finance.docx

1、finance8.1 Payback Period and Net Present Value. If a project with conventional cash flows has a payback period less than its life, can you definitively state thealgebraic sign of the NPV? Why or why not? Answer: A payback period less than the projects life means that the NPV is positive for a zero

2、discount rate, but nothing more definitive can be said. For discount rates greater than zero, the payback period will still be less than the projects 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. 8.2. Net

3、 Present Value. Suppose a project has conventional cash flows and a positive NPV. What do you know about its payback? Its profitability index? Its IRR? Explain. Answer： If a project has a positive NPV for a certain discount rate, then it will also have a positive NPV for a zero discount rate; thus t

4、he payback period must be less than the project life. If NPV is positive, then the present value of future cash inflows is greater than the initial investment cost; thus PI must be greater than 1. If NPV is positive for a certain discount rate R, then it will be zero for some larger discount rate R*

5、; thus the IRR must be greater than the required return. 8.3 Payback Period. 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? b. What are the problems a

6、ssociated with using the payback period as a means of evaluating cash flows? c. What are the advantages of using the payback period to evaluate cash flows? Are there any circumstance under which using payback might be appropriate? Explain. Answer: a. Payback period is simply the break-even point of

7、a series of cash flows. To actually compute the payback period, it is assumed that any cash flow occurring during a given period is realized公司金融校级精品课程（双语类） 章后习题 CHAPTER 8 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA 8-2 continuously throughout the period, and not at a single point in time. The pa

8、yback is then the point in time for the series of cash flows when the initial cash outlays are fully recovered. Given some predetermined cutoff for the payback period, the decision rule is to accept projects that payback before this cutoff, and reject projects that take longer to payback. b. The wor

9、st problem associated with payback period is that it ignores the time value of money. In addition, the selection of a hurdle point for payback period is an arbitrary exercise that lacks any steadfast rule or method. The payback period is biased towards short-term projects; it fully ignores any cash

10、flows that occur after the cutoff point. c. Despite its shortcomings, payback is often used because (1) the analysis is straightforward and simple and (2) accounting numbers and estimates are readily available. Materiality consider-actions often warrant a payback analysis as sufficient; maintenance

11、projects are another example where the detailed analysis of other methods is often not needed. Since payback is biased towards liquidity, it may be a useful and appropriate analysis method for short-term projects where cash management is most important. 8.4Average Accounting Return. Concerning AAR:

12、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? b. What are the problems associated with using the AAR as a means of evaluating a projects cash flows? What

13、underlying feature of AAR is most troubling to you from a financial perspective? Does the AAR have any redeeming qualities? Answer: a. The average accounting return is interpreted as an average measure of the accounting performance of a project over time, computed as some average profit measure due

14、to the project divided by some average balance sheet value for the project. This text computes AAR as average net income with respect to average (total) book value. Given some predetermined cutoff for AAR, the decision rule is to accept projects with an AAR in excess of the target measure, and rejec

15、t all other projects. b. AAR is not a measure of cash flows and market value, but a measure of financial statement accounts that often bear little semblance to the relevant value of a project. In addition, the selection of a cutoff is arbitrary, and the time value of money is ignored. For a financia

16、l manager, both the reliance on accounting numbers rather than relevant market data and the exclusion of time value of money considerations are troubling. Despite these problems, AAR continues to be used in practice because (1) the accounting information is usually available, (2) analysts often use

17、accounting ratios to analyze firm performance, and (3) managerial compensation is often tied to the attainment of certain target accounting ratio goals.公司金融校级精品课程（双语类） 章后习题 CHAPTER 8 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA 8-3 8.5 Net Present Value. Concerning NPV: a. Describe how NPV is cal

18、culated and describe the information this measure provides about a sequence of cash flows. What is the NPV criterion decision rule? b. Why is NPV considered to be a superior method of evaluation the cash flows from project? Suppose the NPV for a projects cash flows is computed to be $2,500. What doe

19、s this number represent with respect to the firms shareholders? Answer: a.NPV is simply the sum of the present values of a projects cash flows. NPV specifically measures, after considering the time value of money, the net increase or decrease in firm wealth due to the project. The decision rule is t

20、o accept projects that have a positive NPV, and reject projects witha negative NPV. b. NPV is superior to the other methods of analysis presented in the text because it has no serious flaws. The method unambiguously ranks mutually exclusive projects, and can differentiate between projects of differe

21、nt scale and time horizon. The only drawback to NPV is that it relies on cash flow and discount rate values that are often estimates and not certain, but this is a problem shared by the other performance criteria as well. A project with NPV = $2,500 implies that the total shareholder wealth of the f

22、irm will increase by $2,500 if the project is accepted. 8.6 Internal Rate of Return. Concerning IRR: 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? b. What is relationship between IRR and N

23、PV? Are there any situation in which you might prefer one method over the other? Why? c. Despite its shortcomings in some situations, why do most financial managers use IRR along with NPV when evaluating projects? Can you think of a situation in which IRR might be a more appropriate measure to use t

24、han NPV? Explain. Answer: a. The IRR is the discount rate that causes the NPV of a series of cash flows to be equal to zero. IRR can thus be interpreted as a financial break-even rate of return; at the IRR discount rate, the net value of the project is zero. The IRR decision rule is to accept projec

25、ts with IRRs greater than the discount rate, and to reject projects with IRRs less than the discount rate. b. IRR is the interest rate that causes NPV for a series of cash flows to be zero. NPV is preferred in all situations to IRR; IRR can lead to ambiguous results if there are non-conventional cas

26、h flows, and also ambiguously ranks some mutually exclusive projects. However, for stand-alone projects with conventional cash flows, IRR and NPV are interchangeable techniques. c. IRR is frequently used because it is easier for many financial managers and analysts to rate performance in relative te

27、rms, such as “12%”, than in absolute terms, such as “$46,000.” IRR公司金融校级精品课程（双语类） 章后习题 CHAPTER 8 NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA 8-4 may be a preferred method to NPV in situations where an appropriate discount rate is unknown or uncertain; in this situation, IRR would provide more in

28、formation about the project than would NPV. 8.7 Profitability Index. Concerning the profitability index: a. Describe how the profitability index is calculated and describe the information this measure provides about a sequence of cash flows. What is the profitability index decision rule? b. What is

29、the relationship between the profitability index and the NPV? Are there any situations in which you might prefer one method over the other? Explain. Answer: a. The profitability index is the present value of cash inflows relative to the project cost. As such, it is a benefit/cost ratio, providing a

30、measure of the relative profitability of a project. The profitability index decision rule is to accept projects with a PI greater than one, and to reject projects with a PI less than one. b. PI = ( NPV + cost ) / cost = 1 + ( NPV / cost ). If a firm has a basket of positive NPV projects and is subje

31、ct to capital rationing, PI may provide a good ranking measure of the projects, indicating the “bang for the buck” of each particular project. 8.8 Payback and Internal Rate of Return. A project has perpetual cash flows of C per period, a cost of I, and a required return of R. What is the relationshi

32、p between the projects payback and its IRR? What implications does your answer have for long-lived projects with relatively constant cash flows? Answer: For a project with future cash flows that are an annuity: Payback = I / C And the IRR is: 0 = I + C / IRR Solving the IRR equation for IRR, we get: IRR = C / I Notice this is just the reciprocal of the payback. So: IRR = 1 / Payback For long-lived projects with relatively c