Chapter 8

What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%? A. $13,397.57 B. $14,473.44 C. $16,081.60 D. $33,748.58

$16,081.60

What is the equivalent annual cost for a project that requires a $40,000 investment at time zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost of capital is 10%? A. $20,000.00 B. $21,356.95 C. $22,618.83 D. $25,237.66

$22,618.83

A polisher costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 10% and the polisher will last for 5 years, what is the equivalent annual cost of the tool? A. $17,163.04 B. $22,187.84 C. $22,637.98 D. $19,411.15

$22,637.98

What is the profitability index for a project costing $40,000 and returning $15,000 annually for 4 years at an opportunity cost of capital of 12%? A. 0.139 B. 0.320 C. 0.500 D. 0.861

0.139

What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years? A. 0.57% B. 1.21% C. 5.69% D. 12.10%

0.57%

The ratio of net present value to initial investment is known as the: A. net present value. B. internal rate of return. C. payback period. D. profitability index.

profitability index.

When a manager does not accept a positive-NPV project, shareholders face an opportunity cost in the amount of the: A. project's initial cost. B. project's NPV. C. project's discounted cash inflows. D. soft capital rationing budget.

project's NPV.

If the net present value of a project that costs $20,000 is $5,000 when the discount rate is 10%, then the: A. project's IRR equals 10%. B. project's rate of return is greater than 10%. C. net present value of the cash inflows is $4,500. D. project's cash inflows total $25,000.

project's rate of return is greater than 10%.

As long as the NPV of a project declines smoothly with increases in the discount rate, the project is acceptable if its: A. internal rate of return is positive. B. payback period is greater than one. C. rate of return exceeds the cost of capital. D. cash inflows equal the initial cost.

rate of return exceeds the cost of capital.

Soft capital rationing: A. is costly to shareholders. B. is used to evaluate mutually exclusive projects. C. should be costless to the shareholders of the firm. D. solves the problem of investment timing.

should be costless to the shareholders of the firm.

If a project's expected rate of return exceeds its opportunity cost of capital, one would expect: A. the profitability index to exceed 1.0. B. the opportunity cost of capital to be too low. C. the IRR to exceed the opportunity cost of capital. D. the NPV to be zero.

the IRR to exceed the opportunity cost of capital.

To justify postponing a project for one year, the NPV needs to increase over that year by a rate that is equal to or greater than: A. the project's IRR. B. the risk-free rate. C. the cost of capital. D. zero.

the cost of capital.

A project's opportunity cost of capital is: A. the foregone return from investing in the project. B. the return earned by investing in the project. C. equal to the average return on all company projects. D. designed to be less than the project's IRR.

the foregone return from investing in the project.

The opportunity cost of capital is equal to: A. the discount rate that makes the project NPV equal zero. B. the return offered by other projects of equal risk. C. a project's internal rate of return. D. the average rate of return for a firm's projects.

the return offered by other projects of equal risk.

Borrowing and lending projects usually can be distinguished by whether: A. they have positive or negative IRRs. B. the time-zero cash flow is positive or negative. C. their IRR increases as the discount rate increases. D. their rate of return is high or low.

the time-zero cash flow is positive or negative.

One method that can be used to increase the NPV of a project is to decrease the: A. project's payback period. B. profitability index. C. time until the receipt of cash inflows. D. number of project IRRs.

time until the receipt of cash inflows.

A project costing $20,000 generates cash inflows of $9,000 annually for the first 3 years, followed by cash outflows of $1,000 annually for 2 years. At most, this project has ______ different IRR(s). A. one B. two C. three D. five

two

Which one of the following statements is correct for a project with a positive NPV? A. The IRR must be greater than 0. B. Accepting the project has an indeterminate effect on shareholders. C. The discount rate exceeds the cost of capital. D. The profitability index equals 1.

A. The IRR must be greater than 0.

Which one of the following best illustrates the problem imposed by capital rationing? A. Accepting projects with the highest NPVs first B. Accepting projects with the highest IRRs first C. Bypassing projects that have positive NPVs D. Bypassing projects that have zero IRRs

Bypassing projects that have positive NPVs

You are analyzing a project that is equivalent to borrowing money. This project's: A. NPV graph rises as discount rates decrease. B. initial cash flow is an outflow of funds. C. value increases when the cost of capital increases. D. acceptance requires its IRR to exceed the cost of capital.

value increases when the cost of capital increases.

Firms that make investment decisions based on the payback rule may be biased toward rejecting projects: A. with short lives. B. with long lives. C. with late cash inflows. D. that have negative NPVs.

with long lives.

