Homework answers / question archive / Chapter 9  Capital Budgeting Criteria   True/False   1)      Errors resulting from a capital budgeting decision are not considered major since the consequences of such errors average out over the life of the investment

Chapter 9  Capital Budgeting Criteria   True/False   1)      Errors resulting from a capital budgeting decision are not considered major since the consequences of such errors average out over the life of the investment

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Chapter 9 

Capital Budgeting Criteria

 

True/False

 

1)      Errors resulting from a capital budgeting decision are not considered major since the consequences of such errors average out over the life of the investment.

         

2.       One drawback of the payback method is that it focuses primarily on breaking even versus measuring total project value.

         

3.       The required rate of return reflects the costs of funds needed to finance a project.

         

4.       The profitability index provides the same decision result as the net present value (NPV) method.

         

5.       The internal rate of return (IRR) will increase as the required rate of return of a project is increased.

         

6.       Whenever the IRR on a project equals that project’s required rate of return, the NPV equals zero.

         

 

7.       High required rates of return tend to make long-term projects less attractive than short-term projects.

         

8.       One of the disadvantages of the payback method is that it ignores cash flows beyond the payback period.

         

9.       Both the IRR rule and the accounting rate of return rule take into consideration the time value of money.

         

10.     In general, all discounted cash flow criteria are consistent and will give similar accept-reject decisions.

         

11.     When several sign reversals in the cash flow stream occur, the IRR equation can have more than one positive IRR.

         

12.     Many firms today continue to use the payback method but employ the NPV or IRR methods as secondary decision methods of control for risk.

         

13.     The required rate of return represents the cost of capital for a project.

         

14.    The IRR assumes that cash flows are reinvested at the cost of capital. 

        

15.    According to the modified internal rate of return (MIRR) technique, when a project’s MIRR is greater than its cost of capital, the project should be accepted.

        

16.     If the NPV of a project is zero, then the profitability index should equal one.

         

17.     The net present value profile is a graph showing how a project’s NPV changes as the IRR changes.

         

18.     If the NPV of a project is positive, the profitability index must be greater than one.

         

19.     It is possible for a project to have more than one IRR if there is more than one sign change in the after-tax cash flows due to the project.

         

20.     The higher the discount rate, the more valued is the proposal with the early cash flows.

         

21.     If the project’s payback period is greater than or equal to zero, the project should be accepted.

         

22.     The NPV of a project will equal zero whenever the payback period of a project equals the required rate of return.

         

23.     The NPV of a project will equal zero whenever the average rate of return equals the required rate of return.

         

24.     The IRR is the discount rate that equates the present value of the project’s future net cash flows with the project’s initial outlay.

         

25.     If a project’s profitability index is less than 0.0, then the project should be rejected.

         

26.     A single project can only have one NPV, PI, and IRR.

         

27.     Competitive market forces make it imperative for a firm to have a systematic strategy for generating capital-budgeting projects.

         

28.     Spending on capital equipment in the U.S. has been growing at an extremely rapid pace.

         

29.     The size of capital investments and the difficulty in reversing them once they are made make capital-budgeting decisions very important to the firm.

         

30.     In recent years, more and more capital expenditures have been aimed at introducing new products, rather than being directed at cost-saving and productivity-improving projects.

         

31.     Payback period is the least sophisticated capital-budgeting technique.

         

32.     The discounted payback period is superior to the traditional payback period; however, its use as a capital-budgeting tool is still limited.

         

33.     An NPV of zero indicates that a project is expected to provide the required rate of return.

         

34.     NPV is the most theoretically correct capital-budgeting method.

         

35.     There are no disadvantages to the Net Present Value method.

         

36.     Capital budgeting is the decision-making process with respect to investment in working capital.

         

37.     NPV is a better capital-budgeting technique than IRR.

         

38.     If NPV equals zero, then the discount rate used to calculate NPV must equal the project’s IRR.

         

39.     If NPV is negative, then the project’s cost is less than the project’s expected benefit.

         

40.     If NPV is positive, then the project is expected to return more than the required rate of return.

         

41.     Currently, most firms use NPV and IRR as their primary capital-budgeting technique.

         

42.     Most firms use the payback period as a secondary capital-budgeting technique, which in a sense allows them to control for risk.

         

43.     Although discounted cash flow decision techniques have become widely accepted, their use depends to some degree on the size of the project and where within the firm the decision is being made.

