Chapter 11 Investment Decision Criteria

24) Project Full Moon has an initial outlay of $30,000, followed by positive cash flows of $10,000 in year 1, $15,000 in year 2, and $15,000 in year 3. The project should be accepted if the required rate of return is A) greater than 0. B) less than 14.6%. C) less than 16.25%. D) greater than 12%.

B

25) WKW, 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? A) 1.04 B) 1.55 C) 1.78 D) 1.97

B

26) WSU Inc. has various options for replacing a piece of manufacturing equipment. The present value of costs for option Ell is $84,000. Option Ell has a useful life of 5 years; annual operating costs were discounted at 9%. What is the equivalent annual cost? A) $16,800 B) $21,595.77 C) $14,035.77 D) $18,312

B

4) Which of the following techniques will always produce a single rate of return estimate? A) IRR B) MIRR C) PI D) Discounted payback

B

10) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). A) All possible IRR's for this project are negative. B) It is not possible to compute an IRR for this project. C) This project might have more than one IRR, but only one MIRR. D) The project is unacceptable at any required rate of return. This project might have more than one IRR.

C

37) 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.

C

5) 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%.

C

5) Which of the following is a typical capital budgeting decision? A) Purchase of office supplies B) Granting credit to a new customer C) Replacement of manufacturing equipment with more modern and efficient equipment D) Financing the firm with more long-term debt and less equity

C

6) 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%

C

7) When various capital budgeting techniques rank mutually exclusive projects differently, which of the following is theoretically most reliable? A) IRR B) Equivalent annual cost (EAC). C) NPV D) Discounted payback

C

18) Which of the following is a correct equation to solve for the NPV of the project that has an initial outlay of $30,000, followed by incremental cash inflows in the next 3 years of $15,000, $20,000, and $30,000? Assume a discount rate of 10%. A) NPV = - $30,000 + $15,000(1.10)1 + $20,000(1.10)2 + $30,000(1.10)3 B) NPV = - $30,000 + $15,000/(1.10)1 + $20,000/(1.10)2 + $30,000/(1.10)3 C) NPV = - $30,000 + $15,000/(1.01).10 + $20,000/(1.02).10 + $30,000/(1.03).10 D) NPV = - $30,000 + $15,000/(1.1).10 + $20,000(1.2).10 + $30,000(1.3).10

B

19) Project EH! requires an initial investment of $50,000, and has a net present value of $12,000. Project BE requires an initial investment of $100,000, and has a net present value of $13,000. The projects are mutually exclusive. The firm should accept A) project EH!. B) project BE. C) both projects. D) neither project.

B

2) Errors in capital budgeting decisions A) tend to average out over time. B) decrease the firm's value. C) are diminished because the time value of money makes future cash flows less important. D) are easily reversed.

B

22) A machine has a cost of $5,575,000. 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%, the project should be A) accepted. B) rejected. C) discounted at a lower rate. D) abandoned after the first year.

B

22) 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%

B

10) 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 answer to the nearest $10.) A) $490 B) $570 C) $900 D) -$150

B

11) 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) Other investment criteria might need to be considered.

B

39) The payback method focuses primarily on the length of time required to recover the cost of the investment rather than estimating the total value the project will add to the firm.

TRUE

40) One advantage of the payback method is that it can be readily understood by people with no special training in finance.

TRUE

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

FALSE

5) Which of the following techniques might be useful in situations where the economic life of a project is highly uncertain? A) IRR B) MIRR C) PI D) Discounted payback

D

11.2 Net Present Value 1) Project Sigma requires an investment of $1 million and has a NPV of $10. Project Delta requires an investment of $500,000 and has a NPV of $150,000. The projects involve unrelated new product lines. A) Both projects should be accepted because they have positive NPV's. B) Neither project should be accepted because they might compete with one another. C) Only project Delta should be accepted. Alpha's NPV is too low for the investment. D) The company should look at other investment criteria, not just NPV.

A

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

TRUE

11) 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.

TRUE

11) Some capital budgeting decisions may be mandated by government regulations.

TRUE

48) 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.

TRUE

49) 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.

TRUE

2) If a project has a profitability index greater than 1 A) the npv will also be positive. B) the irr will be higher than the required rate of return. C) the present value of future cash flows will exceed the amount invested in the project. D) all of the above.

