Homework 5 - Capital Budgeting

What is the equivalent annual cost for a project that requires a $40,000 investment at time zero, and a $10,000annual expense during each of the next 4 years, if the opportunity cost of capital is 10%? A)$22,618.83 B)$20,000.00 C)$21,356.95 D)$25,237.66

A)$22,618.83

What is the profitability index of your recommendations? A)1.1142 B)1.1086 C)1.0957 D)1.1535

A)1.1142

What is the IRR for a project that costs $100,000 and provides annual cash inflows of $30,000 for 6 years starting one year from today? A)19.91% B)15.84% C)22.09% D)16.67%

A)19.91%

What is the decision rule in the case of sign changes that produce multiple IRRs for a project? A)Evaluate the project according to NPV B)Select the highest IRR to maximize the benefits C)Any or all of the IRRs are justified to use D)Select the lowest IRR to be conservative

A)Evaluate the project according to NPV

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

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

Which mutually exclusive project would you select, if both are priced at $1,000 and your required return is15%: Project A with three annual cash flows of $1,000; or Project B, with 3 years of zero cash flow followed by3 years of $1,500 annually? A)Project A B)Project B C)You are indifferent since the NPVs are equal. D)Neither project should be selected.

A)Project A

Todd and Margo plan to retire 3 years from today, sell their home for $580,000 (future price), and move to the beach. Today, they found a beach house that they can buy today for $615,000. If they buy the home, they also have a tenant that will rent it for $4,200 per month for the next 3 years with the first rent payment starting one month from today. If Todd and Margo have a cost of capital is 6% and assuming they do not want to lose money on the transaction, should they buy the beach house today? A)Yes, because the net present value is $7,732.32 B)No, because the internal rate of return exceeds the cost of capital C)Yes, because the increase in value is $116,200.00 D)No, because the net present value is -$8,980.58

A)Yes, because the net present value is $7,732.32

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

A)changes in the sign of the cash flows.

The investment timing decision is aimed at analyzing whether the: A)investment should occur now or at some future point. B)cash flows occur at the beginning or end of each time period. C)payback period or NPV analysis should be used. D)project is a borrowing or lending project.

A)investment should occur now or at some future point.

You have been asked by management to evaluate and recommend for acceptance projects in the table above. A$100,000 capital ration has been established. Which projects should be selected? Assume a cost of capital of7%. A)A and B B)A and D C)B and C D)C and D

B)A and D

Which one of the following best illustrates the problem imposed by capital rationing? A)Bypassing projects that have zero IRRs B)Accepting projects with the highest IRRs first C)Accepting projects with the highest NPVs first D)Bypassing projects that have positive NPVs

B)Accepting projects with the highest IRRs first

Old McDonald needs a new combine harvester for his farm and is considering the 2 following options: Blank - Machine 1 - Machine 2 Initial Cost - $165,000 - $225,000 Annual Cost - $1,800 - $2,400 Useful Life - 9 years - 15 years The annual cost of machine 1 will increase each year by 7% starting 2 years from today. The annual cost of machine 2 will increase each year by $100 starting 2 years from today. Annual costs begin at the end of year 1.If the discount rate is 6%, which machine should Old McDonald choose? A)Buy machine 1 and save $73,192.24 in net present value B)Buy machine 2 and save $433.08 in equivalent annual cost C)Buy machine 1 because it has a higher profitability index D)Buy machine 2 and save $10,760.89 in equivalent annual cost

B)Buy machine 2 and save $433.08 in equivalent annual cost

What happens to the equivalent annual cost of a project as the opportunity cost of capital decreases? A)It increases. B)It decreases. C)It is not affected. D)It depends on whether or not the projects are mutually exclusive.

B)It decreases.

Evaluate the following project using an IRR criterion, based on an opportunity cost of 10%: CF0 = -$600,000, CF1 = $330,000, CF2 = $360,000. A)Accept; because the IRR exceeds the opportunity cost B)Reject; because the opportunity cost exceeds the IRR C)Accept; because the opportunity cost exceeds the IRR D)Reject; because the IRR exceeds the opportunity cost

B)Reject; because the opportunity cost exceeds the IRR

The decision rule for net present value is to: A)reject all projects with rates of return exceeding the opportunity cost of capital B)accept all projects with positive net present values C)accept all projects with cash inflows exceeding the initial cost D)reject all projects lasting longer than 10 years

B)accept all projects with positive net present values

When projects are mutually exclusive, you should choose the project with the: A)highest IRR. B)highest NPV. C)longer life. D)larger initial size.

