BUS 30100 - Chapter 9
What is the net present value of a project that has an initial cash outflow of $36,300 and cash inflows of $11,500, $21,700, $0, and $10,400 in Years 1 through 4, respectively? The required return is 15 percent. 1. -$3,945.45 2. -$3,053.51 3. -$2,481.53 4. $2,311.08 5. $2,416.75
1. -$3,945.45 NPV = -$36,300 + $11,500 / 1.15 + $21,700 / 1.152 + $10,400 / 1.154 NPV= -$3,945.45
You are considering a project with an initial cost of $8,600. What is the payback period for this project if the cash inflows are $2,100, $3,140, $3,800, and $4,500 a year over the next four years, respectively? 1. 2.88 years 2. 3.28 years 3. 3.36 years 4. 4.21 years 5. 2.29 years
1. 2.88 years Payback = 2 + ($8,600 - 2,100 - 3,140) / $3,800 = 2.88 years
Net present value: 1. Is the best method of analyzing mutually exclusive projects. 2. Is less useful than the internal rate of return when comparing different sized projects. 3. Is the easiest method of evaluation for nonfinancial managers to use. 4. Cannot be applied when comparing mutually exclusive projects. 5. Is very similar in its methodology to the average accounting return.
1. Is the best method of analyzing mutually exclusive projects.
A project has an initial cost of $27,400 and a market value of $32,600. What is the difference between these two values called? 1. Net present value 2. Internal return 3. Payback value 4. Profitability index 5. Discounted payback
1. Net present value
Samuelson Electronics has a required payback period of three years for all of its projects. Currently, the firm is analyzing two independent projects. Project A has an expected payback period of 2.8 years and a net present value of $6,800. Project B has an expected payback period of 3.1 years with a net present value of $28,400. Which projects should be accepted based on the payback decision rule? 1. Project A only 2. Project B only 3. Both A and B 4. Neither A nor B 5. Either, but not both projects
1. Project A only
Both the NPV and the internal rate of return methods recognize that the timing of cash flows affects project value. 1. True 2. False
1. True
Non-mutually exclusive alternatives can be accepted at the same time. 1. True 2. False
1. True
The internal rate of return is the discount rate that makes the NPV of a project's cash flows equal to zero. 1. True 2. False
1. True
The net present value profile examines the relationship of the discount rate to the net present value. 1. True 2. False
1. True
The payback method is basic to understand and places a heavy emphasis on liquidity. 1. True 2. False
1. True
The payback rule states that a project is acceptable if you get your money back within a specified period. 1. True 2. False
1. True
The profitability index of a positive NPV project is always positive. 1. True 2. False
1. True
Unlike using IRR, selecting projects according to their NPV will always lead to a correct accept-reject decision. 1. True 2. False
1. True
When choosing among mutually exclusive projects, the choice is easy using the NPV rule. As long as at least one project has positive NPV, simply choose the project with the highest NPV. 1. True 2. False
1. True
It will cost $6,000 to acquire an ice cream cart. Cart sales are expected to be $3,600 a year for three years. After the three years, the cart is expected to be worthless as the expected life of the refrigeration unit is only three years. What is the payback period? 1. 1.48 years 2. 1.67 years 3. 1.82 years 4. 1.95 years 5. 2.00 years
2. 1.67 years Payback period = $6,000 / $3,600 = 1.67 years
When the present value of the cash inflows exceeds the initial cost of a project, then the project should be: 1. Accepted because the payback period is less than the required time period. 2. Accepted because the profitability index is greater than 1. 3. Accepted because the profitability index is negative. 4. Rejected because the internal rate of return is negative. 5. Rejected because the net present value is positive.
2. Accepted because the profitability index is greater than 1.
Roger's Meat Market is considering two independent projects. The profitability index decision rule indicates that both projects should be accepted. This result most likely does which one of the following? 1. Conflicts with the results of the net present value decision rule. 2. Assumes the firm has sufficient funds to undertake both projects. 3. Agrees with the decision that would also apply if the projects were mutually exclusive. 4. Bases the accept/reject decision on the same variables as the average accounting return. 5. Fails to provide useful information as the firm must reject at least one of the projects.