D

11.3 Other Investment Criteria 1) Webley Corp. is considering two expansion options, but does not have enough capital to undertake both, Project W requires an investment of $100,000 and has an NPV of $10,000. Project D requires an investment of $80,000 and has an NPV of $8,200. If Webley uses the profitability index to decide, it would A) choose D because it has a higher profitability index. B) choose W because it has a higher profitability index. C) choose D because it has a lower profitability index. D) choose W because it has a lower profitability index.

A

11.4 A Glance at Actual Capital-Budgeting Practices 1) Recent surveys of the CFOs of large U.S. companies rank the popularity of major capital budgeting methods in which order? A) IRR, NPV, Payback, Discounted Payback, Profitability Index B) Payback, Discounted Payback, Profitability Index, IRR, NPV C) NPV, IRR, Profitability Index, Discounted Payback, Payback D) NPV, IRR, Payback, Discounted Payback, Profitability Index

A

14) Project H requires an initial investment of $100,000 and produces annual cash flows of $50,000, $40,000, and $30,000. Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000, $40,000, and $50,000. The projects are mutually exclusive. The company accepts projects with payback periods of 3 years or less. A) Project H will be accepted. B) Project T will be accepted. C) H and T will both be accepted. D) Neither projected will be accepted.

A

15) 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

A

19) What is payback for Project Z? A) Two years B) One year C) Zero years D) Project Z does not payback the original investment.

A

2) Which of the following best explains the continuing popularity of the payback method? A) Mathematical simplicity and some insight into the riskiness of cash flows. B) Uses all cash flows and takes into account the time value of money. C) Reliably selects the projects that add most value to the firm. D) It provides objective selection criteria and is taught as the primary method in most business schools.

A

21) 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 appropriate discount rate is 10% and that the firm's tax rate is 40%. What is the project's discounted payback period? A) 2.81 years B) 2.33 years C) 1.22 years D) The project never reaches payback.

A

24) 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%

A

25) Which of the following is a correct EXCEL formula to solve for the net present value of a project. A) =NPV (k,CF1, CF2,...CFn)+CF0 B) =NPV (k,CF0,CF1, CF2,...CFn) C) =NPV (CF0,CF1, CF2,...CFn) D) =NPV (CF1, CF2,...CFn)+CF0

A

26) Frazier Fudge has a project with an initial outlay of $40,000, followed by three years of annual incremental cash flows of $35,000. At the end of the third year, equipment will be sold producing additional cash flow of $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%

A

30) The owner of a small construction business has asked you to evaluate the purchase of a new front end loader. You have determined that this investment has a large, positive, NPV, but are afraid that your client will not understand the method. A good alternative method in this circumstance might be A) the payback method. B) the profitability index. C) the internal rate of return. D) the modified internal rate of return.

A

31) Whenever the IRR on a project equals that project's required rate of return A) the NPV equals 0. B) The NPV equals the initial investment. C) The profitability index equals 0. D) The NPV equals 1.

A

36) 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) 1.34 B) 0.87 C) 1.85 D) 0.21

A

4) Given the following annual net cash flows, determine the IRR to the nearest whole percent of a project with an initial outlay of $1,800. Year Net Cash Flow 1 $1,000 2 $750 3 $500 A) 14% B) 12% C) 8% D) 25%

A

5) Fitchminster Armored Car can purchase a new vehicle for $200,000 that will provide annual net cash flow over the next five years of $40,000, $45,000, $50,000, $55,000, $60,000. The salvage value of the vehicle will be $25,000. Assume that the vehicle is sold at the end of year 5. Calculate the NPV of the ambulance if the required rate of return is 9%. (Round your answer to the nearest $1.) A) $7,390 B) $6,048 C) $6,780 D) $19,483

A

6) Project H requires an initial investment of $100,000 and the produces annual cash flows of $50,000, $40,000, and $30,000. Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000, $40,000, and $50,000. If the required rate of return is greater than 0% and the projects are mutually exclusive A) H will always be preferable to T. B) T will always be preferable to H. C) H and T are equally attractive. D) The project rankings will change with different discount rates.

A

Use the following information to answer the following question. 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 18) Payback for Project Y is A) two years. B) one year. C) three years. D) four years.

