FIN 3716: Chapter 8 Concepts

C. Project D

Assuming that your capital is constrained, which project should you invest in last? A. Project A B. Project I C. Project D D. Project C

D. Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today

Tanner is choosing between two investment options. He can invest $500 now and get (guaranteed) $550 in one year, or invest $500 now and get (guaranteed) $531.40 back later today. The risk-free rate is 3.5%. Which investment should Tanner prefer? A. $531.40 later today, since $1 today is worth more than $1 in one year B. $550 in one year, since it is $50 more than he invested rather than $31.40 more than he invested C. Neither - both investments have a negative NPV D. Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today

A. Project H

Assuming that your capital is constrained, what is the fifth project that you should invest in? A. Project H B. Project I C. Project B D. Project A

D. (whichever one has the line crossing right after 5)

A bakery is deciding whether to buy an extra van to help deliver its products. The van will cost $28,000, but is expected to increase profits by $6,500 per year over the five years of its working life. Which of the following is the correct net present value (NPV) profile for this purchase?

B. Project II

A company has four projects it wishes to undertake. Which of these investments should be the lowest priority, given a discount rate of 5%? A. Project I B. Project II C. Project III D. Project IV

D. Prep for the Grad School Entry Test, Prep for the Law School Entry Test, and Prep for the Medical School Entry Test

A company that creates education products is planning to create a suite of books to help customers prepare for high-stakes tests for entry into college and grad school. They have 33 in-house writers to create these books. Due to the expertise needed in creating this content is will not be possible to hire temporary writers within the planned time-frame. Which projects should be undertaken? A. Prep for the College Entry Test and Prep for the Law School Entry Test B. Prep for the College Entry Test and Prep for the Grad School Entry Test C. Prep for the Dental School Entry Test, Prep for the Grad School Entry Test, and Prep for the Medical School Entry Test D. Prep for the Grad School Entry Test, Prep for the Law School Entry Test, and Prep for the Medical School Entry Test

D. No, since the value of the cash flows over the first two years are less than the initial investment.

A convenience store owner is contemplating putting a large neon sign over his store. It would cost $50,000, but is expected to bring an additional $24,000 of profit to the store every year for five years. Would this project by worthwhile if evaluated using a payback period of two years or less and if the cost of capital is 10%? A. Yes, since it will pay back its initial investment in two years. B. Yes, since the value of the cash flows into the store, in present dollars, are greater than the initial investment. C. Yes, since the cash flows after two years are greater than the initial investment. D. No, since the value of the cash flows over the first two years are less than the initial investment.

C. $0

A farmer sows a certain crop. It costs $240,000 to buy the seed, prepare the ground, and sow the crop. In one year's time it will cost $93,200 to harvest the crop. If the crop will be worth $350,000, and the interest rate is 7%, what is the net present value (NPV) of this investment? A. $240,000 B. $87,103 C. $0 D. $567,103

C. net present value (NPV)

A firm is considering several mutually exclusive investment opportunities. The best way to choose between them is which of the following? A. profitability index B. payback period C. net present value (NPV) D. internal rate of return (IRR)

D. Hoist B, since it has a greater equivalent annual annuity.

A garage is comparing the cost of buying two different car hoists. Hoist A will cost 20,000, will require serving of $1000 every two years, and last ten years. Hoist B will cost $15,000, require servicing of $800 per year, and last eight years. If the cost of capital is 7%, which is the better option, given that the firm has an ongoing requirement for a hoist A. Hoist A, since it has a greater present value (PV). B. Hoist B, since it has a greater present value (PV). C. Hoist A, since it has a greater equivalent annual annuity. D. Hoist B, since it has a greater equivalent annual annuity.

D. Option B, since it has a greater equivalent annual annuity.

A janitorial services firm is considering two brands of industrial vacuum cleaners to equip their staff. Option A will cost $1,500, require servicing of $200 per year, and it will last five years. Option B will cost $1,000, require servicing of $200 per year, and it will last three years. If the cost of capital is 8%, which is the better option, given that the firm has an ongoing requirement for vacuum cleaners? A. Option A, since it has a lower equivalent annual annuity. B. Option B, since it has a lower equivalent annual annuity. C. Option A, since it has a greater equivalent annual annuity. D. Option B, since it has a greater equivalent annual annuity.