2. Assumes the firm has sufficient funds to undertake both projects.
Which one of the following methods of project analysis is defined as computing the value of a project based on the present value of the project's anticipated cash flows? 1. Constant dividend growth model 2. Discounted cash flow valuation 3. Average accounting return 4. Expected earnings model 5. Internal rate of return
2. Discounted cash flow valuation
A project's payback period is the length of time necessary to generate an NPV of zero. 1. True 2. False
2. False
Cash flow is used for a net present value analysis, and earnings are used for an IRR and payback analysis. 1. True 2. False
2. False
If a project has multiple IRRs, the highest one is assumed to be correct. 1. True 2. False
2. False
Projects with an NPV of zero decrease shareholders' wealth by the cost of the project. 1. True 2. False
2. False
The net present value profile allows a firm to examine the project's net present value over time. 1. True 2. False
2. False
The payback method considers all cash inflows. 1. True 2. False
2. False
The payback rule always makes shareholders better off. 1. True 2. False
2. False
The profitability index is calculated by dividing the project's net present value by the present value of the projected cash outflows. 1. True 2. False
2. False
The selection of a mutually exclusive project means that all other projects with a positive net present value may also be selected. 1. True 2. False
2. False
When NPV and IRR analysis provide inconsistent rankings of projects, the financial manager should generally select the project with the highest IRR. 1. True 2. False
2. False
The length of time a firm must wait to recoup the money it has invested in a project is called the: 1. Internal return period 2. Payback period 3. Profitability period 4. Discounted cash period 5. Valuation period
2. Payback period
Assume a project is independent with financing cash flows. Which one of these statements is correct? 1. The IRR cannot be used to determine the acceptability of the project. 2. The project is acceptable if the required return exceeds the IRR. 3. The project is acceptable only if the NPV is zero or negative. 4. The project's net present value profile is upsloping. 5. The project is acceptable if the internal rate of return is negative.
2. The project is acceptable if the required return exceeds the IRR.
A project has a discounted payback period that is equal to the required payback period. Given this, which of the following statements must be true? 1. The project will not be acceptable under the payback rule. 2. The project must have a profitability index that is equal to or greater than 1.0. 3. The project must have a zero net present value. 4. The project's internal rate of return must equal the required return. 5. The project will still be acceptable if the discount rate is increased.
2. The project must have a profitability index that is equal to or greater than 1.0.
A project has an initial cash outflow of $39,800 and produces cash inflows of $18,304, $19,516, and $14,280 for years 1 through 3, respectively. What is the NPV at a discount rate of 11 percent? 1. $7,675.95 2. -$1,208.19 3. $2,971.13 4. $2,029.09 5. $1,311.16
3. $2,971.13 NPV = -$39,800 + $18,304 / 1.11 + $19,516 / 1.112 + $14,280 / 1.113 NPV = $2,971.13
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? 1. .93; accept 2. 1.07; accept 3. 1.02; accept 4. .93; reject 5. 1.07 reject
3. 1.02; accept PVInflows = $60,800 / 1.13 + $62,300 / 1.132 + $75,000 / 1.133 = $154,574.11 PI = $154,574.11 / $152,000 = 1.02 Since the PI is greater than 1, the project should be accepted.
Project A has cash flows of -$50,000, $29,400, $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 $26,500 for three years. These are mutually exclusive projects. What is the crossover rate? 1. 11.98 percent 2. 14.72 percent 3. 28.15 percent 4. 15.99 percent 5. 16.08 percent
3. 28.15 percent Year 0 difference = -$50,000 - (-50,000) = $0 Year 1 difference = $29,400 - 26,500 = $2,900 Year 2 difference = $27,200 - 26,500 = $700 Year 3 difference = $24,500 - 26,500 = -$2,000 NPV = 0 = $0 + $2,900 / (1 + IRR) + $700 / (1 + IRR)2 + (-$2,000) / (1 + IRR)3 IRR = 28.15 percent
Which of the following are advantages of the payback method of project analysis? 1. Considers time value of money, liquidity bias. 2. Liquidity bias, arbitrary cutoff point. 3. Liquidity bias, ease of use. 4. Ignores time value of money, ease of use. 5. Ease of use, arbitrary cutoff point.
3. Liquidity bias, ease of use.
If a firm accepts Project A it will not be feasible to also accept Project B because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be: 1. Independent 2. Interdependent 3. Mutually exclusive 4. Economically scaled 5. Operationally distinct
3. Mutually exclusive
You are viewing a graph that plots the NPVs of a project to various discount rates that could be applied to the project's cash flows. What is the name given to this graph? 1. Project tract 2. Projected risk profile 3. NPV profile 4. NPV route 5. Present value sequence
3. NPV profile
Which two methods of project analysis are the most biased towards short-term projects? 1. Net present value and internal rate of return 2. Internal rate of return and profitability index 3. Payback and discounted payback 4. Net present value and discounted payback 5. Discounted payback and profitability index
3. Payback and discounted payback
A proposed project has an initial cost of $38,000 and cash inflows of $12,300, $24,200, and $16,100 for years 1 through 3, respectively. The required rate of return is 16.8 percent. Based on IRR, should this project be accepted? Why or why not? 1. No; The IRR exceeds the required return by .58 percent. 2. No; The IRR is less than the required return by 1.03 percent. 3. Yes; The IRR exceeds the required return by .58 percent. 4. Yes; The IRR exceeds the required return by about 1.03 percent. 5. Yes; The IRR is less than the required return by .58 percent.