         

Multiple Choice

 

44.    Which of the following methods assumes that cash flows are reinvested at the IRR?

1. MIRR
2. NPV
3. IRR
4. Both a and b
5. All of the above

 

        

 

45.     The firm should accept independent projects if:

          a.   the payback is less than the IRR.

          b.   the profitability index is greater than 1.0.

          c.   the IRR is positive.

          d.   the NPV is greater than the discounted payback.

 

         

46.     The NPV method:

          a.   is consistent with the goal of shareholder wealth maximization.

          b.   recognizes the time value of money.

          c.   uses cash flows.

          d.   all of the above.

 

         

47.     If the IRR is greater than the required rate of return, the:

          a.   present value of all the cash inflows will be greater than the initial outlay.

2. payback will be less than the life of the investment.
3. project should be rejected.

          d.   both a and b.

 

         

48.    The NPV assumes cash flows are reinvested at the:

1. IRR.
2. NPV.
3. real rate of return.
4. cost of capital.

 

49.     If the cash flow pattern for a project has two sign reversals, then there can be as many as ____________ positive IRR(s).

          a.   one

          b.   two

          c.   three

          d.   four

 

         

50.     A project has an initial outlay of $4,000. It has a single payoff at the end of Year 4 of $6,996.46. What is the IRR for the project (round to the nearest percent)?

          a.   16%

          b.   13%

          c.   21%

          d.   15%

 

         

51.     ABC Service can purchase a new assembler for $15,052 that will provide an annual net cash flow of $6,000 per year for five years. Calculate the NPV of the assembler if the required rate of return is 12%. (Round your answer to the nearest $1.)

          a.   $1,056

          b.   $4,568

          c.   $7,621

          d.   $6,577

 

         

52.     Given the following annual net cash flows, determine the IRR to the nearest whole percent of a project with an initial outlay of $1,520.

Year     Net Cash Flow

 1          $1,000

 2          $1,500

 3          $  500

          a.   48%

          b.   40%

          c.   32%

          d.   28%

 

         

53.     A machine costs $1,000, has a three-year life, and has an estimated salvage value of $100. It will generate after-tax annual cash flows (ACF) of $600 a year, starting next year. If your required rate of return for the project is 10%, what is the NPV of this investment? (Round your answerwer to the nearest $10.)

          a.   $490

          b.   $570

          c.   $900

          d.   -$150

 

54.     Suppose you determine that the NPV of a project is $1,525,855. What does that mean?

          a.   In all cases, investing in this project would be better than investing in a project that has an NPV of $850,000.

          b.   The project would add value to the firm.

          c.   Under all conditions, the project’s payback would be less than the profitability index.

          d.   The project’s IRR would have to be less that the firm’s discount rate.

 

 

 

55.     Initial Outlay                Cash Flow in Period

                            1               2                   3                4

    -$4,000    $1,546.17    $1,546.17    $1,546.17    $1,546.17

The IRR (to the nearest whole percent) is:

          a.   10%.

          b.   18%.

          c.   20%.

          d.   16%.

 

56.     We compute the profitability index of a capital-budgeting proposal by:

          a.   multiplying the IRR by the cost of capital.

          b.   dividing the present value of the annual after-tax cash flows by the cost of capital.

          c.   dividing the present value of the annual after-tax cash flows by the cost of the project.

          d.   multiplying the cash inflow by the IRR.

 

 

57.     What is the payback period for a $20,000 project that is expected to return $6,000 for the first two years and $3,000 for Years 3 through 5?

          a.   3 1/2

          b.   4 1/2

          c.   4 2/3

          d.   5

 

 

58.     Which of the following is NOT an advantage of NPV?

          a.   It can be used as a rough screening device to eliminate those projects whose returns do not materialize until later years.

          b.   All positive NPVs will increase the value of the firm.

          c.   It allows the comparison of benefits and costs in a logical manner.

          d.   It recognizes the timing of the benefits resulting from the project.

 

 

59.    Which of the following techniques may ignore the terminal cash flow of a project?

1. NPV
2. IRR
3. Payback
4. Both b and c

 

 

60.     The IRR is:

          a.   the discount rate that makes the NPV positive.

          b.   the discount rate that equates the present value of the cash inflows with the cost of the project.

          c.   the discount rate that makes the NPV negative and the profitability index greater than one.

          d.   the rate of return that makes the NPV positive.