A

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

TRUE

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

TRUE

27) The equivalent annual cost (EAC) method is appropriate for evaluating accessibility projects mandated by the Americans With Disabilities Act.

TRUE

12) 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

B

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

TRUE

13) 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%

B

15) A new forklift under consideration by Home Warehouse requires an initial investment of $100,000 and produces annual cash flows of $50,000, $40,000, and $30,000. Which of the following will not change if the required rate of return is increased from 10% to 12%. A) The net present value. B) The internal rate of return. C) The profitability index. D) The modified internal rate of return.

B

17) Which of the following series of cash flows could have more than one IRR? (Negative cash flows are in parentheses.) A) $(XX,XXX), $X,XXX , $X,XXX, $X,XXX B) $(XX,XXX), $X,XXX , $X,XXX, $X,XXX, $(XX,XXX) C) $X,XXX, $X,XXX , $X,XXX, $X,XXX, $(XX,XXX) D) $XX,XXX, $X,XXX , $X,XXX, $X,XXX

B

23) 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 + (3 × 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

B

28) 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 $100,000 today, and the firm's cost of capital is 10%. Assume cash flows occur evenly during the year. A) 5.23 years B) 4.26 years C) 4.35 years D) 3.72 years

B

3) With respect to the capital budgeting practices of large U. S. corporations A) the profitability index has been gaining in popularity. B) IRR and NPV have been gaining in popularity. C) payback and discounted payback have been gaining in popularity. D) IRR and NPV have declined in popularity.

B

32) 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%

B

34) 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.

B

4) Central Mass Ambulance Service can purchase a new ambulance for $200,000 that will provide an annual net cash flow of $50,000 per year for five years. The salvage value of the ambulance will be $25,000. Assume the ambulance is sold at the end of year 5. Calculate the NPV of the ambulance if the required rate of return is 9%. (Round your answer to the nearest $1.) A) $(10,731) B) $10,731 C) $(5,517) D) $5,517

B

6) Which of the following techniques might be useful in situations where mutually exclusive projects have unequal lives? A) IRR B) Equivalent annual cost (EAC). C) PI D) Discounted payback

B

7) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). If the company 's required rate of return is 12%, the project should be A) rejected because the IRR is less than 12%. B) accepted because the NPV is positive at 12%. C) the project is unacceptable at any discount rate. D) rejected because there may be more than one IRR.

B

7) Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years. Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1, $40,000 in year 2, and $70,000 in year 3. If the discount rate is 10% and the projects are mutually exclusive A) Project H should be chosen. B) Project T should be chosen. C) H and T are equally attractive. D) Both projects should be chosen.

B

Use the following information to answer the following question. 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 23) Discounted payback periods for projects Y and Z are A) 1.64 and 1.71 years. B) 3.14 years and never. C) 2 years and 2 years. D) 5 years and never.

B

Use the following to answer the following question(s). 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 16) 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.

B

29) The higher the discount rate, the greater the importance of the early cash flows.

TRUE

30) The equivalent annual cost (EAC) method is helpful for mutually exclusive projects with unequal economic lives.

TRUE

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

TRUE

12) Project January has a NPV of $50,000, project December has a NPV of $40,000. Which of the following circumstances could make it possible to choose December over January? A) January has a shorter payback period. B) The projects are mutually exclusive. C) The projects have unequal lives. D) The projects are mandated.

C

20) 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

C

20) Project Eh! requires an initial investment of $50,000, and has a net present value of $12,000. Project B requires an initial investment of $100,000, and has a net present value of $13,000. The projects are proposals for increasing revenue and are not mutually exclusive. The firm should accept A) project Eh!. B) project B. C) both projects. D) neither project.