If a project has a payback period of 5 years and a cost of capital of 10%, then the discounted payback will: A. exceed 5 years. B. be less than 5 years. C. decrease if the cost of capital increases. D. decrease if the payback period increases due to revised cash flows.

exceed 5 years.

When projects are mutually exclusive, selection should be made according to the project with the: A. longer life. B. larger initial size. C. highest IRR. D. highest NPV.

highest NPV.

In order for a manager to correctly decide to postpone an investment until one year into the future, the NPV of the investment should: A. grow more rapidly than the IRR. B. increase over that year. C. not decrease. D. remain stable.

increase over that year.

Soft capital rationing is imposed upon a firm from _____ sources, while hard capital rationing is imposed from _____ sources. A. internal; external B. internal; internal C. external; internal D. external; external

internal; external

When managers cannot determine whether to invest now or wait until costs decrease later, the rule should be to: A. postpone until costs reach their lowest level. B. invest now to maximize the NPV. C. postpone until the opportunity cost reaches its lowest level. D. invest at the date that provides the highest NPV today.

invest at the date that provides the highest NPV today.

The investment timing decision is aimed at analyzing whether the: A. cash flows occur at the beginning or end of each time period. B. payback period or NPV analysis should be used. C. project is a borrowing or lending project. D. investment should occur now or at some future point.

investment should occur now or at some future point.

If a project has a cost of $50,000 and a profitability index of .4, then: A. its cash inflows are $70,000. B. the present value of its cash inflows is $20,000. C. its IRR is 20%. D. its NPV is $20,000.

its NPV is $20,000.

You can continue to use your less efficient machine at a cost of $8,000 annually for the next 5 years. Alternatively, you can purchase a more efficient machine for $12,000 plus $5,000 annual maintenance. At a cost of capital of 15%, you should: A. buy the new machine and save $600 in equivalent annual costs. B. buy the new machine and save $388 in equivalent annual costs. C. keep the old machine and save $388 in equivalent annual costs. D. keep the old machine and save $580 in equivalent annual costs.

keep the old machine and save $580 in equivalent annual costs.

The profitability index selects projects based on the: A. highest net discounted value at time zero. B. highest internal rate of return. C. largest dollar investment per rate of return. D. largest return per dollar invested.

largest return per dollar invested.

When mutually exclusive projects have different lives, the project that should be selected will have the: A. highest IRR. B. longest life. C. lowest equivalent annual cost. D. highest NPV, discounted at the opportunity cost of capital.

lowest equivalent annual cost.

When managers select correctly from among mutually exclusive projects, they: A. may give up rate of return for NPV. B. may give up NPV for rate of return. C. have a tendency to select the largest project. D. focus on the payback method to avoid conflicting signals.

may give up rate of return for NPV.

The modified internal rate of return can be used to correct for: A. negative NPV calculations. B. multiple internal rates of return. C. undefined payback periods. D. borrowing projects.

multiple internal rates of return.

If the opportunity cost of capital for a lending project exceeds the project's IRR, then the project has a(n): A. positive NPV. B. negative NPV. C. acceptable payback period. D. positive profitability index.

negative NPV.

If the IRR for a project is 15%, then the project's NPV would be: A. negative at a discount rate of 10%. B. positive at a discount rate of 20%. C. negative at a discount rate of 20%. D. positive at a discount rate of 15%.

negative at a discount rate of 20%.

When a project's internal rate of return equals its opportunity cost of capital, then the: A. project should be rejected. B. project has no cash inflows. C. net present value will be positive. D. net present value will be zero.

net present value will be zero.

The "gold standard" of investment criteria refers to the: A. net present value. B. internal rate of return. C. payback period. D. profitability index.

net present value.

According to the NPV rule, all projects should be accepted if NPV is positive when discounted at the: A. internal rate of return. B. opportunity cost of capital. C. risk-free interest rate. D. accounting rate of return.

opportunity cost of capital.

Which of the following projects would you feel safest in accepting? Assume the opportunity cost of capital to be 12% for each project. A. "A" has a small, but negative, NPV. B. "B" has a positive NPV when discounted at 10%. C. "C's" cost of capital exceeds its rate of return. D. "D" has a zero NPV when discounted at 14%.

"D" has a zero NPV when discounted at 14%.

