Deck 4: A First Encounter With Capital Budgeting Rules

Question 1

The internal rate of return evaluation technique assumes that the cash flows can be reinvested at

A)the project's IRR.
B)the risk-free rate of interest.
C)the firm's cost of capital.
D)the project's hurdle rate.

Answer 1

the project's IRR.

Question 2

A project will cost $250,000 and is expected to produce a single cash flow of $275,000 two years after the initial investment is made. What is this project's IRR? Round your answer to the
Nearest tenth of a percent.

A)10.0%
B)4.9%
C)6.6%
D)none of the above

Answer 2

4.9%

Question 3

A project is expected to produce equal annual cash flows of $16,883 a year for five years after the initial investment. If the required rate of return is 10%, at what maximum investment level
Will the project add value to the firm?

A)The initial investment must be less than $64,000.
B)The initial investment must be less than $84,415.
C)The initial investment must be less than $79,812.
D)This cannot be determined without knowing the internal rate of return of the project.

Answer 3

The initial investment must be less than $64,000.

Question 4

Which of the following statements regarding estimation errors in calculating NPVs is correct?

A)For short-term projects, an error in estimating the appropriate cost of capital will result in a much larger error in the NPV than the same percentage error in estimating the cash
Flows.
B)For long-term projects, an error in estimating the cash flows will result in a much larger error in the NPV than the same percentage error in the cost of capital.
C)For short-term projects, an error in estimating the cash flows will result in a much larger error in the NPV than the same percentage error in the cost of capital.
D)For long-term projects, it is more difficult to estimate the appropriate cost of capital to use than it is to estimate cash flows that are expected to occur in the distant future.

Question 5

The Jacobi Project requires an initial cash outlay of $75,000 and is expected to produce net cash flows of $20,000 at the end of each year of its 5-year life. If the required return on the project is
10%, what is its net present value? Round your answer to the nearest dollar.

A)$25,000
B)$62,582
C)$12,418
D)none of the above

Question 6

Project Target will cost the Dart Corporation $65,000. It is expected to produce net cash flows of $15,000 a year for 10 years. The required return on the project is 8%. What is its net present
Value, to the nearest dollar?

A)$4,479
B)$85,000
C)$73,889
D)$35,651

Question 7

Which of the following statements regarding net present value is (are)true?

A)Both positive and negative NPV projects are extremely scarce.
B)You should take all the positive NPV projects that are available only as long as you have the available cash to do so.
C)You should reassess your inputs if you determine that a project under consideration has a positive NPV since positive NPV projects are rare.
D)All of the above are true statements.

Question 8

A project's cash flows are discounted at the appropriate cost of capital of 10%. The net present value of the project is determined to be zero. This means that

A)the project offers a return of 10%.
B)undertaking the project will result in a decrease in firm value.
C)undertaking the project will result in an increase in firm value.
D)the project offers a return of 0%.

Question 9

Explain why it is that positive NPV projects should be accepted and negative ones
rejected.

Question 10

Project Epsilon requires an initial cash outlay of $20,000 and is expected to produce net cash flows of $5,000, $8,000, and $10,000 in years one, two, and three, respectively. If the required
Rate of return on the project is 12%, what is its net present value? Round your answer to the
Nearest dollar.

A)+$2,162
B)-$3,629
C)+$3,000
D)-$2,040

Question 11

Another name for the internal rate of return is the

A)benefit-cost ratio
B)capital recovery ratio
C)cost of capital
D)yield-to-maturity

Question 12

A project requires an initial cash outflow of $80,000. The investment is expected to produce net cash inflows of $15,000 each year for eight years. The internal rate of return on this investment
To the nearest tenth of a percent is

A)6.7%.
B)10.0%.
C)18.8%.
D)50.0%.

Question 13

Which of the following statements is necessarily true if the NPV of a project is determined to be negative?

A)The discount rate used to calculate the NPV was too high.
B)The cost of capital used to calculate the NPV is equal to the project's internal rate of return.
C)The cost of capital used to calculate the NPV is greater than the project's internal rate of return.
D)The cost of capital used to calculate the NPV is less than the project's internal rate of return.

Question 14

The ID project will cost $8,500,000 and is expected to produce cash flows of $2 million, $2.5 million, $3 million, and $3.5 million at the end of each of the following four years. Calculate
The project's IRR to the nearest tenth of a percent.

A)10.1%
B)11.4%
C)11.0%
D)12.3%

Question 15

A project will cost $35,000. It is expected to return $10,250 in years one through six and
$17,750 in year seven. If the appropriate hurdle rate is 18%, should the project be
undertaken? Explain.