B)highest NPV.

When managers cannot determine whether to invest now or wait until costs decrease later, the rule should be to: A)postpone until the opportunity cost reaches its lowest level. B)invest at the date that provides the highest NPV today. C)invest now to maximize the NPV. D)postpone until costs reach their lowest level.

B)invest at the date that provides the highest NPV today.

You are considering replacing an old machine in your manufacturing plant. The old machine costs $8,000 per year to maintain. You can purchase a new machine for $25,000 today that will last for 10 years. In addition, it will cost $3,500 in annual maintenance. If the cost of capital is 14.5%, what should you do? A)buy the new machine and save $4,500 in equivalent annual costs. B)keep the old machine and save $386.72 in equivalent annual costs. C)buy the new machine and save $2,000 in equivalent annual costs. D)keep the old machine and save $488.35 in equivalent annual costs.

B)keep the old machine and save $386.72 in equivalent annual costs.

When a manager does not accept a positive NPV project, shareholders face an opportunity cost in the amount of the: A)project's budget. B)project's NPV. C)project's initial cost. D)project's discounted cash inflows.

B)project's NPV.

A project's opportunity cost of capital is: A)the return earned by investing in the project. B)the return that shareholders could expect to earn by investing in the financial markets. C)designed to be rate earned on all projects. D)equal to the average return on all company projects.

B)the return that shareholders could expect to earn by investing in the financial markets.

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

C)$16,081.60

A polisher costs $110,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 9% and the polisher will last for 15 years, what is the equivalent annual cost of the tool? A)$17,474.77 B)$19,163.04 C)$33,646.48 D)$22,187.84

C)$33,646.48

Assuming the uninvested balance of the capital ration is not otherwise utilized over the next 5 years, what will be its future value 5 years from today if it is invested today at the opportunity cost of capital? A)$25,245.93 B)$5,610.21 C)$50,491.86 D)$30,856.14

C)$50,491.86

Based on your recommendations, what is the total initial investment? A)$82,000 B)$96,000 C)$64,000 D)$78,000

C)$64,000

What is the profitability index for a project costing $40,000 and returning $15,000 annually for 4 years at an opportunity cost of capital of 12%? A)0.861 B)0.500 C)0.139 D)0.320

C)0.139

What is the payback period on a project with an initial cost of $26,000 and the following cash flows: CF1 =$9,000, CF2 = $12,000, CF3 = -3,000, CF4 = $8,000, CF5 = $2,000, and CF6 = $1,500? A)4.2 years. B)5.0 years C)4.0 years D)3.8 years

C)4.0 years

What is the minimum number of years in which an investment costing $210,000 must return $65,000 per year at a discount rate of 13% in order to be an acceptable investment? A)8.69 years B)7.51 years C)4.46 years D)5.37 years

C)4.46 years

Which one of the following changes will increase the NPV of a project? A)A decrease in the number of cash inflows B)A decrease in the size of the cash inflows C)A decrease in the discount rate D)An increase in the initial cost of the project

C)A decrease in the discount rate

You want to restore your 1970 Plymouth Roadrunner. You are not in any hurry, so you receive 3 pricing options to begin the project today, one year from today, or two years from today as indicated in the table below. The project will take one year to complete regardless of when you start. Table: project start option - down payment due at start - balance due upon completion today - $20,000 - $20,000 end of year 1 - $22,000 - $22,000 end of year 2 - $24,000 - $24,000 Assuming your cost of capital is 10%, when should you start your restoration project? A)Today B)End of Year 1 C)End of Year 2 D)It does not matter because the net present value is identical for each option

C)End of Year 2

The marketing department is asking for $2 million today to promote a new product that is expected to return$600,000 one year from today and then grow at an annual rate of 5% for each of the next 4 years. If the firm's cost of capital is 14%, should marketing be given the money? A)No, because the internal rate of return is greater than the cost of capital B)Yes, because it will bring in $762,815.63 over the initial $2 million C)No, because the net present value is -$131,181.85 D)Yes, because the net present value is $423,522.48

C)No, because the net present value is -$131,181.85

Which of the following investment decision rules tends to improperly reject long-lived projects? A)Net present value B)Profitability index C)Payback period D)Internal rate of return

C)Payback period

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

C)The IRR must be greater than 0.

