Financial Analysis - USCA MBA - Ch5 HW

Which of the following methods of project analysis are biased towards short-term projects?

payback and discounted payback

The internal rate of return for a project will increase if:

the initial cost of the project can be reduced.

An analyst is considering two mutually exclusive projects that have been assigned the same discount rate of 10.5 percent. Project A has an initial cost of $54,500, and should produce cash inflows of $16,400, $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial cost of $79,400, and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. What is the incremental IRR?

−15.40% 0 = [−$79,400 - (−$54,500)] + ($0 - 16,400) / (1 + IRR) + ($48,300 - 28,900) / (1 + IRR)2 + ($42,100 - 31,700) / (1 + IRR)3; IRR = −15.40%

Of the following statements about net present value (NPV), which one is correct?

Both investing and financing type projects should be accepted if their NPVs are positive and rejected if they are negative.

A project costing $102,000 initially should produce cash inflows of $54,000 per year for six years. At the end of the six years, the project will be shut down and will be sold for an estimated net cash amount of $48,000. What is the net present value of this project if the required rate of return is 11 percent?

$152,112 NPV = −$102,000 + $54,000[(1 − 1/1.11^6)/.11] + $48,000/1.11^6 NPV = $152,112

A proposed new venture will cost $175,000 and should produce annual cash flows of $48,500, $85,000, $40,000, and $40,000 for Years 1 to 4, respectively. The required payback period is 3 years and the discounted payback period is 3.5 years. The required rate of return is 9 percent. Which methods indicate project acceptance and which indicate project rejection?

Accept: NPV, IRR, PI; Reject: payback, discounted payback

Comparing the NPV profile of an investment type project to that of a financing type project demonstrates why the:

IRR decision rule for investment projects is the opposite of the rule for financing projects.

Why do managers suggest that ignoring all cash flows following the required payback period is not a major flaw of the payback method of capital budgeting analysis?

If the cash flows after the required period are significant, managers will use their discretion to override the payback rule.

An investment project has an initial cost of $260 and cash flows $75, $105, $100, and $50 for Years 1 to 4, respectively. The cost of capital is 12 percent. What is the discounted payback period?

Never

The possibility that more than one discount rate will make the NPV of an investment equal to zero presents the problem referred to as:

multiple rates of return.

The ________ is the difference between the present value of an investment's future cash flows and its initial cost.

net present value

A project has an initial cost of $2,250. The cash inflows are $0, $500, $900, and $700 for Years 1 to 4, respectively. What is the payback period?

never

Assume a firm is more concerned about quickly recovering its initial investment than it is about the amount of value created. Accordingly, the firm is most likely to employ the ________ method of capital project analysis.

payback

The ________ is the length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment.

payback period

If you want to review a project from a benefit-cost perspective, you should use the _____ method of analysis.

profitability index

The net present value method of capital budgeting analysis does all of the following except:

provide a specific anticipated rate of return.

The payback method:

requires an arbitrary choice of a cutoff point.

The discounted payback rule may cause:

some positive net present value projects to be rejected.

The net present value of an investment project increases when ________, all else constant.

the required rate of return decreases

Assume a firm accepts a positive net present value project. An analyst would be most justified in concluding that:

the stockholders' value in the firm is expected to increase.

Assume a project has been assigned a required rate of return of zero. Accordingly:

the timing of the project's cash flows has no bearing on the value of the project.

The elements that cause problems with the use of the IRR in projects that are mutually exclusive are referred to as the:

timing and scale problems.

An investment costing $25 returns $27.50 at the end of one year with no risk. Given this, you know that the NPV:

is zero if the required rate of return is 10 percent.

What is the net present value of a project that has an initial cash outflow of $7,670 and cash inflows of $1,280 in Year 1, $6,980 in Year 3, and $2,750 in Year 4? The discount rate is 12.5 percent.

$86.87 NPV = −$7,670 + $1,280 / 1.125 + $6,980 / 1.1253 + $2,750 / 1.1254 = $86.87

A proposed project has an initial cost of $128,600 and cash flows of $64,500, $98,300, and −$15,500 for Years 1 to 3 respectively. If all negative cash flows are moved to Time 0 at a discount rate of 10 percent, what is the modified internal rate of return?