Question 16

A particular investment requires an initial cash outflow of $110,000. The investment is expected to produce net cash flows of $20,000, $25,000, $30,000, $38,000, and $50,000 in years
One, two, three, four, and five, respectively. To the nearest tenth of a percent, the internal rate
Of return on this investment is

A)67.5%.
B)48.2%.
C)12.5%.
D)No IRR exists for these cash flows.

Question 17

The internal rate of return on a project

A)is the discount rate that, when applied to a project's cash flows, causes the net present value of the project to be zero.
B)will always be greater than the opportunity cost of capital.
C)will always be greater than zero.
D)All of the above are true statements.

Question 18

Project Hush will cost the Lullaby Company $26,000. The project is expected to generate net cash flows of $7,244 a year for six years. What is the project's IRR? Round your answer to the
Nearest tenth of a percent.

A)3.6%
B)17.0%
C)27.9%
D)6.0%

Question 19

A project will cost $100,000 and is expected to produce a single cash flow of $118,000 at the end of one year. To the nearest tenth of a percent, the IRR of this project is

A)18.0%.
B)11.8%.
C)8.5%.
D)none of the above.

Question 20

The net present value evaluation technique will always lead to a wealth-maximizing decision except when

A)choosing between mutually exclusive projects that have different cash flow patterns.
B)a firm does not have the cash available to invest today.
C)choosing between mutually exclusive projects that require different investment outlays.
D)The net present value technique will always result in a wealth-maximizing decision if the inputs are correct.

Question 21

The Acorn Project will require an initial cash outflow of $25,000. The project is
expected to return $8,000, $10,000, and $14,000 in years one, two, and three,
respectively. The project has a required rate of return of 15%. Use the internal rate of
return evaluation technique to determine whether or not this project should be
accepted. Explain your answer.

Question 22

What decision should be made regarding each of the following two independent projects if the appropriate cost of capital is 12%?

A)Project A should be undertaken since it represents an investment that offers a rate of return that exceeds the cost of capital.
B)Both projects should be undertaken since both projects offer a return that is greater than the cost of capital.
C)Project B should be rejected since it represents a borrowing situation; therefore, the IRR can be interpreted as the cost of borrowing, and this exceeds the cost of capital.
D)Both B and C are correct choices.

Question 23

A project that costs $12,000 today is expected to produce $35,000 at the end of the first
year. It is expected
that the cash flow at the end of year 2 will be -$25,000. Two IRRs can be calculated:
25% and 66.67%. If the firm's cost of capital is 10%, should the project be undertaken?

Question 24

Project Jupiter requires an initial investment of $100,000 and is expected to produce cash flows of $15,582 a year for the following 10 years. The project's NPV at the estimated cost of capital
Of 7.5% is $6,956. How high can the project's hurdle rate be before this project would no longer
Be acceptable? Round your answer to the nearest tenth of a percent.

A)It can be no greater than 8.5%.
B)It can be no greater than 7.5%.
C)It can be no greater than 9.0%.
D)It can be no greater than 7.0%.

Question 25

Which of the following statements regarding projects with no IRR or multiple IRRs is true?

A)Projects with no IRR should always be rejected since they offer no return.
B)A project with multiple IRRs should be accepted as long as at least one of the IRRs exceeds the cost of capital.
C)A project with multiple IRRs should be accepted so long as all of the IRRs exceed the cost of capital.
D)None of the above statements is true.

Question 26

A Treasury security that matures in one year has a face value of $10,000 and sells for $9,300. What is its yield-to-maturity, to the nearest tenth of a percent?

A)9.3%
B)7.5%
C)5.5%
D)7.0%

Question 27

What potential problem can arise when choosing between two bond investments by
comparing their yields-to-maturity?

Question 28

Which of the following statements is necessarily true?

A)If two projects are mutually exclusive, the one with the higher internal rate of return should be selected so long as its internal rate of return is greater than the cost of capital for
The firm.
B)If the internal rate of return of a project is equal to its required rate of return, the project will have a positive NPV.
C)If the internal rate of return of a project is greater than 0, the project will also have a positive NPV.
D)If the internal rate of return of a project is less than its required rate of return, the project should always be rejected.

Question 29

A 9%, semiannual, level-coupon Treasury note will mature in 6 years , at which point it will repay its principal of $5,000. The note is currently selling for $5,746.55. What is its true
Yield-to-maturity?