 

 

61.     All of the following criteria for capital-budgeting decisions adjust for the time value of money EXCEPT:

          a.   IRR.

          b.   NPV.

          c.   payback period.

          d.   profitability index.

 

 

62.     Which of the following is NOT a criticism of the payback period criteria?

          a.   Time value of money is not accounted for.

          b.   Returns occurring after the payback are ignored.

          c.   It deals with accounting profits as opposed to cash flows.

          d.   Both a & c

 

 

63.     Artie’s Soccer Ball Company is considering a project with the following cash flows:

Initial outlay = $750,000

Incremental after-tax cash flows from operations Years 1-4 = $250,000 per year

Compute the NPV of this project if the company’s discount rate is 12%.

          a.   $9,337

          b.   $7,758

          c.   $4,337

          d.   $2,534

 

 

64.     Dieyard Battery Recyclers is considering a project with the following cash flows:

Initial outlay = $13,000

Cash flows: Year 1 = $5,000

                    Year 2 = $3,000

                    Year 3 = $9,000

If the appropriate discount rate is 15%, compute the NPV of this project.

          a.   $4,000

          b.   -$466

          c.   $27,534

          d.   $8,891

 

 

65.     Your company is considering a project with the following cash flows:

Initial outlay = $1,748.80

Cash flows Years 1-6 = $500

Compute the IRR on the project.

          a.   9%

          b.   11%

          c.   18%

          d.   24%

 

66.     For the NPV criteria, a project is acceptable if the NPV is __________, while for the profitability index, a project is acceptable if the profitability index is __________.

          a.   less than zero, greater than the required return

          b.   greater than zero, greater than one

          c.   greater than one, greater than zero

          d.   greater than zero, less than one

 

 

67.     Compute the payback period for a project with the following cash flows, if the company’s discount rate is 12%.

Initial outlay = $450

Cash flows: Year 1 = $325

                    Year 2 = $ 65

                    Year 3 = $100

          a.   3.43 years

          b.   3.17 years

          c.   2.88 years

          d.   2.6 years

 

 

68.     Consider a project with the following cash flows:

              After-Tax           After-Tax

             Accounting           Cash Flow

Year          Profits          from Operations

 1                $799                 $  750

 2                $150                 $1,000

 3                $200                 $1,200

Initial outlay = $1,500

Terminal cash flow = 0

Compute the profitability index if the company’s discount rate is 10%.

          a.   15.8

          b.   1.61

          c.   1.81

          d.   0.62

 

 

69.     If the NPV of a project is positive, then the project’s IRR ____________ the required rate of return.

          a.   must be less than

          b.   must be greater than

          c.   could be greater or less than

          d.   cannot be determined without actual cash flows

 

 

70.     What is the term for the discount rate that equates the present value of a project’s future net cash flows with the project’s initial cash outlay?

          a.   The MIRR

          b.   The hurdle rate

          c.   The IRR

          d.   The accounting rate of return

 

 

71.     The ____________ is equal to the present value of inflows less the present value of outflows, discounted at the cost of capital.

          a.   accounting rate of return

          b.   profitability index

          c.   NPV

          d.   IRR

 

 

72.     You are considering investing in a project with the following year-end after-tax cash flows:

Year 1: $5,000

Year 2: $3,200

Year 3: $7,800

If the initial outlay for the project is $12,113, compute the project’s IRR.

          a.   14%

          b.   10%

          c.   32%

          d.   24%

 

73.     Which of the following capital-budgeting techniques assume the same reinvestment rate of cash flows?

          a.   MIRR

          b.   NPV

          c.   IRR

          d.   Both a & b

          e.   All of the above

 

 

74.     Which of the following best describes the payback period?

          a.   The amount needed to recover the entire IRR

          b.   The number of years needed to recover the initial cash outlay

          c.   The value of the cash flows at the end of a project

          d.   The rate of return that is needed to pay back investors

 

 

 

75.     Payback period:

          a.   ignores the time value of money.

          b.   deals with cash flows rather than accounting profits.

          c.   measures how quickly the project will return its original investment.

          d.   does all of the above.

 

 

76.     A project costs $10,000 and is expected to return after-tax cash flows of $3,000 each year for the next 10 years. This project’s payback period is:

          a.   three years.

          b.   three and one-third years.

          c.   four years.

          d.   10 years.

