Question 1

15 Points

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 associated 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 circumstances under which using payback might be appropriate? Explain.

LO 2

Question 2

10 Points

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?

b. Why is NPV considered to be a superior method of evaluating the cash flows from a project? Suppose the NPV for a project's cash flows is computed to be $2,500. What does this number represent with respect to the firm's shareholders?

LO 3

Question 3

15 Points

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?

b. What is the relationship between IRR and NPV? Are there any situations in which you might prefer one method over the other? Explain.

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 than NPV? Explain.

Question 4

10 Points

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 the relationship between the profitability index and the NPV? Are there any situations in which you might prefer one method over the other? Explain.