chapter 8
mary is in contract negotiations with a publishing house for her new novel. she has 2 options. she may be paid 100,000 up front, and receive royalties that are expected to total, 26,000 at the end of each of the next 5 years. alternatively, she can receive 200,000 up front and no royalties. which of the following investment rules would indicate that she should take the former deal, given a discount rate of 8%? 1. the net present value rule 11. the payback rule with a payback period of 2 years 111. the internal are of return rule a. 1 b. 111 c. 11 and 111 d. 1 and 11
a
the present value of an investment is ________? a. the amount that an investment would yield if the benefit were realized today b. the difference between the cost of the investment and the benefit of the investment in dollars today c. the amount you need to invest at the current interest rate to re-create the cash flow from the investment d. the amount of which the cash flow of an investment exceeds or falls short of the cash flow generated by the same amount of money invested at market rate
a
which of the following best describes the net present value rule? a. take any investment opportunity where the next present value is not negative, turn down any opportunity when it is negative b. take any investment opportunity where the NPV exceeds the opportunity cost of capital, turn down any opportunity where the cost of capital exceeds the NPV c. when choosing among any list of investment opportunities where resources are limited, always choose those projects with the highest net present value d. if the difference between the present cost of an investment and the present value of its benefits after a fixed number of years is positive the investment should be taken otherwise it should be rejected
a
you are trying to decide between 3 mutually exclusive investment opportunities. the most appropriate tool for identifying the correct decision is _________ a. net present value b. profitability index c. internal rate of return d. incremental internal rate of return
a
A lawn maintenance company compares two ride-on mowersthe Excelsior, which has an expected working-life of six years, and the Grassassinator, which has a working life of four years. After examining the equivalent annual annuities of each mower, the company decides to purchase the Excelsior. Which of the following, if true, would be most likely to make them change that decision? a. fuel prices are expected to rise and raise the annual running costs of all mowers b. the mower is only expected to be needed for 3 years c. the price of equivalent mowers are expected to grow in the near future as lawnmower manufacturers consolidate d. the number of customers requiring lawn-mowing services is expected to sharply increase in the near future
b
Peter has a business opportunity that requires him to invest 10,000 today, and receive 12,000 in one year. he can either us 10,000 that he already has for this investment or borrow money from his bank at an interest rate of 10%. however, the 10,000 he has right now is needed for urgent rapids to his home, repairs that will cost at least 15,000 if he delays them for a year. what is the best alternative for Peter out of the following choices? a. no since the NPV of the investment, should he take it, is less than the NPV of the home repairs if he delays them for 1 year b. yes since he can borrow the 10,000 from a bank, repair his home, invest the 10,000 in the business opportunity, since it has a NPV>0 will mean he will still come out ahead after repaying the loan c. yes, since the NPV of the investment is > 0 he can invest the 10,000 in the business opportunity and the next year use this money plus the benefit from this money to make the necessary repairs d. yes, since the NPV of the investment, should he take it, is greater than the NPV of the home repairs if he delays them for 1 year
b
the owners of a hair salon spends 1,000,000 to renovate its premises, estimating that this will increase her cash flow by 220,000 per year. she constructs the above graph, which shows the NPV as a function of the discount rate. if her discount rate is 6%, should she accept the project? a. yes, because the NPV is positive at that rate b. no, because the NPV is negative at that rate c. no, because the NPV is positive at that rate d. cannot be determined from the information given
b
when comparing two projects with different lives, why do you compute an annuity with an equivalent present value to the net present value a. so you can see which project has the greatest net present value b. so the projects can be compared on their cost or value created per year c. to reduce the danger that changes in the estimate of the discount rate will lead to choosing the project with a shorter timeframe d. to ensure the cash flows from the project with a longer life that occur after the project with the shorter life has ended are considered
b
which of the following is not a limitation of the payback period rule? a. it does not account for the time value of money b. it is difficult to calculate c. it ignores cash flows after payback d. it does not account for changes in the discount rate
b
which of the following statements is false? a. the payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea b. an internal rate of return will always exist for an investment opportunity c. a net present value, NPV, will always exist for an investment opportunity d. in general, there can be as many internal rates of return as the number of times the project's cash flows change sign over time
b
which of the following statements is false? a. the payback rule is useful in case where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the net present value (NPV) b. the payback rule is reliable because it considers the time value of money and depends on the cost of capital c. for most investment opportunities, expenses occur initially and cash is received later d. fifty percent of firms surveyed reported using the payback rule for making decisions
b
a firm is considering several mutually exclusive investment opportunities. the best way to choose between them is which of the following? a. profitability index b. payback period c. net present value d. internal rate of return
c
according to graham and Harvey's 2001 survey, the most popular decision rules for capital budgeting used by CFO's are ____________ a. npv, irr, mirr b. mirr, irr, payback period c. irr, npv, payback period d. profitability index, npv, irr
c
which of the following is not a limitation of the payback rule? a. it does not consider the time value of money b. lacks a decision criterion that is economically based c. it is difficult to calculate d. it does not consider cash flows occurring after the payback period