 

 

77.    Manheim Candles is considering a project with the following incremental cash flows. Assume a discount rate of 10%.

            Year                 Cash Flow

0               ($20,000)

1               0

2               $30,000

3               $30,000

         Calculate the project’s MIRR. (Round to the nearest whole percentage.)

a.   31%

b.   47%

c.   53%

d.   61%

 

 

Use the following information to answer questions 78 through 84.

 Below are the expected after-tax cash flows for Projects Y and Z. Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.

 

                           Project Y   Project Z

          Year 1       $12,000     $10,000

          Year 2       $8,000       $10,000

          Year 3       $6,000           0

          Year 4       $2,000           0

          Year 5       $2,000           0

 

78.     Payback for Project Y is:

          a.   two years.

          b.   one year.

          c.   three years.

          d.   four years.

 

 

79.     What is payback for Project Z?

          a.   Two years

          b.   One year

          c.   Zero years

          d.   Project Z does not payback the original investment.

 

 

80.     Discounted payback for Project Y is:

          a.   three years.

          b.   3.14 years.

          c.   four years.

          d.   two years.

 

81.     What is discounted payback for Project Z?

          a.   Two years

          b.   One year

          c.   Zero years

          d.   Project Z does not have a discounted payback because the initial cash outlay is never fully recovered.

 

 

82.     Project Y’s NPV is:

          a.   less than zero.

          b.   $1,826.26.

          c.   $10,000.

          d.   $4,636.42.

 

 

 

83.     Project Y’s IRR is:

          a.   less than zero.

          b.   less than 17%.

          c.   22.51%.

          d.   12.51%.

 

 

84.     Project Y’s MIRR is:

          a.   22.51%.

          b.   19.06%.

          c.   11.91%.

          d.   10%.

 

 

85.     Who decides upon the acceptable discounted payback period?

          a.   The IRS

          b.   The SEC

          c.   The firm

          d.   The investment banking firm

 

 

86.     You have been asked to analyze a capital investment proposal. The project’s cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project’s discounted payback period?

          a.   5.35 years

          b.   3.74 years

          c.   4.02 years

          d.   2.75 years

 

 

87.     Which of the following statements is FALSE?

          a.   Accepting positive NPV projects is consistent with the goal of shareholder wealth maximization.

          b.   If NPV is positive, then the project is expected to return more than the required rate of return.

          c.   If NPV is negative, then the project’s cost is less than the project’s expected benefit.

          d.   If NPV is negative, then the project is expected to return less than the required rate of return.

 

 

Use the following to answer questions 88-90. The information below describes a project with an initial cash outlay of $10,000 and a required return of 12%.

                                       After-tax cash inflow

                                      Year 1          $6,000

                                      Year 2          $2,000

                                      Year 3          $2,000

                                      Year 4          $2,000

 

88.     Which of the following statements is correct?

          a.   The project should be accepted since its NPV is $353.87.

          b.   The project should be rejected since its NPV is -$353.87.

          c.   The project should be accepted since it has a payback of less than four years.

          d.   The project should be rejected since its NPV is -$23.91.

 

 

89.     This project:

          a.   has an IRR of 9.86%.

          b.   should be accepted based on the IRR criterion.

          c.   has an IRR of 12%.

          d.   both a and b.

 

 

90.     The profitability index for this project:

          a.   is 1.

          b.   is greater than 1.

          c.   is 0.96.

          d.   indicates that the project should be accepted.

 

 

91.    The IRR of a project increases as the _________ decreases.

1. discount rate
2. initial outlay of the project
3. incremental cash inflow
4. both a and b
5. all of the above

 

 

92.    An increase in the cost of capital will cause __________ to increase.

1. the NPV
2. the IRR
3. the discounted payback period
4. none of the above

 

 

93.    The profitability index of the project would increase if ______________ increased.

   a.   the discount rate

         b.   the terminal cash flow

   c.   the NPV

   d.   both b and c

 

 

94.    Manheim Candles is considering a project with the following incremental cash flows. Assume a discount rate of 10%.