A)9.0%
B)6.0%
C)6.4%
D)6.1%

Question 30

Calculate the yield-to-maturity of a zero-coupon bond that costs $650 today and will pay $1,000 at the end of five years. Round your answer to the nearest tenth of a percent.

A)8.6%
B)9.0%
C)5.4%
D)none of the above

Question 31

Project A has a profitability index of 0.85. Project B has a profitability index of 1.24. The two projects are independent. Which of the following statements is (are)true?

A)Only Project B should be accepted since it is the only one of the two projects that will maximize value.
B)Both projects should be accepted since they are independent and each one has a profitability index greater than zero.
C)Both Project A and Project B will have net present values that are greater than zero.
D)Both A and C are true statements.

Question 32

Which of the following statements about the profitability index evaluation technique is true?

A)When used to compare projects, the profitability index evaluation technique will tend to favor those projects with lower initial investment requirements.
B)If a project has a profitability index greater than zero, it should be accepted.
C)It is most useful when evaluating mutually exclusive projects.
D)All of the above statements are true.

Question 33

Project Thor requires an initial investment of $50,000 and is expected to offer cash flows of $20,000 a year for the following three years. This project will be profitable, so long as the
Discount rate is

A)less than the cost of capital.
B)greater than the risk-free rate.
C)less than 9.7%.
D)greater than 10%.

Question 34

In which of the following scenarios will the IRR always provide you with the correct, wealth-maximizing decision?

A)Whenever you are evaluating an independent project--i.e., one that is not affected by the acceptance or rejection of another project.
B)When you are evaluating mutually exclusive projects that have different investment requirements.
C)When you are evaluating a single project that requires an initial cash outflow followed by positive cash flows in subsequent years.
D)The IRR will provide you with the correct, wealth-maximizing decision in all of the above situations.

Question 35

A $20,000, level-coupon Eurobond pays interest annually at the coupon rate of 6% and repays the principal value when it matures in 5 years. If it is currently selling for $18,403, what is its
Yield-to-maturity? Round your answer to the nearest tenth of a percent.

A)7.7%
B)6.0%
C)8.0%
D)4.8%

Question 36

The following information is provided for projects X and Y: Note that a discrepancy exists between the NPV and IRR rankings. Why does this
discrepancy occur? Which project should be undertaken if the required return for each
project is 5%?

Question 37

A level-coupon bond has a yield-to-maturity of 10%. In order for an investor to be assured an average annual yield of 10% on his investment in the bond, which of the following is NOT
Necessary?

A)The investor must reinvest all the coupon payments he receives at 10%.
B)The issuer must not default or be late with its payments.
C)The investor must hold the bond until it matures.
D)All of the above are necessary to insure the investor earns an average annual return of 10% on this investment.

Question 38

A project will cost $20,000 and is expected to produce cash flows of $10,000, $8,000, and $5,000 at the end of each of the first three years, respectively. If the cost of capital is 7%, what is the
Project's profitability index? Round your answer to the nearest hundredth.

A)1.02
B)0.02
C)0.98
D)1.15

Question 39

Two mutually exclusive projects have the following expected cash flows, net present values, and internal rates of return: If the appropriate discount rate is 15%, which project should be undertaken and why?

A)Project B since its initial investment is returned in the first year and can then be invested in another project
B)Project B since its IRR is higher than that of Project A
C)Project A since it has the higher net present value of the two projects
D)Project B since its total cash inflows are more than twice the cost of the project, whereas Project A's cash inflows are just twice the initial investment.

Question 40

Which of the following is an advantage of the IRR?

A)The IRR is the easiest to calculate of all the capital budgeting techniques.
B)The IRR will always lead to a wealth-maximizing decision as long as the inputs are correct.
C)The IRR can be calculated even if the appropriate cost of capital is unknown.
D)Both A and B are advantages of the IRR.

Question 41

Which of the following statements is necessarily true?

A)If the profitability index is equal to 1.0, the net present value of the project is equal to 0.
B)If the profitability index is equal to 0, the net present value of the project is also 0.
C)If the profitability index is equal to 0, the internal rate of return is equal to the hurdle rate.
D)If the profitability index is equal to 1.0, the internal rate of return is greater than the hurdle rate.

Question 42

In practice, what evaluation techniques are most often used to make capital budgeting
decisions? Do these techniques lead to value maximization? Explain.

Question 43

The Carter project has a net present value of $6,000. Its only cash outflow is its cost of $8,000. The profitability index is

A)1.75
B)1.33.
C)2.33
D)0.75.

Question 44

Which of the following set of calculations must be erroneous if the required rate of return is 12%?

