FIN 3200 Ch 9
A project has cash flows of -$148,400, $42,500, $87,300, and $43,200 for Years 0 to 3, respectively. The required rate of return is 11 percent. Based on the internal rate of return of ________ percent for this project, you should ________ the project. A) 7.91; accept B) 8.03; reject C) 6.67; reject D) 7.91; reject E) 8.03; accept
B) 8.03; reject Explanation: NPV = 0 = −$148,400 + $42,500/(1 + IRR) + $87,300/(1 + IRR)2 + $43,200/(1 + IRR)3 IRR = .0803, or 8.03% Since the IRR is less than the required return, you should reject the project.
A project has cash flows of −$152,000, $60,800, $62,300 and $75,000 for Years 0 to 3, respectively. The required rate of return is 13 percent. What is the profitability index? Should you accept or reject the project based on this index value? A) .93; accept B) 1.07; accept C) 1.02; accept D) .93; reject E) 1.07 reject
C) 1.02; accept Explanation: PVInflows = $60,800/1.13 + $62,300/1.132 + $75,000/1.133 PVInflows = $154,574.11 PI = $154,574.11/$152,000 PI = 1.02 Since the PI is greater than 1, the project should be accepted.
In actual practice, managers most frequently use which two types of investment criteria? A) Net present value and payback B) Average accounting return and internal rate of return C) Internal rate of return and net present value D) Internal rate of return and payback E) Net present value and profitability index
C) Internal rate of return and net present value IRR and NPV are generally best if used together and are the simplest to calculate, the easiest to understand, and the most accurate.
You are considering a project with conventional cash flows, an IRR of 11.63 percent, a PI of 1.04, an NPV of $987, and a payback period of 2.98 years. Which one of the following statements is correct given this information? A) The discounted payback period must be greater than 2.98 years. B) The break-even discount rate must be less than 11.63 percent. C) The discount rate used in computing the net present value was less than 11.63 percent. D) The AAR is equal to the IRR/PI. E) The project should be rejected based on its PI value.
C) The discount rate used in computing the net present value was less than 11.63 percent. Since all of the relevant information is a positive indicator on the project (IRR, NPV, PI), that means that the IRR was greater than the discount rate. Since the IRR is 11.63, that means the discount rate must be less than 11.63.
A project has average net income of $6,250 a year over its 6-year life. The initial cost of the project is $98,400 which will be depreciated using straight-line depreciation to a book value of zero over the life of the project. The firm set a minimum average accounting return of 12.5 percent. The firm should ________ the project because the AAR is ________ percent. A) accept; 12.52 B) accept; 12.46 C) accept; 12.70 D) reject; 12.46 E) reject; 12.70
C) accept; 12.70 Explanation: AAR = $6,250/[$98,400 + 0)/2] AAR = .1270, or 12.70%
Drinkable Water Systems is analyzing a project with projected cash inflows of $127,400, $209,300, and -$46,000 for Years 1 to 3, respectively. The project costs $251,000 and has been assigned a discount rate of 12.5 percent. Should this project be accepted based on the discounting approach to the modified internal rate of return? Why or why not? A) Yes; The MIRR is 11.85 percent. B) No; The MIRR is 11.33 percent. C) Yes; The MIRR is 11.33 percent. D) No; The MIRR is 11.68 percent. E) No; The MIRR is 11.85 percent.
B) No; The MIRR is 11.33 percent. Explanation: NPV = 0 = [−$251,000 − $46,000/1.1253] + $127,400/(1 + MIRR) + $209,300/(1 + MIRR)2 MIRR = .1133, or 11.33% Since the MIRR does not exceed the required return and this is an investment project, the project should be rejected
Which one of the following is a project acceptance indicator given an independent project with investing type cash flows? A) Profitability index that is less than 1.0 B) Project's internal rate of return that is less than the required return C) Discounted payback period that is greater than the required return D) Average accounting return that is less than the internal rate of return E) Modified internal rate of return that exceeds the required return
E) Modified internal rate of return that exceeds the required return When the MIRR is greater than the required return it means that the return percentage is higher than what the return percentage had to be which makes it a good project to invest in.
You are considering two mutually exclusive projects. Project A has cash flows of −$72,000, $21,400, $22,900, and $56,300 for Years 0 to 3, respectively. Project B has cash flows of −$81,000, $20,100, $22,200, and $74,800 for Years 0 to 3, respectively. Both projects have a required 2.5-year payback period. Should you accept or reject these projects based on payback analysis? A) Accept Project A and reject Project B B) Reject Project A and accept Project B C) Accept both Projects A and B D) Reject both Projects A and B E) You cannot apply the payback method to these projects.