         Year                         Cash Flow

0. ($15,000)
1.  $10,000
2.  $20,000
3.  $30,000

         Calculate the discounted payback period of the project.

a.   2.15 years

b.   2.36 years

c.   2.57 years

d.   2.78 years

 

95.     Which method of evaluating capital-budgeting decisions has the superior reinvestment assumption?

          a.   The payback

          b.   The NPV

          c.   The IRR

          d.   The accounting rate of return

 

96.     Which of the following investment projects should be undertaken?

          a.   Those having an IRR that exceeds the firm’s weighted average cost of capital.

          b.   Those projects that have a discounted payback that exceeds the IRR.

          c.   Those projects that have a capital asset pricing model that exceeds the weighted average cost of capital.

          d.   Those having an NPV that exceeds the firm’s average cost of capital.

          e.   None of the above.

 

97.     When using the NPV method of evaluating capital investment alternatives, the implicit assumption is that the cash flows generated from the project are reinvested at:

          a.   the current 90-day T-bill rate.

          b.   the project’s IRR.

          c.   the discount rate established by the firm.

          d.   the current yield on AAA long-term corporate bonds.

          e.   the firm’s CAPM.

 

98.     Which of the following capital-budgeting decision criteria are correct?

          a.   Accept projects that have a positive NPV.

          b.   Accept projects that generate an IRR that is greater than the firm’s discount rate.

          c.   Accept projects that have a profitability index of greater than 1.0.

          d.   Accept projects that generate an MIRR that is greater than the firm’s discount rate.

          e.   All of the above are correct.

 

99.     Which of the below would be acceptable projects?

          a.   Those that generate an IRR that is greater than the firm’s discount rate.

          b.   Any project that has a positive payback.

          c.   Ones that generate an IRR that is greater than the accounting rate of return.

          d.   Any project that produces a profitability index that is greater than the firm’s MIRR.

 

 

100. A negative NPV indicates that a project has a(n):

a. IRR less than the cost of capital.

b. profitability index greater than 1.

c. MIRR more than the discount rate.

d. both b and c.

 

 

101. As the cost of capital is increased, the:

1. IRR remains constant.
2. payback period remains the same.
3. discounted payback period increases.
4. both b and c.
5. all of the above.

 

 

102.   MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000. The project will generate after-tax cash flows of $33,100 in Year 1, $31,500 in Year 2, and $31,200 in Year 3. Assume that the firm’s proper rate of discount is 10% and that the firm’s tax rate is 40%. What is the project’s payback?

          a.   0.33 years

          b.   1.22 years

          c.   2.33 years

          d.   Three years

          e.   More than three years

 

103. Which of the following is the correct equation to solve for the NPV of the project that has an initial outlay of $30,000, followed by three years of $20,000 in incremental cash inflow? Assume a discount rate of 10%.

a.  NPV = -$30,000 + $20,000(1.10)¹ + $20,000(1.10)² + $20,000(1.10)³

b.  NPV = -$30,000 + $20,000(1.10)^-1 + $20,000(1.10)^-2 + $20,000(1.10)^-3

c.  NPV = -$30,000 + $20,000/(1.01)^.10 + $20,000/(1.02)^.10 + $20,000/(1.03)^.10

d.  NPV = -$30,000 + $20,000/(1.1)^.10+ $20,000(1.2)^.10 + $20,000(1.3)^.10

 

 

104. Frazier Fudge has a project with an initial outlay of $40,000, followed by three years of annual incremental cash flows of $35,000. The terminal cash flow of the project is $10,000. Assuming a cost of capital of 10%, calculate the MIRR of the project.

a.   46.5%          

b.   51.3%

c.   62.9%

d.   74.7%

 

105.   A machine has a cost of $5,375,000. It will produce cash inflows of $1,825,000 (Year 1); $1,775,000 (Year 2); $1,630,000 (Year 3); $1,585,000 (Year 4); and $1,650,000 (Year 5). At a discount rate of 16.25%, what is the NPV?

          a.   $81,724

          b.   $257,106

          c.   $416,912

          d.   $190,939

 

 

106.   Analysis of a machine indicates that it has a cost of $5,375,000. The machine is expected to produce cash inflows of $1,825,000 in Year 1; $1,775,000 in Year 2; $1,630,000 in Year 3; $1,585,000 in Year 4; and $1,650,000 in Year 5. What is the machine’s IRR?

          a.   12.16%

          b.   17.81%

          c.   23.00%

          d.   11.11%

 

107.   You have been asked to analyze a capital investment proposal. The project’s cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. What is the project’s IRR?

          a.   8.04%

          b.   16.75%

          c.   23.78%

          d.   19.16%

 

 

108.   When Net Present Value is equal to $0, the discount rate is equal to the project’s:

          a.   internal rate of return.

          b.   capital asset pricing model.

          c.   modified internal rate of return.

          d.   both a & c.                       