9.82%

Kumail is considering a project with cash inflows of $950 per year for Years 1 to 4, respectively. The project has a required discount rate of 11 percent and an initial cost of $2,100. What is the discounted payback period?

2.68 years

An investment project has an initial cost of $382 and cash flows $105, $130, $150, and $150 for Years 1 to 4, respectively. The cost of capital is 9 percent. What is the discounted payback period?

3.57 years

An investment with an initial cost of $4,000 produces cash flows of $3,400, −$500, $2,800, −$100, and $6,000 for Years 1 to 5, respectively. How many IRRs does this project have?

5

An investment is acceptable if the payback period:

is less than some pre-specified period of time.

Anxin Fashion is considering two mutually exclusive projects that will not be repeated. The required rate of return is 13.9 percent for Project A and 12.5 percent for Project B. Project A has an initial cost of $54,500, and should produce cash inflows of $16,400, $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial cost of $69,400, and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. Which project, or projects, if either, should be accepted and why?

Project A; because its NPV is positive while Project B's NPV is negative

You are considering two independent projects with the same discount rate of 11 percent. Project A costs $284,700 and has cash flows of $75,900, $106,400, and $159,800 for Years 1 to 3, respectively. Project B costs $115,000, and has a cash flow of $50,000 per year for Years 1 to 3. You have sufficient funds to finance any decision you make. Which project or projects, if either, should you accept and why?

Project B; because its IRR exceeds the discount rate

Which of the following provides the best example of two mutually exclusive projects?

Renting out a company warehouse or selling it outright

For investment type projects, the internal rate of return (IRR):

is the rate generated solely by the cash flows of the investment.

An investment type project has an internal rate of return of 12.3 percent, a net present value of $798, and a payback period of 3.12 years. Given this information, which one of the following statements is correct?

The discount rate used in computing the net present value was less than 12.3 percent.

How should a profitability index of zero be interpreted?

The project's cash flows subsequent to the initial cash flow have a present value of zero.

The profitability index:

is useful as a decision tool when investment funds are limited and all available funds are allocated.

Which one of the following statements is true? - You must have a discount rate to compute NPV, IRR, PI, and discounted payback. - Payback uses the same discount rate as that applied in the NPV calculation. - You must know the discount rate to compute the NPV but not the IRR. - Financing projects are acceptable if the NPV is negative. - Financing projects can only ever have one IRR.

You must know the discount rate to compute the NPV but not the IRR.

Gabriel is considering two independent projects with 2-year lives. Both projects have been assigned a discount rate of 13 percent. She has sufficient funds to finance one or both projects. Project A costs $38,500 and has cash flows of $19,400 and $28,700 for Years 1 and 2, respectively. Project B costs $41,000, and has cash flows of $25,000 and $22,000 for Years 1 and 2, respectively. Which project, or projects, if either, should Gabriel accept based on the profitability index method and what is the correct reason for that decision?

You should only accept Project A since it is the only project with a PI greater than 1. PIA = ($19,400/1.13 + $28,700/1.132)/$38,500 PIA = 1.03

A mutually exclusive project is a project whose:

acceptance or rejection affects the acceptance of other projects.

A project will have more than one IRR if and only if the:

cash flow pattern exhibits more than one sign change.

All else equal, the payback period for a project will decrease whenever the:

cash inflows are moved earlier in time.

The internal rate of return tends to be:

easier for managers to comprehend than the net present value.

A project has an initial cost of $26,000, a discount rate of 11.7 percent, a life of 5 years, and an NPV of $11,216. Given this, you know that the project is expected to earn a return:

equal to 11.7 percent of $26,000 plus an additional $11,216.

An independent investment is acceptable if the profitability index (PI) of the investment is:

greater than 1.0

You are trying to determine whether to accept Project A or Project B. These projects are mutually exclusive. As part of your analysis, you should compute the incremental IRR by determining the:

internal rate of return for the differences in the cash flows of the two projects.

Project A costs $84,500 and has cash flows of $32,300, $36,400, and $30,000 for Years 1 to 3, respectively. Project B has an initial cost of $79,000 and has cash flows of $30,000, $36,000, and $29,000 for Years 1 to 3, respectively. What is the incremental IRR of these two mutually exclusive projects?

−20.37%