C

29) 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%

C

3) Central Mass Ambulance Service can purchase a new ambulance for $200,000 that will provide an annual net cash flow of $50,000 per year for five years. Calculate the NPV of the ambulance if the required rate of return is 9%. (Round your answer to the nearest $1.) A) $50,000 B) $(5,061) C) $(5,517) D) $5,517

C

3) Which of the following factors is least important to capital budgeting decisions? A) The time value of money B) The risk-return tradeoff C) Net income based on accrual accounting principles D) Cash flows directly resulting from the decision

C

33) Aroma Candles, Inc. is evaluating a project with the following cash flows. The project involves a new product that will not affect the sales of any other project. Which two methods would always lead to the same accept/reject decision for this project, regardless of the discount rate. Year Cash Flows 0 ($120,000) 1 $30,000 2 $70,000 3 $90,000 A) Payback and Discounted Payback B) NPV and Payback C) NPV and IRR D) Discounted Payback and IRR

C

38) 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

C

1) Which of the following are typical consequences of good capital budgeting decisions? A) The firm increases in value. B) The firm gains knowledge and experience that may be useful in future decisions. C) Good capital budgeting decisions help a company define its core competencies. D) All of the above.

D

11) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). The company accepts all projects with a payback period of 2 years or less. A) The payback rule would reject this project because of its risks are too high. B) The payback rule would reject this project because all negative cash flows are added together. C) If strictly applied, the payback rule would reject this project. D) If strictly applied, the payback rule would accept this project.

D

13) The present value of the total costs over a five year period for Project April is $50,000. The net present value of total costs over a 4 year period for Project October is $40,000. The company uses a discount rate of 9%. Which project should it choose and why? A) April because it has a higher net present value (NPV). B) April because is has a higher equivalent annual cost (EAC). C) October because it has a shorter life. D) October because it has a lower equivalent annual cost (EAC).

D

14) Warchester Inc. is considering the purchase of copying equipment that will require an initial investment of $15,000 and $4,000 per year in annual operating costs over the equipment's estimated useful life of 5 years. The company will use a discount rate of 8.5%. What is the equivalent annual cost? A) $4,000 B) $7,000 C) $6,152.51 D) $7,806.49

D

16) Project Ell requires an initial investment of $50,000 and the produces annual cash flows of $30,000, $25,000, and $15,000. Project Ess requires an initial investment of $60,000 and then produces annual cash flows of $25,000 per year for the next ten years. The company ranks projects by their payback periods. A) Projects with unequal lives cannot be ranked using the payback method. B) Ess will be ranked higher than Ell. C) Ell and Ess will be ranked equally. D) Ell will be ranked higher than Ess.

D

17) 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) $582,380

D

2) 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

D

21) 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

D

27) Frazier Fudge has a project with an initial outlay of $40,000, followed by three years of annual incremental cash flows of $35,000. At the end of the third year, equipment will be sold producing additional cash flow of $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) + $35,000/(1.IRR) + $45,000/(1 + IRR)

D

3) 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%

D

35) 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%

D

4) Which of the following would be considered a capital budgeting decision? A) Walmart purchases inventory for resale to customers. B) Apple sells bonds and uses the proceeds to repurchase stock. C) Goldman Sachs obtains short-term loans to finance day to day operations. D) Pfizer develops a new therapy and brings it to market.

D

6) Good capital investment opportunities are most likely to exist when A) many firms compete to sell similar products. B) interest rates are high and rising. C) goods and services can be produced cheaply using readily available tools and technologies. D) a line of business is expensive to enter and uses proprietary technology.

D

8) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). A) All possible IRR's for this project are negative. B) It is not possible to compute an IRR for this project. C) The project is unacceptable at any required rate of return. D) This project might have more than one IRR.

D

8) Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years. Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1, $40,000 in year 2, and $70,000 in year 3. If the discount rate is 10% and the projects are not mutually exclusive A) Project H should be chosen. B) Project T should be chosen. C) H and T are equally attractive. D) Both projects should be accepted.

D

9) 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

D

9) Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years. Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1, $40,000 in year 2, and $70,000 in year 3. If the discount rate increases from 10% to 16% A) Project T should be chosen. B) Both projects should be rejected. C) H and T are equally attractive. D) The project rankings will change.

D

43) The profitability index provides the same accept/reject decision result as the net present value (NPV) method but would not necessarily rank mutually exclusive projects the same way.

TRUE

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

TRUE

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

FALSE

12) The primary objective of all capital budgeting decisions is to increase the size of the firm.

FALSE

42) If the project's internal rate of return is greater than or equal to zero, the project should always be accepted.

FALSE

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

FALSE

7) 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.

FALSE

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

FALSE

47) Unlike the basic IRR method, the MIRR method allows the analyst to specify a reinvestment rate for positive cash flows.

TRUE

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

TRUE