capital ever cause a change in the IRR ranking of two such projects? why or why not?

c) Suppose a firm is considering two manually exclusive projects. One has a life of 6 years and the other a life of 10 years. Would the failure to employ some type of replacement chain analysis bias an NPV analysis against one of the projects? Expain

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