Chapter 8

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%?

0.139

What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years?

0.57%

Which of the following investment decision rules tends to improperly reject long-lived projects?

Payback period

What is the decision rule in the case of sign changes that produce multiple IRRs for a project?

Evaluate the project according to NPV

What happens to the equivalent annual cost of a project as the opportunity cost of capital decreases?

It decreases.

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%?

Its payback period is 3.45 years

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?

The NPV is negative.

Why may the IRR criterion lead to an incorrect decision when applied to mutually exclusive projects?

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

When will you be indifferent between two mutually exclusive projects of similar size?

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?

Without capital rationing, the NPV method must be used instead

When hard capital rationing exists, projects may be accurately evaluated by use of:

a profitability index.

The internal rate of return is most reliable when evaluating:

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

The decision rule for net present value is to:

accept all projects with positive net present values.

A project with an IRR that is less than the opportunity cost of capital should be:

accepted for all borrowing projects.

If two projects offer the same positive NPV, then they:

add the same amount of value to the firm.

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:

be unchanged.

For mutually exclusive projects, the IRR can be used to select the best project:

by calculating the IRR based on incremental cash flows.

Use of a profitability index to evaluate mutually exclusive projects in the absence of capital rationing:

can result in misguided selections.

NPV fails as a decision rule when the firm encounters:

capital rationing.

A project can have as many different internal rates of return as it has:

changes in the sign of the cash flows.

As the discount rate is increased, the NPV of a specific project will:

decrease.

If a project has a payback period of 5 years and a cost of capital of 10%, then the discounted payback will:

exceed 5 years

When projects are mutually exclusive, selection should be made according to the project with the:

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:

increase over that year.

Soft capital rationing is imposed upon a firm from _____ sources, while hard capital rationing is imposed from _____ sources.

internal; external

When managers cannot determine whether to invest now or wait until costs decrease later, the rule should be to:

invest at the date that provides the highest NPV today.

The investment timing decision is aimed at analyzing whether the:

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:

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:

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

The profitability index selects projects based on the:

largest return per dollar invested.

When mutually exclusive projects have different lives, the project that should be selected will have the:

lowest equivalent annual cost.

When managers select correctly from among mutually exclusive projects, they:

may give up rate of return for NPV.

The modified internal rate of return can be used to correct for:

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):

negative NPV.

If the IRR for a project is 15%, then the project's NPV would be:

negative at a discount rate of 20%.

When a project's internal rate of return equals its opportunity cost of capital, then the

net present value will be zero

The "gold standard" of investment criteria refers to the:

net present value.

You are analyzing a project that is equivalent to borrowing money. This project's:

value increases when the cost of capital increases.

Firms that make investment decisions based on the payback rule may be biased toward rejecting projects:

with long lives.

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%?

$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

$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%.

$14,410.99

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%?

$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%?

$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?

$22,637.98

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?

$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%.

$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%?

$56,861.80

Which of the following projects would you feel safest in accepting? Assume the opportunity cost of capital to be 12% for each project.

"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?

$1,584.63

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?

19.91%

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).

2

How many IRRs are possible for the following set of cash flows? CF0 = -$1,000, C1 = $500, C2 = -$300, C3 = $1,000, C4 = $200.

3

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?

4.46 years

If a project costs $72,000 and returns $18,500 per year for 5 years, what is its IRR?

8.98%

Which one of the following changes will increase the NPV of a project?

A decrease in the discount rate

Which one of the following best illustrates the problem imposed by capital rationing?

Bypassing projects that have positive NPVs

Which of the following investment criteria takes the time value of money into consideration?

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?

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:

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.

Reject; because the opportunity cost exceeds the IRR

Which one of the following statements is correct for a project with a positive NPV?

The IRR must be greater than 0.

What should occur when a project's net present value is determined to be negative?

The project should be rejected.

Given a particular set of project cash flows, which one of the following statements must be correct?

There can be more than one IRR for the project.

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%?

Yes; The IRR of the project is 4.06%.

When calculating a project's payback period, cash flows are discounted at:

a discount rate of zero.

According to the NPV rule, all projects should be accepted if NPV is positive when discounted at the:

opportunity cost of capital.

The ratio of net present value to initial investment is known as the:

profitability index.

When a manager does not accept a positive-NPV project, shareholders face an opportunity cost in the amount of the:

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:

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:

rate of return exceeds the cost of capital.

Soft capital rationing:

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:

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:

the cost of capital.

A project's opportunity cost of capital is:

the foregone return from investing in the project.

The opportunity cost of capital is equal to:

the return offered by other projects of equal risk.

Borrowing and lending projects usually can be distinguished by whether:

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:

time until the receipt of cash inflows.