 

 

109.   Why does the NPV method of evaluating an investment proposal require that the cash inflows of a project be discounted to the present?

          a.   It is the only way to arrive at the correct amount to divide into the cost in order to determine the rate of return.

          b.   The IRS requires it.

          c.   This enables the analyst to determine the amount of the investment outlay.

          d.   It provides a measurement of the value of an investment proposal in terms of today’s dollars.

 

 

110. Kannan Enterprise has a project with an initial outlay of $40,000, followed by three years of annual incremental cash flows of $35,000. The terminal cash flow of the project is $10,000. Assuming a discount rate of 10%, which of the following is the correct equation to solve for the IRR of the project?

a.  $40,000 = $35,000(1.12)¹ + $35,000(1.12)² + $45,000(1.12)³

         b.  $40,000 = $35,000(1 + IRR)¹ + $35,000(1+IRR)² + $45,000(1+IRR)³

c.  $40,000 = $35,000/(1.12)^IRR + $35,000/(1.12)^IRR + $45,000/(1.12)^IRR

d.  $40,000 = $35,000(1+IRR)^-1 + $35,000(1.IRR)^-2 + $45,000(1+IRR)^-3

 

 

111. We-Know-Widgets, Inc. is analyzing a project that requires an initial investment of $10,000, followed by cash inflows of $1,000 in Year 1, $4,000 in Year 2, and $15,000 in Year 3. The cost of capital is 10%. What is the profitability index of the project? (Round to the nearest $.)

a.   1.04

b.   1.55

c.   1.78

d.   1.97

 

112. Mayhem Mines, Inc. is analyzing a project that requires an initial investment of $50,000, followed by cash inflows of $15,000 in Year 1, $60,000 in Year 2, and $75,000 in Year 3. The cost of capital is 10%.  Calculate the profitability index of the project. (Round to the nearest $.)

a.   2.14

b.   2.26

c.   2.39

d.   2.47

 

 

113.   Which of the following capital-budgeting decision criteria are correct?

          a.   Accept projects that have a positive NPV.

          b.   Accept projects that generate an IRR that is greater than the firm’s CAPM.

          c.   Accept projects that have a profitability index of greater than the IRR.

          d.   Accept projects that generate an MIRR that is greater than the IRR.

          e.   All of the above are correct.

 

114. Mayhem Mines, Inc. is analyzing a project that has a profitability index of 2.5. Given the following cash flows for the project, calculate the present value of inflows for the project.

            Year                Cash Flow

0. ($100,000)
1.  $120,000
2.  $130,000
3.  $200,000

a.   $250,000

b.   $350,000

c.   $450,000

d.   $550,000

 

115.   If the NPV of a project is positive, what will occur?

          a.   The value of the firm will be increased.

          b.   The IRR will be greater than the payback period.

          c.   The equivalent annual annuity will exceed the IRR.

          d.   The discounted payback period will be greater than the payback period.

 

 

116.   You have been asked to analyze a capital investment proposal. The project’s cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project’s NPV?

          a.   $101,247

          b.   $285,106

          c.   $473,904

          d.   $581,880

 

 

117. Wheatley Estates has evaluated a project with an initial outlay of $100,000 with three years of positive incremental cash flows. The projected cash flow in Year 1 is $40,000 and $90,000 in Year 3. The company determined that the payback period of the project is 1.6 years. Based on their results, what was the incremental cash flow for Year 2?

1. $60,000
2. $100,000
3. $160,000
4. $200,000

 

 

118.   So long as money has a time value, the discounted payback will always be greater than the:

          a.   payback.

          b.   IRR.

          c.   NPV.

          d.   payback.