B. The mower is only expected to be needed for three years.

A lawn maintenance company compares two ride-on mowers - the Excelsior, which has an expected working-life of six years, and the Grassassinator, which has a working life of four years. After examining the equivalent annual annuities of each mower, the company decides to purchase the Excelsior. Which of the following, if true, would be most likely to make them change that decision? A. Fuel prices are expected to rise and raise the annual running costs of all mowers. B. The mower is only expected to be needed for three years. C. The prices of equivalent mowers are expected to grow in the future as lawnmower manufacturers consolidate. D. The number of customers requiring lawn-mowing services is expected to sharply increase in the near future.

A. Yes, because it agrees with the Net Present Value rule.

A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year and, estimating that the discount rate across this period will be 4%, decides to take the money at the end of each year. Was her decision correct? A. Yes, because it agrees with the Net Present Value rule. B. Yes, because it agrees with the payback rule. C. Yes, because it agrees with both the Net Present Value rule and the payback rule. D. Yes, because it disagrees with the Net Present Value rule.

C. Job C, Job B, and Job E

A print shop has contracted to print a number of jobs within 24 hours. Any jobs not completely printed within this time will result in a penalty, as shown in the table above. However too many jobs have been accepted, and not all can be printed. Which jobs should be printed in the next 24 hours? A. Job D and Job A B. Job C and Job B C. Job C, Job B, and Job E D. Job D, Job A, and Job E

D. No, since net present value (NPV) is negative.

A security firm is offered $80,000 in one year for providing CCTV coverage of a property. The cost of providing this coverage to the security firm is $74,000, payable now, and the interest rate is 8.5%. Should the firm take the contract? A. Yes, since net present value (NPV) is positive. B. It does not matter whether the contract is taken or not, since NPV = 0. C. Yes, since net present value (NPV) is negative. D. No, since net present value (NPV) is negative.

B. Fabrics, Luggage, Hardware, Watches, and Shoe Repair

A small department store in a mall has the opportunity to rent an additional 20,000 square feet for five years. It can divide up this space between the above new departments. Each department will require a different amount of space, and each department is expected to make a yearly profit as shown, for each of the next five years. The discount rate is 10%. Based on this information, what departments should be added? A. Pet, Fabrics, Hardware, and Shoe Repair B. Fabrics, Luggage, Hardware, Watches, and Shoe Repair C. Pets, Fabrics, Books, and Luggage D. Pet, Fabrics, Luggage, Hardware, and Show Repair

C. IRR, NPV, Payback period

According to Graham and Harvey's 2001 survey (Figure 8.2 in the test), the most popular decision rules for capital budgeting used by CFOs are _____. A. NPV, IRR, MIRR B. MIRR, IRR, Payback period C. IRR, NPV, Payback period D. Profitability index, NPV, IRR

A. profitability index

Assuming that your capital is constrained, which investment tool should you use to determine the correct investment decisions? A. profitability index B. incremental IRR C. net present value (NPV) D. internal rate of return (IRR)

A. Project C

Assuming that your capital is constrained, which project should you invest in first? A. Project C B. Project G C. Project B D. Project F

D. Project C and Project D

An investor has a budget of $30 million. He can invest in the projects shown above. If the cost of capital is 5%, what investment or investments should he make? A. Project A B. Project B C. Project B and Project D D. Project C and Project D

C. Project B and Project C

An investor has a budget of $35 million. He can invest in the projects shown above. If the cost of capital is 8%, what investment or investments should he make? A. Project A B. Project B C. Project B and Project C D. Project C and Project D

C. The investor should take investment B since it has a greater net present value (NPV).

An investor is considering the two investments shown above. Her cost of capital is 8%. Which of the following statements about these investments is true? A. The investor should take investment A since it has a greater net present value (NPV). B. The investor should take investment A since it has a greater internal rate of return (IRR). C. The investor should take investment B since it has a greater net present value (NPV). D. The investor should take investment B since it has a greater internal rate of return (IRR).