A) Accept Project A and reject Project B Explanation: PaybackA = 2 + ($72,000 − 21,400 − 22,900)/$56,300 PaybackA = 2.49 years PaybackB = 2 + ($81,000 − 20,100 − 22,200)/$74,800 PaybackB = 2.52 years To be accepted the project must pay back in 2.5 years or less. Accept A and reject B.
Net present value: A) is the best method of analyzing mutually exclusive projects. B) is less useful than the internal rate of return when comparing different-sized projects. C) is the easiest method of evaluation for nonfinancial managers. D) cannot be applied when comparing mutually exclusive projects. E) is very similar in its methodology to the average accounting return.
A) is the best method of analyzing mutually exclusive projects. Net present value takes into account the next best opportunity (the discount rate) and accounts for future and current cash flows in current dollars, making it the best tool for analyzing mutually exclusive projects.
A project will produce cash inflows of $5,400 a year for 3 years with a final cash inflow of $2,400 in Year 4. The project's initial cost is $13,400. What is the net present value if the required rate of return is 14.2 percent? A) −$311.02 B) $505.92 C) −$165.11 D) $218.98 E) $668.02
B) $505.92 Explanation: NPV = −$13,400 + $5,400([1 − (1/1.1423)]/.142) + $2,400/(1.142)4 NPV = $505.92. you can use calc
Two mutually exclusive projects have an initial cost of $47,500 each. Project A produces cash inflows of $25,300, $37,100, and $22,000 for Years 1 through 3, respectively. Project B produces cash inflows of $43,600, $19,800 and $10,400 for Years 1 through 3, respectively. The required rate of return is 14.7 percent for Project A and 14.9 percent for Project B. Which project(s) should be accepted and why? A) Project A, because it has the higher required rate of return. B) Project A, because it has the larger NPV. C) Project B, because it has the largest cash inflow in Year 1. D) Project B, because it has the higher required rate of return. E) Project B, because it has the larger NPV
B) Project A, because it has the larger NPV. Explanation: NPVA = −$47,500 + $25,300/1.147+ $37,100/1.1472+ $22,000/1.1473 NPVA = $17,336.57 NPVB = −$47,500 + $43,600/1.149 + $19,800/1.1492+ $10,400/1.1493 NPVB = $12,299.79
Project A has cash flows of −$50,000, $49,400, $27,200, and $24,500 for Years 0 to 3, respectively. Project B has an initial cost of $50,000 and an annual cash inflow of $18,500 for four years. These are mutually exclusive projects. What is the crossover rate? A) 30.89 percent B) 16.08 percent C) −30.89 percent D) Cannot be computed E) −16.08 percent
C) −30.89 percent Explanation: Year 0 difference = −$50,000 − (−50,000) = $0 Year 1 difference = $49,400 − 18,500 = $30,900 Year 2 difference = $27,200 − 18,500 = $8,700 Year 3 difference = $24,500 − 18,500 = $6,000 Year 4 difference = $0 − 18,500 = −$18,500 NPV = 0 = $0 + $30,900/(1 + IRR) + $8,700/(1 + IRR)2 + $6,000/(1 + IRR)3 + (-$18,500)/(1 + IRR)4 IRR = −.3089, or −30.89%
JJ's is reviewing a project with a required discount rate of 15.2 percent and an initial cost of $309,000. The cash inflows are $47,000, $198,000, and $226,000 for Years 2 to 4, respectively. Should the project be accepted based on discounted payback if the required payback period is 2.5 years? A) Accept; The discounted payback period is 2.18 years. B) Accept; The discounted payback period is 2.32 years. C) Accept; The discounted payback period is 2.98 years. D) Reject; The discounted payback period is 3.87 years. E) Reject; The project never pays back on a discounted basis.
E) Reject; The project never pays back on a discounted basis. Explanation: PV = $47,000/1.1522 + $198,000/1.1523 + $226,000/1.1524 PV = $293,248.02 The project should be rejected because the PV of the cash inflows is less than the initial cost.
A project has a net present value of zero. Which one of the following best describes this project? A) The project has a zero percent rate of return. B) The project requires no initial cash investment. C) The project has no cash flows. D) The summation of all of the project's cash flows is zero. E) The project's cash inflows equal its cash outflows in current dollar terms.
E) The project's cash inflows equal its cash outflows in current dollar terms. A project of Net Zero means that it is no better than the next best opportunity (represented by the discount rate).
The internal rate of return: A) may produce multiple rates of return when cash flows are conventional. B) is best used when comparing mutually exclusive projects. C) is rarely used in the business world today. D) is principally used to evaluate small dollar projects. E) is easy to understand.
E) is easy to understand. The IRR is simply the rate of return on a project or the rate in which the NPV is zero. This makes it very easy to understand.