3. Yes; The IRR exceeds the required return by .58 percent. NPV = 0 = -$38,000 + $12,300 / (1 + IRR) + $24,200 / (1 + IRR)2 + $16,100 / (1 + IRR)3 IRR = 17.38 percent This is an investment project so it should be accepted because the IRR exceeds the requirement.
Which one of the following statements related to the internal rate of return (IRR) is correct? 1. The IRR yields the same accept and reject decisions as the net present value method given mutually exclusive projects. 2. A project with an IRR equal to the required return would reduce the value of a firm if accepted. 3. The IRR is equal to the required return when the net present value is equal to zero. 4. Financing type projects should be accepted if the IRR exceeds the required return. 5. The average accounting return is a better method of analysis than the IRR from a financial point of view.
3. The IRR is equal to the required return when the net present value is equal to zero.
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? 1. The discounted payback period must be equal to 0 years 2. The break-even discount rate must be less than 11.63 percent 3. The discount rate used in computing the net present value was less than 11.63 percent 4. The AAR is equal to the IRR / PI 5. The project should be rejected based on its PI value
3. The discount rate used in computing the net present value was less than 11.63 percent
Projects A and B are mutually exclusive and both have an initial cost of $78,000. Project A has annual cash flows for three years of $28,300, $31,500, and $42,300, respectively. Project B has annual cash flows for three years of $26,900, $30,500, and $44,900. What is the crossover rate? 1. 9.17 percent 2. 3.33 percent 3. 14.32 percent 4. 5.16 percent 5. 15.20 percent
4. 5.16 percent Year 0 difference = -$78,000 - (-78,000) = $0 Year 1 difference = $28,300 - 26,900 = $1,400 Year 2 difference = $31,500 - 30,500 = $1,000 Year 3 difference = $42,300 - 44,900 = -$2,600 NPV = 0 = $0 + $1,400 / (1 + IRR) + $1,000 / (1 + IRR)2 + (-$2,600) / (1 + IRR)3 IRR = 5.16 percent
The internal rate of return is defined as the: 1. Maximum rate of return a firm expects to earn on a project. 2. Rate of return a project will generate if the project in financed solely with internal funds. 3. Discount rate that equates the net cash inflows of a project to zero. 4. Discount rate which causes the net present value of a project to equal zero. 5. Discount rate that causes the profitability index for a project to equal zero.
4. Discount rate which causes the net present value of a project to equal zero.
Which one of the following will decrease the net present value of a project? 1. Increasing the value of each of the project's discounted cash inflows. 2. Moving each of the cash inflows forward to a sooner time period. 3. Decreasing the required discount rate. 4. Increasing the project's initial cost at time zero. 5. Increasing the amount of the final cash inflow.
4. Increasing the project's initial cost at time zero.
The profitability index is most closely related to which one of the following? 1. Payback 2. Discounted payback 3. Average accounting return 4. Net present value 5. Modified internal rate of return
4. Net present value
The present value of an investment's future cash flows divided by the initial cost of the investment is called the: 1. Net present value 2. Internal rate of return 3. Average accounting return 4. Profitability index 5. Profile period
4. Profitability index
The Square Box is considering two independent projects, both of which have an initial cost of $18,000. The cash inflows of Project A are $3,000, $7,000, and $10,000 over the next three years, respectively. The cash inflows for Project B are $3,000, $7,000, and $15,000 over the next three years, respectively. The required return is 12 percent and the required discounted payback period is 3 years. Based on discounted payback, which project(s), if either, should be accepted? 1. Both projects should be accepted. 2. Both projects should be rejected. 3. Project A should be accepted and Project B should be rejected. 4. Project A should be rejected and Project B should be accepted. 5. You should be indifferent to accepting either or both projects.