D. Neither investment should be taken since they both have a negative net present value (NPV).

An investor is considering the two investments shown above. Which of the following statements about these investments is true? A. The investor should take investment A since it has a greater net present value (NPV). B. The investor should take investment A since it has a greater internal rate of return (IRR). C. The investor should take investment B since it has a greater net present value (NPV). D. Neither investment should be taken since they both have a negative net present value (NPV).

D. invest in project Beta, since NPVBeta > NPVAlpha > 0

Assume that projects Alpha and Beta are mutually exclusive. The correct investment decision and the best rationale for that decision is to _____. A. invest in project Beta, since NPVBeta > 0 B. invest in project Alpha, since NPVBeta < NPVAlpha C. invest in project Beta, since IRRB > IRRA D. invest in project Beta, since NPVBeta > NPVAlpha > 0

A. CBFH

Assuming that your capital is constrained, so that you only have $600,000 available to invest in projects, which project should you invest in and in what order? A. CBFH B. CBGF C. BCFG D. CBFG

A. invest in project A, since NPVB < NPVA

Consider the following two projects: Assume that projects A and B are mutually exclusive. The correct investment decision and the best rationale for that decision is to _____. A. invest in project A, since NPVB < NPVA B. invest in project B, since IRRB > IRRA C. invest in project B, since NPVB > NPVA D. invest in project A since NPVA > 0

The y-intercept of a net present value (NPV) profile is the algebraic sum of the project cash flows, since the discount rate is zero at that point.

How can you calculate the y-intercept of a net present value (NPV) profile without using TVM concepts?

B. Project B

If WiseGuy Inc is choosing one of the above mutually exclusive projects (Project A or Project B), given a discount rate of 7%, which should the company choose? A. Project A B. Project B C. Neither project - both have negative NPV. D. Both projects - both have positive NPV.

B. Project B

If WiseGuy Inc. uses IRR rule to choose projects, which of the following projects (Project A or Project B) will rank highest? A. Project A B. Project B C. Project A and Project B have the same ranking D. Cannot calculate a payback period without a discount rate.

A. Project A

If WiseGuy Inc. uses payback period rule to choose projects, which of the projects (Project A or Project B) will rank highest? A. Project A B. Project B C. Project A and Project B have the same ranking. D. Cannot calculate a payback period without a discount rate.

A. Rule I only

Mary is in contract negotiations with a publishing house for her new novel. She has two options. She may be paid $100,000 up front, and receive royalties that are expected to total $26,000 at the end of the each of the next five years. Alternatively, she can receive $200,000 up front and no royalties. Which of the following investment rules would indicate that she should take the former deal, given a discount rate of 8%? Rule I: The Net Present Value rule Rule II: The Payback Rule with a payback period of two years Rule III: The internal rate of return (IRR) Rule A. Rule I only B. Rule III only C. Rule II and III D. Rule I and II

D. present value (PV)

Most corporations measure the value of a project in terms of which of the following? A. discount value B. discount factor C. future value (FV) D. present value (PV)

B. Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the business opportunity, which, since it has a NPV > 0 will mean he will still come out ahead after repaying the loan.

Peter has a business opportunity that requires him to invest $10,000 today, and receive $12,000 in one year. He can either use $10,000 that he already has for this investment or borrow the money from his bank at an interest rate of 10%. However, the $10,000 he has right now is needed for urgent repairs to his home, repairs that will cost at least $15,000 if he delays them for a year. What is the best alternative for Peter out of the following choices? A. No, since the net present value (NPV) of the investment, should he take it, is less than the net present value (NPV) of the home repairs if he delays them for one year. B. Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the business opportunity, which, since it has a NPV > 0 will mean he will still come out ahead after repaying the loan. C. Yes, since the net present value (NPV) of the investment is greater than zero he can invest the $10,000 in the business opportunity, and then next year use the money plus the benefit from this money to make the necessary home repairs. D. Yes, since the net present value (NPV) of the investment, should he take it, is greater than the net present value (NPV) of the home repairs if he delays them for one year.