Because of its age, your car costs $4,000 annually in maintenance expense. You could replace it with a newer vehicle costing $8,000. Both vehicles would be expected to last 4 more years. If your opportunity cost is 8%, by how much must maintenance expense decrease on the newer vehicle to justify its purchase? A. $1,625.40 B. $1,584.63 C. $1,469.08 D. $1,409.54

$1,584.63

What is the maximum that should be invested in a project at time zero if the inflows are estimated at $50,000 annually for 3 years, and the cost of capital is 9%? A. $101,251.79 B. $109,200.00 C. $126,564.73 D. $130,800.00

$126,564.73

What is the NPV for the following project cash flows at a discount rate of 15%? C0 = ($1,000), C1 = $700, C2 = $700. A. ($308.70) B. ($138.00) C. $138.00 D. $308.70

$138.00

A currently used machine costs $10,000 annually to run. What is the maximum that should be paid to replace the machine with one that will last 3 years and cost only $4,000 annually to run? The opportunity cost of capital is 12%. A. $15,209.84 B. $9,607.33 C. $14,410.99 D. $10,338.56

$14,410.99

If a project's IRR is 13% and the project provides annual cash flows of $15,000 for 4 years, how much did the project cost? A. $44,617.07 B. $52,208.18 C. $41,909.29 D. $49,082.11

$44,617.07

What is the minimum cash flow that could be received at the end of year 3 to make the following project "acceptable"? Initial cost = $100,000; cash flows at end of years 1 and 2 = $35,000; opportunity cost of capital = 10%. A. $29,494 B. $30,000 C. $39,256 D. $52,250

$52,250

What is the maximum amount a firm should pay for a project that will return $15,000 annually for 5 years if the opportunity cost is 10%? A. $24,157.65 B. $56,861.80 C. $62,540.10 D. $48,021.19

$56,861.80

What is the IRR for a project that costs $100,000 and provides annual cash inflows of $30,000 for 6 years starting one year from today? A. 19.91% B. 16.67% C. 15.84% D. 22.09%

19.91%

What is the minimum number of years in which an investment costing $210,000 must return $65,000 per year at a discount rate of 13% in order to be an acceptable investment? A. 8.69 years B. 5.37 years C. 7.51 years D. 4.46 years

4.46 years

Which one of the following changes will increase the NPV of a project? A. A decrease in the discount rate B. A decrease in the size of the cash inflows C. An increase in the initial cost of the project D. A decrease in the number of cash inflows

A decrease in the discount rate

If a project costs $72,000 and returns $18,500 per year for 5 years, what is its IRR? A. 8.98% B. 7.39% C. 8.50% D. 7.67%

8.98%

A project can have as many different internal rates of return as it has: A. cash inflows. B. cash outflows. C. periods of cash flow. D. changes in the sign of the cash flows.

changes in the sign of the cash flows.

What is the decision rule in the case of sign changes that produce multiple IRRs for a project? A. Select the lowest IRR to be conservative B. Select the highest IRR to maximize the benefits C. Any or all of the IRRs are justified to use D. Evaluate the project according to NPV

Evaluate the project according to NPV

Which of the following statements is true for a project with a $20,000 initial cost, cash inflows of $5,800 per year for 6 years, and a discount rate of 15%? A. Its payback period is 3.45 years. B. Its NPV is $2,094. C. Its IRR is 17.85%. D. Its profitability index is 0.104.

Its payback period is 3.45 years.

What happens to the equivalent annual cost of a project as the opportunity cost of capital decreases? A. It increases. B. It decreases. C. It is not affected. D. It depends on whether or not the projects are mutually exclusive.

It decreases.

Which of the following investment decision rules tends to improperly reject long-lived projects? A. Net present value B. Internal rate of return C. Payback period D. Profitability index

Payback period

Which of the following investment criteria takes the time value of money into consideration? A. Net present value only B. Profitability index and net present value only C. Internal rate of return and net present value only D. Profitability index, internal rate of return, and net present value

Profitability index, internal rate of return, and net present value

Which mutually exclusive project would you select, if both are priced at $1,000 and your required return is 15%: Project A with three annual cash flows of $1,000; or Project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually? A. Project A B. Project B C. You are indifferent since the NPVs are equal. D. Neither project should be selected.

Project A

Projects A and B are mutually exclusive lending projects. Project A has an IRR of 20% while Project B has an IRR of 30%. You would be most apt to select Project A if: A. Project B has a longer life than Project A. B. Project A has more risk than Project B. C. Project A is twice the size of Project B. D. Project B has a larger cash inflow in Year 1 than Project A.

Project A is twice the size of Project B.

Evaluate the following project using an IRR criterion, based on an opportunity cost of 10%: C0 = -$6,000, C1 = $3,300, C2 = $3,300. A. Accept; because the IRR exceeds the opportunity cost B. Reject; because the opportunity cost exceeds the IRR C. Accept; because the opportunity cost exceeds the IRR D. Reject; because the IRR exceeds the opportunity cost

Reject; because the opportunity cost exceeds the IRR

Which one of the following should be assumed about a project that requires a $100,000 investment at time zero, then returns $20,000 annually for 5 years? A. The NPV is negative. B. The NPV is zero. C. The profitability index is 1.0. D. The IRR is negative.