4. Project A should be rejected and Project B should be accepted. Discounted cash flowsA = $3,000 / 1.12 + $7,000 / 1.122 + $10,000 / 1.123 Discounted cash flowsA = $15,376.73 Project A never pays back on a discounted basis. DPBB = 2 + [$18,000 - $3,000 / 1.12 - $7,000 / 1.122] / ($15,000 / 1.123) DPBB= 2.91 years Project B should be accepted because it pays back within the required period.
A project has a required payback period of three years. Which one of the following statements is correct concerning the payback analysis of this project? 1. The cash flows in each of the three years must exceed one-third of the project's initial cost if the project is to be accepted. 2. The cash flow in year three is ignored. 3. The project's cash flow in year three is discounted by a factor of (1 + R)3. 4. The cash flow in year two is valued just as highly as the cash flow in year one. 5. The project is acceptable whenever the payback period exceeds three years.
4. The cash flow in year two is valued just as highly as the cash flow in year one.
The IRR that causes the net present value of the differences between two project's cash flows to equal zero is called the: 1. Required return 2. Zero-sum rate 3. Present value rate 4. Break-even rate 5. Crossover rate
5. Crossover rate
The length of time a firm must wait to recoup, in present value terms, the money it has invested in a project is referred to as the: 1. Net present value period 2. Internal return period 3. Payback period 4. Discounted profitability period 5. Discounted payback period
5. Discounted payback period
There are two distinct discount rates at which a particular project will have a zero net present value. In this situation, the project is said to: 1. Have two net present value profiles 2. Have operational ambiguity 3. Create a mutually exclusive investment decision 4. Produce multiple economies of scale 5. Have multiple rates of return
5. Have multiple rates of return
The internal rate of return: 1. May produce multiple rates of return when cash flows are conventional. 2. Is best used when comparing mutually exclusive projects. 3. Is rarely used in the business world today. 4. Is principally used to evaluate small dollar projects. 5. Is easy to understand.
5. Is easy to understand.
You estimate that a project will cost $27,700 and will provide cash inflows of $11,800 in year 1 and $24,600 in year 3. Based on the profitability index rule, should the project be accepted if the discount rate is 14 percent? Why or why not? 1. Yes; The PI is .97. 2. Yes; The PI is .84. 3. Yes; The PI is 1.06. 4. No; The PI is 1.06. 5. No; The PI is .97.
5. No; The PI is .97. PVInflows = $11,800 / 1.14 + $24,600 / 1.143 = $26,955.18 PI = $26,955.18 / $27,700 = .97 The PI is less than 1 so the project should be rejected.
Which one of these statements related to discounted payback is correct? 1. Payback is a better method of analysis than discounted payback. 2. Discounted payback is used more frequently in business than payback. 3. Discounted payback does not require a cutoff point. 4. Discounted payback is biased towards long-term projects. 5. The discounted payback period decreases as the discount rate decreases.
5. The discounted payback period decreases as the discount rate decreases.
Swenson's is considering two mutually exclusive projects, Projects A and B, and has determined that the crossover rate for these projects is 11.7 percent. Given this you know that: 1. Neither project will be accepted if the discount rate is less than 11.7 percent. 2. Both projects have a negative NPV at discounts rates greater than 11.7 percent. 3. Both projects provide an internal rate of return of 11.7 percent. 4. Both projects have a zero NPV at a discount rate of 11.7 percent. 5. The project that is preferred at a discount rate of 11 percent will be the opposite project of that preferred at a discount rate of 12 percent.
5. The project that is preferred at a discount rate of 11 percent will be the opposite project of that preferred at a discount rate of 12 percent.
A project has a net present value of zero. Which one of the following best describes this project? 1. The project has a zero percent rate of return. 2. The project requires no initial cash investment. 3. The project has no cash flows. 4. The summation of all of the project's cash flows is zero. 5. The project's cash inflows equal its cash outflows in current dollar terms.
5. The project's cash inflows equal its cash outflows in current dollar terms.
You are considering two mutually exclusive projects. Project A has cash flows of -$125,000, $51,400, $52,900, and $63,300 for years 0 to 3, respectively. Project B has cash flows of -$85,000, $23,100, $28,200, and $69,800 for years 0 to 3, respectively. Project A has a required return of 9 percent while Project B's required return is 11 percent. Should you accept or reject these projects based on IRR analysis? 1. Accept Project A and reject Project B 2. Reject Project A and accept Project B 3. Accept both projects 4. Reject both projects 5. You should not use IRR; use a different method of analysis.
5. You should not use IRR; use a different method of analysis. Because these are mutually exclusive projects of differing sizes you should not apply the IRR rule.