No; personal preferences for cash flow should not affect the decision-making process. A manager should decide based on always maximizing the net present value (NPV).

Should personal preferences for cash today versus cash tomorrow play a role in the net present value (NPV) decision-making process?

B. Investment B

The cash flows for four investments have been identified as follows: Based on the above information, and with an interest rate of 7%, which is the best investment? A. Investment A B. Investment B C. Investment C D. Investment D

C.

The cash flows for four projects are shown below, along with the cost of capital for these projects. If these projects are mutually exclusive, which one should be taken?

D. none of these investments

The cash flows for three projects are shown above. The cost of capital is 9.5%. If an investor decided to take projects with a payback period two years or less, which of these projects would he take? A. Investment A B. Investment B C. Investment C D. none of these investments

B. No, because the NPV is negative at that rate

The owner of a hair salon spend $1,000,000 to renovate its premises, estimating that this will increase her ash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of this discount rate. If her discount rate is 6%, should she accept the project? A. Yes, because the NPV is positive at that rate. B. No, because the NPV is negative at that rate. C. No, because the NPA is positive at that rate. D. Cannot be determined from the information given.

D. The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity.

The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV) as a function of the discount rate. At what dollar value should the nPV profile cross the vertical axis? A. $780,000 B. $1,000,000 C. Cannot be determined because inadequate information is given. D. The vertical axis crossing point cannot be calculated since the cash inflows are in perpetuity.

B. 3.78%

The owner of a number of gas stations is considering installing coffee machines in his gas stations. It will cost $270,000 to install the coffee machines, and they are expected to boost cash flows by $120,536 per year for their five-year working life. What must the cost of capital be if this investment has a profitability index of 1? A. 1.89% B. 3.78% C. 7.55% D. 9.44%

A. the amount that an investment would yield if the benefit were realized today

The present value (PV) of an investment is _____. A. the amount that an investment would yield if the benefit were realized today B. the difference between the cost of the investment and the benefit of the investment in dollars today C. the amount you need to invest at the current interest rate to re-create the cash flow from the investment D. the amount by which the cash flow of an investment exceeds or falls short of the cash flow generated by the same amount of money invested at market rate

A. 0.110

The timeline of an investment is shown above. If the cost of capital is 8%, what is the profitability index of this investment? A. 0.110 B. 0.121 C. 0.275 D. 0.441

The Net Present Value rule states to accept a project if its net present value (NPV) is greater than zero.

What is the Net Present Value rule?

The decision criteria using internal rate of return (IRR) rule for project type cash flows is to accept projects if the internal rate of return (IRR) is greater than the cost of capital.

What is the decision criteria using internal rate of return (IRR) rule?

The decision criteria using the Net Present Value rule is to reject projects if their net present value (NPV) is less than zero.

What is the decision criterion using the Net Present Value rule?

The payback rule does not have any decision criteria. Consequently, decision making using payback rule is rather subjective.

What is the decision criterion while using the payback rule?

The net present value (NPV) profile can be upward sloping if the benefits of the cash flows occur before the costs. In that case the net present value (NPV) value profile will be a rising function of discount rate.

What is the general shape of the net present value (NPV) profile?

B. so that the projects can be compared on their cost or value created per year

When comparing two projects with different lives, why do you compute an annuity with an equivalent present value (PV) to the net present value (NPV)? A. so that you can see which project has the greatest net present value (NPV) B. so that the projects can be compared on their cost or value created per year C. to reduce the danger that changes in the estimate of the discount rate will lead to choosing the project with a shorter timeframe D. to ensure that cash flows from the project with a longer life that occur after the project with the shorter life has ended are considered

A. Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.