In simple cases when hard capital rationing exists, projects may be evaluated by : A)mutually exclusive IRRs. B)the modified internal rate of return. C)a profitability index. D)the payback period.

C)a profitability index.

As the discount rate is increased, the NPV of a specific project will: A)increase. B)remain constant. C)decrease. D)decrease to zero, then remain constant.

C)decrease.

Soft capital rationing is imposed upon a firm from ________ sources, while hard capital rationing is imposed from________ sources. A)external; external B)external; internal C)internal; external D)internal; internal

C)internal; external

If the IRR for a project is 15%, then the project's NPV would be: A)positive at a discount rate of 20%. B)positive at a discount rate of 15%. C)negative at a discount rate of 20%. D)negative at a discount rate of 10%.

C)negative at a discount rate of 20%.

According to the NPV rule, all projects should be accepted if NPV is positive when discounted at the: A)internal rate of return. B)accounting rate of return. C)opportunity cost of capital. D)risk-free interest rate.

C)opportunity cost of capital.

Firms that make investment decisions based on the payback rule may be biased toward rejecting projects: A)with late cash inflows. B)with short lives. C)with long lives. D)that have negative NPVs.

C)with long lives.

Which of the following projects would you feel safest in accepting? Assume the opportunity cost of capital to be12% for each project. A)"A" has a small, but negative, NPV. B)"B" has a positive NPV when discounted at 10%. C)"C" has a cost of capital that exceeds its rate of return. D)"D" has a zero NPV when discounted at 14%.

D)"D" has a zero NPV when discounted at 14%.

What is the NPV for the following project cash flows at a discount rate of 15%? CF0 = -$1,000, CF1 = $700, CF2 = $700. A)$308.70 B)($138.00) C)($308.70) D)$138.00

D)$138.00

What is the maximum that should be invested in a project at time zero if the inflows are estimated at $35,000 annually for 6 years? Assume a 9% cost of capital. A)$189,200.15 B)$210,000.00 C)$101,251.79 D)$157,007.15

D)$157,007.15

The project in the table results in a negative NPV and should be rejected. If a cash inflow could be added at the end of year 4, what is the minimum amount it would need to be in order to produce a positive NPV? Assume a cost of capital of 12.5%. Cash Flow - Amount Initial - -$50,000 End of Year 1 - $10000 End of Year 2 - $20000 End of Year 3 - $30000 A)$8,436.29 B)$5,666.67 C)$12,842.75 D)$6,789.56

D)$6,789.56

What is the total net present value (NPV) provided to the firm by your recommendations? A)$90,208.29 B)$104,909.67 C)$86,007.90 D)$71,306.51

D)$71,306.51

Which of the following statements is true for a project with a $38,000 initial cost, cash inflows of $11,000 per year for 6 years, and a discount rate of 15%? A)Its NPV is $3,635. B)Its IRR is 18.53%. C)Its profitability index is 0.0959. D)Its payback occurs in year 4.

D)Its payback occurs in year 4.

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

D)The project should be rejected.

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

D)a negative NPV.

If two projects offer the same positive NPV, then they: A)also have the same return. B)must have the same initial cost. C)have the same project life. D)add the same amount of value to the firm.

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

Use of a profitability index to evaluate mutually exclusive projects in the absence of capital rationing: A)will provide the same rankings as an NPV criterion. B)is technically impossible. C)will maximize NPV, but not IRR. D)can result in misguided selections.

D)can result in misguided selections.

If a project has a cost of $50,000 and a profitability index of 2, then: A)it has a negative NPV. B)its NPV could be positive or negative depending on the cost of capital. C)its cash flow is $100,000. D)it has a positive NPV.

D)it has a positive NPV.

The profitability index selects projects based on the: A)highest internal rate of return. B)largest dollar investment per rate of return. C)highest net discounted value at time zero. D)largest return per dollar invested.

D)largest return per dollar invested.

When mutually exclusive projects have different lives, the project that should be selected will have the: A)highest NPV, discounted at the opportunity cost of capital. B)highest IRR. C)longest life. D)lowest equivalent annual cost.

D)lowest equivalent annual cost.