Chapter 8

Payback definition

period in capital budgeting refers to the time required to recoup the funds expended in an investment, or to reach the break-even point

6) When projects are mutually exclusive, you should choose the project with the: A) highest IRR. B) highest NPV. C) longer life. D) shorter payback period.

B) highest NPV.

22) Which mutually exclusive project would you select, if both require initial investment of $1,000 and your required rate of return is 15%: Project A with three annual cash flows of $1,000, starting from next year (t=1); or Project B, with 3 years of zero cash flow followed by 3 years of $1,000 annually? [You may answer this question without actually calculating both NPVs.] A) Project A B) Project B C) Neither project should be selected. D) You are indifferent since the NPVs are equal.

A) Project A

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

B) changes in the sign of the cash flows.

9) Which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities? A) Payback B) Internal rate of return C) Profitability index D) Net present value

D) Net present value

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

D) add the same amount of value to the firm.

26) 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) change but the discount rate must be known to determine the nature of the change. D) be unchanged.

D) be unchanged.

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

D) multiple internal rates of return.

33) You are considering the following two mutually exclusive projects. The required return on each project is 12 percent. Which project should you accept and what is the best reason for that decision? [Note: You can eliminate B and C without acutually calculting IRR because IRR is not appropriate for mutually exclusive projects] A) Project A, because it pays back fasterB) Project A, because it has the higher internal rate of return C) Project B, because it has the higher internal rate of return D) Project B, because it has the higher net present valueE) Project A, because it has the higher net present value

E) Project A, because it has the higher net present value

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

.B) The IRR must be greater than 0.

7) The internal rate of return is the: A) project's current market rate of return .B) discount rate that results in a zero net present value for the project. C) rate of return required by the project's investors .D)discount rate that causes a project's aftertax income to equal zero. E) discount rate that results in a net present value equal to the project's initial cost.

.B) discount rate that results in a zero net present value for the project.

29) Selecting the project(s) with the highest NPV(s) is not the correct decision rule when: A) there are mutually exclusive projects .B) there is capital rationing. C) projects are long-lived. D) projects are independent.

.B) there is capital rationing.

20) What is the IRR of a project with the following cash flows: C0 = $200, C1 = $ 110, C2 = $121? [Can you answer this question without using financial calculator or spreadsheet? ] A) 5% B) Zero C) 10%

C) 10%

19) Using the Profitability Index, which of the four projects is the best investment? Project NPV Investment A $ 2.3 mil B $ 1.2 mil C $ 3.5 mil D $ 4.4 mil A) Project A B) Project B C) Project C D) Project D $ 5.2 mil $ 2.8 mil $ 6.9 mil $ 8.9 mil

C) Project C

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

C) exceed 5 years

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

C) net present value will be zero.

30) What is the net present value of a project with the following cash flows if the discount rate is 15%? A) $1,044.16 B) $1,035.24 C) -$1,618.48 D) -$2,687.98 E) $9,593.19

D) -$2,687.98

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

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

5) The payback rule always makes shareholders better off.

False

Profitability index definition

Is the ratio of payoff to investment of a proposed project.

3) When using a profitability index to select projects, a high value is preferred over a low value. True/False

True

32) Services United is considering a new project that requires an initial cash investment of $26,000. The project will generate cash inflows of $2,500, $11,700, $13,500, and $10,000 over each of the next four years, respectively. How long will it take to recover the initial investment?[Hint: calculate payback period] A) 2.87 years B) 3.27 years C) 3.68 years D) 2.99 years E) 2.74 years

A) 2.87 years

18) Given the various investment options listed, what investment criteria concept might make an investor select Project B over other projects? Project NPV Profitability Index A $ 1.3 mil 0.23 B $ 2.2 mil 0.54 C $ 3.5 mil 0.49 D $ 4.6 mil 0.38 [Note: Under Gold Standard, Porject D should be selected because is has the largest NPV. ] A) Capital rationing B) Mutually exclusive projects C) The Gold Standard D) The Internal Rate of Return Rule `

A) Capital rationing

25) Which of the following investment decision rules tends to improperly reject long-lived projects? [This method also has bias toward short-lived projects.] A) Payback period B) Net present value C) Internal rate of return D) Profitability index

A) Payback period

16) Which one of the following can be defined as a benefit-cost ratio? A) Profitability index B) Internal rate of return C) Net present value D) Modified internal rate of return

A) Profitability index

24) If a project has a cost of $50,000 and a profitability index of 0.45, then: A) it has a positive NPV. B) its cash flow is $100,000. C) its NPV could be positive or negative depending on the cost of capital . D) it has a negative NPV.

A) it has a positive NPV.

12) A project requires an initial outlay of $10 million. If the cost of capital exceeds the project IRR, then the project has a(n): A) negative NPV. B) acceptable payback period. C) positive NPV. D) positive profitability index.

A) negative NPV.

An investor typically sets the required rate of return by

An investor typically sets the required rate of return by adding a risk premium to the interest percentage that could be gained by investingexcess funds in a risk-free investment.

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

B) $16,081.60

If a project's NPV is calculated to be positive what should a project manager do? A) The present value of the project cost should be determined .B) The profitability index should be calculated. C) The project should be rejected. D) The discount rate should be decreased.

B) The profitability index should be calculated.

21) 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) Three C) Four D) Two

B) Three

11) If a project's NPV is calculated to be negative what should a project manager do? A) The present value of the project cost should be determined .B) The profitability index should be calculated. C) The project should be rejected. D) The discount rate should be decreased.

C) The project should be rejected.

31) A project has the following cash flows. What is the payback period? A) 3.33 years B) 2.38 years C) 3.01 years D) 2.74 years chary 0 -28000 1 11,600 2 11,600 3 6500 4 6500

D) 2.74 years

17) Mary has just been asked to analyze an investment to determine if it is acceptable. Unfortunately, she is not being given sufficient time to analyze the project using various methods. She must select one method of analysis and provide an answer based solely on that method. Which method do you suggest she use in this situation? A) Payback period B) Internal rate of return C) Profitability index D) Net present value E) Discounted payback period

D) Net present value

1) The IRR is the rate of return on the cash flows of the investment, also known as the opportunity cost of capital. True/False

False

2) For mutually exclusive projects, the project with the higher IRR is the correct selection. True/False

False

4) If a project has multiple IRRs, the lowest one is incorrect.

False

Internal rate of return definition

is a metric used in capital budgeting to estimate the profitability of potential investments.

When does The profitability index equals 1?

the project's cash outflows areexpected to equal its cash inflows.