A)Project C
B)Project A
C)Project B
D)Project D

Question 45

Which of the following set of calculations must be erroneous if the required rate of return for all the projects is 10%?

A)Project C
B)Project B
C)Project D
D)Project A

Question 46

Consider the following mutually exclusive projects, all of which have a 12% required
return. Which project should be undertaken? Why?

Question 47

Consider the following three mutually exclusive projects: If the appropriate cost of capital is 10% for all three projects, which project should be undertaken?

A)Project C since it has the highest IRR
B)Project B since it has the higher payback period
C)Project A since it has the highest NPV
D)A correct decision cannot be made unless the actual cash flows from each project are known.

Question 48

Which of the following is not considered to be an advantage associated with the payback evaluation technique?

A)It is helpful in assessing future liquidity if a firm has limited capital resources.
B)It takes time value of money into consideration.
C)It is simple to calculate and understand.
D)All of the above are advantages of the payback evaluation technique.

Question 49

Project Bertha requires an initial cost outlay of $5,200 and is expected to produce cash flows of $2,000 at the end of the following three years. If the hurdle rate is 10%, should the project be
Undertaken?

A)Yes. The profitability index
B)Yes. The profitability index
C)No. The profitability index
D)No. The profitability index

Question 50

Which of the following statements about the payback period evaluation technique is true?

A)Since cash flows received in the future are less certain than cash flows received today, the payback period technique takes risk into consideration.
B)The payback period evaluation technique will always lead to the same decision as the net present value technique if the post-payback duration is zero.
C)The payback period technique favors investments that return large cash flows in the initial years of the investment's life.
D)Both A and C are true statements.

Question 51

What evaluation technique attempts to compare your project's earnings to the earnings of other firms?

A)internal rate of return
B)accounting rate of return
C)earning multiples
D)profitability index

Question 52

Project Kappa will cost $80,000 and is expected to pay back $20,000, $30,000, $25,000, $25,000, $10,000, and $10,000 at the end of each of the following six years. What is its payback period?

A)2 years
B)5 years
C)4 years
D)3 years

Question 53

The payback period of Project A is 2 years while that of Project B is 4 years. Which of the following statements is true?

A)Project B must be riskier than Project A since it has a longer payback period.
B)The IRR for Project A will be higher than that of Project B since Project A offers a quicker return on its investment.
C)Project A should be chosen since it will increase value sooner than will Project B.
D)None of the above is a true statement.

Question 54

A certain project has a net present value of $3,200. The only cash outflow is the initial investment of $17,000. What is the project's profitability index? Round your answer to the
Nearest hundredth.

A)1.23
B)0.19
C)1.19
D)0.81

Question 55

Project Mars' only cash outlay is its cost of $15,000. The project has a net present value of $18,000. Its profitability index is

A)1.83.
B)0.55.
C)1.20.
D)2.20.

Question 56

Which of the following capital budgeting techniques is most favored by CFOs?

A)payback period
B)internal rate of return
C)profitability index
D)P/E ratios

Question 57

Two projects have the following projected cash flows:
Refer to the information above. Which one would be selected if the payback evaluation
technique were used? Will this necessarily be a value-maximizing decision?

Question 58

Two projects have the following projected cash flows:
Refer to the information above. Assume that the appropriate discount rate for both
projects is 10%. Calculate the profitability index for each project. Which, if either,
project should be undertaken based on your calculations? If the projects are mutually
exclusive, can you choose between them using this method? Why or why not?

Question 59

Project A has a net present value of $1,500, a payback period of 2 years, and an internal rate of return of 12%. Project B has a net present value of $1,800, a payback period of 4 years, and an
Internal rate of return of 10%. Project C has a net present value of $1,750, a payback period of 3
Years, and an internal rate of return of 11%. If the projects are mutually exclusive, which
Project should be undertaken?

A)Project B and Project C are equally acceptable since each would increase firm value by the same amount.
B)Project C because it has an NPV that is only slightly less than that of Project B and offers a higher IRR and a shorter payback period than Project B.
C)Project A because it has a higher IRR than the other two projects and pays back in the shortest period of time.
D)Project B because it has the highest NPV of the three projects.

Question 60

The Thunderstruck Corporation paid $130,000 for an asset. The asset is expected to generate end-of-year cash flows of $50,000, $50,000, $32,000, $28,000, and $25,000 in years one through
Five, respectively. Calculate the payback period for the project, assuming all the cash flows
From the project occur at the end of the year.

A)3 years
B)1 year
C)2 years
D)4 years