Which of the following best describes the Net Present Value rule? A. Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative. B. Take any investment opportunity where the net present value (NPV) exceeds the opportunity cost of capital; turn down any opportunity where the cost of capital exceeds the net present value (NPV). C. When choosing among any list of investment opportunities where resources are limited, always choose those projects with the highest net present value (NPV). D. If the difference between the presents cost of an investment and the present value (PV) of its benefits after a fixed number of years is positive the investment should be taken, otherwise it should be rejected.

D. payback period

Which of the following decision rules is best defined as the amount of time it takes to pay back the initial investment? A. internal rate of return (IRR) B. profitability index C. net present value (NPV) D. payback period

D. payback period

Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favors liquidity? A. profitability index B. MIRR C. equivalent annual annuity D. payback period

B. It is difficult to calculate.

Which of the following is NOT a limitation of the payback period rule? A. It does not account for the time value of money. B. It is difficult to calculate. C. It ignores cash flows after payback. D. It does not account for changes in the discount rate.

C. It is difficult to calculate.

Which of the following is NOT a limitation of the payback rule? A. It does not consider the time value of money. B. Lacks a decision criterion that is economically based. C. It is difficult to calculate. D. It does not consider cash flows occurring after the payback period.

D. Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the project's lifetime

Which of the following is NOT a valid method of modifying cash flows to produce a MIRR? A. Discount all of the negative cash flows to time 0 and leave the positive cash flows alone. B. Leave the initial cash flow alone and compound all of the remaining cash flows to the final period of the project. C. Discount all of the negative cash flows to the present and compound all of the positive cash flows to the end of the project. D. Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the project's lifetime.

D. relies on accurate estimate of the discount rate

Which of the following is a disadvantage of the Net Present Value rule? A. can be misleading if inflows come before outflows B. not necessarily consistent with maximizing shareholder wealth C. ignores cash flows after the cutoff point D. relies on accurate estimate of the discount rate

C. Attention must be taken when using it to make sure that all of the constrained resource is utilized.

Which of the following is true regarding the profitability index? A. It does not use the net present value (NPV) to assess benefits. B. It is very simple to compute. C. Attention must be taken when using it to make sure that all of the constrained resource is utilized. D. It is unreliable when used for choosing between different projects.

D. All of the above can lead to IRR giving a different decision than NPV.

Which of the following situations can lead to IRR giving a different decision than NPV? A. delayed investment B. multiple IRRs C. differences in project scale D. All of the above can lead to IRR giving a different decision than NPV.

D. If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.

Which of the following statements is FALSE? A. In general, the difference between the cost of capital and the internal rate of return (IRR) is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision. B. The internal rate of return (IRR) can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital. C. If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate. D. If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.

B. An internal rate of return (IRR) will always exist for an investment opportunity.

Which of the following statements is FALSE? A. The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea. B. An internal rate of return (IRR) will always exist for an investment opportunity. C. A net present value (NPV) will always exist for an investment opportunity. D. In general, there can be as many internal rates of return (IRRs) as the number of times the project's cash flows change sign over time.

B. The payback rule is reliable because it considers the time value of money and depends on the cost of capital.

Which of the following statements is FALSE? A. The payback rule is useful in cases where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the net present value (NPV). B. The payback rule is reliable because it considers the time value of money and depends on the cost of capital. C. For most investment opportunities, expenses occur initially and cash is received later. D. Fifty percent of firms surveyed reported using the payback rule for making decisions.

A. $0

Year 0, 1, 2, 3, 4 Cash Flow -12000, 3000, 3000, 3000, 3000 Given the cash flows in the table above, the point at which the NPV profile crosses the vertical axis is _____. A. $0 B. $12,000 C. 23% D. 19%

D. profitability index

You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space? A. internal rate of return (IRR) B. payback period C. net present value (NPV) D. profitability index

A. net present value (NPV)

You are trying to decide between three mutually exclusive investment opportunities. The most appropriate tool for identifying the correct decision is _____. A. net present value (NPV) B. profitability index C. internal rate of return (IRR) D. incremental internal rate of return (IRR)