         

 

119.   The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm’s cost of capital is 10%. Assume cash flows occur evenly during the year, 1/365th each day. What is the discounted payback period for this investment?

          a.   5.23 years

          b.   4.86 years

          c.   4.35 years

          d.   3.72 years

          e.   3.35 years

 

 

120.   The director of capital budgeting of South Park Development Corporation is evaluating a project that will cost $200,000; it is expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year. If the firm’s cost of capital is 14% and its tax rate is 40%, what is the project’s IRR?

          a.   8%

          b.   14%

          c.   18%

          d.   -5%

          e.   12%

 

 

121.   Dizzyland Enterprises has been presented with an investment opportunity which will yield end-of-year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm’s cost of capital is 10%. What is the profitability index for this investment?

          a.   1.28

          b.   0.87

          c.   1.85

          d.   0.21

 

122.   Under which of the following conditions will the IRR of a project be equal to the rate at which projects are discounted?

          a.   When the discounted payback is equal to MIRR

          b.   When the profitability index is equal to the CAPM

          c.   When the NPV is equal to zero

          d.   When the payback is equal to the IRR

          e.   None of the above

 

 

123.   Suppose you determine that the IRR of a project is 27.99%. What does that mean?

          a.   The project is acceptable.

          b.   The project is acceptable only if the IRR is greater than the discounted payback period.

          c.   The project would be acceptable if the project’s profitability index is positive.

          d.   The project would be acceptable if the IRR is greater than the firm’s discount rate.

 

 

124. Aroma Candles, Inc. is evaluating a project with the following cash flows. Calculate the IRR of the project. (Round to the nearest whole percentage.)

        

         Year        Cash Flows

0 ($120,000)

1   $ 30,000

2           $ 70,000

3           $ 90,000

a.   18%

b.   23%

c.   28%

d.   33%

 

 

125.   What deficiency of the IRR does the MIRR overcome?

          a.   The fact that the IRR fails to consider risk

          b.   The possibility of arriving at multiple solutions

          c.   The fact that the IRR does not take the time value of money into consideration

          d.   The ranking problem

          e.   None of the above

 

 

126.   Which of the following statements about the MIRR is false?

          a.   The MIRR has the same reinvestment assumption as the IRR.

          b.   If a project’s MIRR exceeds the firm’s discount rate, the project is acceptable.

          c.   The MIRR has the same reinvestment assumption as the NPV.

          d.   A project’s MIRR could be lower than a project’s IRR.

 

127.   You have been asked to analyze a capital investment proposal. The project’s cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project’s MIRR?

          a.   12.62%

          b.   10.44%

          c.   16.73%

          d.   19.99%

 

128.   Which of the following is considered to be a deficiency of the IRR?

          a.   It fails to properly rank capital projects.

          b.   It could produce more than one rate of return.

          c.   It fails to utilize the time value of money.

          d.   It is not useful in accounting for risk in capital budgeting.

 

129.   A firm is considering two projects, A and B. Both have the same initial cash outlay and the same payback period. Project A is expected to generate after-tax cash flows for 10 years, while Project B is expected to generate after-tax cash flows for 15 years. Given that payback is the same for both projects, will the firm be indifferent between these two projects? Explain why or why not.

 

130. Tinker Tools, Inc. is considering a project with the following cash flows. Calculate the MIRR of the project assuming a reinvestment rate of 8%.

Year              Cash Flows

1. 0.     ($70,000)
   1.     ($55,000)
   2.      $40,000
   3.      $60,000
   4.      $100,000

 

        

131. Define the reinvestment rate assumption. What is the underlying assumption for NPV and IRR? Which assumption is most acceptable? How does the MIRR adjust the reinvestment rate assumption of IRR?

 

 

132.   Carter Paving plans to purchase a new grader. The one under consideration costs $250,000 and has a depreciable life of five years. After-tax cash flows are expected to be $67,124 in each of the five years and nothing thereafter. Calculate the IRR for the grader.

 

         

 

133.   What is the NPV of a $45,000 project that is expected to have an after-tax cash flow of $14,000 for the first two years, $10,000 for the next two years, and $8,000 for the fifth year? Use a 10% discount rate. Would you accept the project?

 

134.   Referring to the above problem, if the discount rate was 8%, what would the NPV be? Would you accept or reject the investment?

 

 

135.   Determine the IRR on the following projects:

a.   Initial outlay of $35,000 with an after-tax cash flow at the end of

      the year of $5,836 for seven years

b.   Initial outlay of $350,000 with an after-tax cash flow at the end

      of the year of $70,000 for seven years

c.   Initial outlay of $3,500 with an after-tax cash flow at the end of

      the year of $1,500 for three years