c
which of the following is true regarding the profitability index? a. it does not use the net present value to assess benefits b. it is very simply to compute c. attention must be taken when using it to make sure that all of the constrained resource is utilized d. it is unreliable when used for choosing between different projects
c
A janitorial services firm is considering two brands of industrial vacuum cleaners to equip their staff. Option A will cost $1,500, require servicing of $200 per year, and it will last five years. Option B will cost $1,000, require servicing of $100 per year, and it will last three years. If the cost of capital is 8%, which is the better option, given that the firm has an ongoing requirement for vacuum cleaners? a. option a, since it has a lower equivalent annual annuity b. option b, since it has a lower equivalent annual annuity c. option a, since it has a greater equivalent annual annuity d. option b, since it has a greater equivalent annual annuity
d
a convenience store owner is contemplating putting a large neon sign over his store. it would cost 50,000 but is expected to bring an additional 24,000 of profit to the store every year for 5 years. would this project be worthwhile if evaluated using a payback period of 2 years or less and if the cost of capital is 10% a. yes, since it will pay back its initial investment in 2 years b. yes, since the value of cash flows into the store in present dollars, are greater than the initial investment c. yes, since the cash flows after 2 years are greater than the initial investment d. no, since the value of cash flows over the first 2 years are less than the initial investment
d
a security firm is offered 80,000 in one year for providing CCTV coverage of a property. the cost of providing this coverage to the security firm is 74,000, payable now, and the interest rate is 8.5%. should the firm take the contract? a. yes, since net present value is positive b. it doesn't matter whether the contract is taken or not, since NPV=0 c.yes, since net present value is negative d. no, since net present value is negative
d
most corporations measure the value of a project in terms of which of the following? a. discount value b. discount factor c. future value d. present value
d
tanner is choosing between two investment options. he can invest 500 now and get guaranteed 550 in one year, or invest 500 now and get guaranteed 531.40 back later today. the risk free rate is 3.5%. which investment should tanner prefer? a. 531.40 today since, 1 today is worth more than 1 in one year b. 550 in one year, since its 50 more than he invested rather than 31.40 more than he invested c. neither, both investments have a negative NPV d. tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today
d
which of the following decision rules is best defined as the amount of time it takes to payback the initial investment? a. internal rate of return b. profitability index c. net present value d. payback period
d
which of the following decision rules might best be used as a supplement to net present value by a firm that favors liquidity a. profitability index b. MIRR c. equivalent annual annuity d. payback period
d
which of the following is a disadvantage of NPV rule? a. can be misleading if inflows come before outflows b. not necessarily consistent with maximizing shareholder wealth c. ignores cash flows after the cutoff point d. relies on accurate estimate of discount rate
d
which of the following is not a valid method of modifying cash flows to produce a MIRR? a. discount all of the negative cash flows to time 0 and leave the positive cash flows alone b. leave the initial cash flow alone and compound all of the remaining cash flows to the final period of the project c. discount all of the negative cash flows to the present and compound all of the positive cash flows to the end of the project d. turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the project's lifetime
d
which of the following situations can lead to IRR giving a different decision than NPV? a. delayed investment b. multiple IRRs c. differences in project scale d. all of the above can lead to IRR giving a different decision than NPV
d
which of the following statements is false? a. in general, the difference between the cost of capital and the internal rate of return, IRR, is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision b. the IRR can provide information on how sensitive your analysis to errors in the estimate of your cost of capital c. if you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in his estimate d. if the cost of capital estimate is more than the IRR, the net present value will be positive
d
internal rate of return (IRR) can reliably be used to choose between mutually exclusive projects, t or f
f
preference for cash today versus cash in the future in part determines net present value, t or f
f
the internal rate of return (IRR) rule will agree with the net present value rule even when positive cash flows precede negative cash flows, t or f
f
when different projects put different demands on a limited resource, then net present value is always the best way to choose the best project, t or f
f
when using equivalent annual annuities to compare the cost of projects with different lives, you should not consider any changes in the expected replacement cost of equipment, t or f
f
net present value is the difference between the present value of the benefits and the present value of the costs of a project or investment, t or f
t
net present value is usefully supplemented by internal rate of return, since IRR gives a good indication of the sensitivity of any decision made to changes in the discount rate, t or f
t
the net present value rule implies that we should compare a project net present value to 0, t or f
t
the payback rule is based on the idea that an opportunity that pays back its initial investment quickly is a worthwhile opportunity, t or f
t
the profitability index can break down completely when dealing with multiple resource restraints, t or f
t
when an alternative decision rule disagrees with the net present value, the NPV should be followed, t or f
t
when comparing mutually exclusive projects which have different scales, you must know the dollar impact of each investment rather than percentage returns, t or f
t
when different investment rules give conflicting answers, then decisions should be based on the net present value rule, as it is the most reliable and accurate decision rule, t or f
t
you can evaluate alternative projects with different lives by calculating and comparing their equivalent annual annuity, t or f
t