The NPV is negative.

Why may the IRR criterion lead to an incorrect decision when applied to mutually exclusive projects? A. The NPVs of mutually exclusive projects cross over at some discount rate. B. Cash flows cannot be discounted when considering mutually exclusive projects. C. Mutually exclusive projects produce negative IRR values. D. Mutually exclusive projects have multiple IRRs.

The NPVs of mutually exclusive projects cross over at some discount rate.

What should occur when a project's net present value is determined to be negative? A. The discount rate should be decreased. B. The profitability index should be calculated. C. The present value of the project cost should be determined. D. The project should be rejected.

The project should be rejected.

A project's payback period is determined to be 4 years. If it is later discovered that additional cash flows will be generated in years 5 and 6, then the project's payback period will: A. be reduced. B. be increased. C. be unchanged. D. change but the discount rate must be known to determine the nature of the change.

be unchanged.

For mutually exclusive projects, the IRR can be used to select the best project: A. by calculating the modified internal rate of return. B. by calculating the IRR based on incremental cash flows. C. by using the discount rate to calculate the IRR. D. never. IRR cannot be utilized for mutually exclusive projects.

by calculating the IRR based on incremental cash flows.

Given a particular set of project cash flows, which one of the following statements must be correct? A. There can be only one NPV for the project, even with multiple discount rates. B. There can be only one IRR for the project. C. There can be more than one IRR for the project. D. There can be only one profitability index for the project, even with multiple discount rates.

There can be more than one IRR for the project.

How many IRRs are possible for the following set of cash flows? CF0 = -$1,000, C1 = $500, C2 = -$300, C3 = $1,000, C4 = $200. A. One B. Two C. Three D. Four

Three

When will you be indifferent between two mutually exclusive projects of similar size? A. When the required return on the projects is equal to the crossover discount rate B. When the time period of the projects are equal C. When both projects have only cash inflows following the initial cash outflow D. When both projects have IRR's that exceed the crossover discount rate

When the required return on the projects is equal to the crossover discount rate

A firm plans to use the profitability index to select between two mutually exclusive investments. If no capital rationing has been imposed, which project should be selected? A. Select the project with the higher profitability index B. Select the project with the lower profitability index C. Without capital rationing, both projects can be selected D. Without capital rationing, the NPV method must be used instead

Without capital rationing, the NPV method must be used instead

A firm is considering a project with the following cash flows: Time 0 = +$20,000, Years 1-5 = -$4,500. Should the project be accepted if the cost of capital is 10%? A. Yes; The IRR of the project is 4.06%. B. Yes; The IRR of the project is 12.5%. C. No; The IRR of the project is 4.06%. D. No; The IRR of the project is 12.5%.

Yes; The IRR of the project is 4.06%.

When calculating a project's payback period, cash flows are discounted at: A. the opportunity cost of capital. B. the internal rate of return. C. the risk-free rate of return. D. a discount rate of zero.

a discount rate of zero.

When hard capital rationing exists, projects may be accurately evaluated by use of: A. the payback period. B. mutually exclusive IRRs. C. a profitability index. D. borrowing, rather than lending, projects.

a profitability index.

The internal rate of return is most reliable when evaluating: A. a single project with alternating cash inflows and outflows over several years. B. mutually exclusive projects of differing sizes. C. a single project with only cash inflows following the initial cash outflow. D. a single project with cash outflows at time 0 and the final year and inflows in all other time periods.

a single project with only cash inflows following the initial cash outflow.

Use of a profitability index to evaluate mutually exclusive projects in the absence of capital rationing: A. will provide the same rankings as an NPV criterion. B. will maximize NPV, but not IRR. C. can result in misguided selections. D. is technically impossible.

can result in misguided selections.

NPV fails as a decision rule when the firm encounters: A. capital rationing. B. mutually exclusive projects. C. long-lived projects. D. independent projects.

capital rationing.

As the discount rate is increased, the NPV of a specific project will: A. increase. B. decrease. C. remain constant. D. decrease to zero, then remain constant.

decrease.

The decision rule for net present value is to: A. accept all projects with cash inflows exceeding the initial cost. B. reject all projects with rates of return exceeding the opportunity cost of capital. C. accept all projects with positive net present values. D. reject all projects lasting longer than 10 years.

accept all projects with positive net present values.

A project with an IRR that is less than the opportunity cost of capital should be: A. accepted for all project types. B. accepted for all lending projects. C. accepted for all borrowing projects. D. rejected for all projects.

accepted for all borrowing projects.

If two projects offer the same positive NPV, then they: A. also have the same IRR. B. have the same payback period. C. are mutually exclusive projects. D. add the same amount of value to the firm.

add the same amount of value to the firm.