Question 1

An investment's average net income divided by its average book value defines the average:
A) Net present value.
B) Internal rate of return.
C) Accounting return.
D) Profitability index.
E) Payback period.

Accepted Answer

The average accounting return is calculated by dividing an investment's average net income by its average book value.

Question 2

The average accounting return (AAR) rule can be best stated as:
A) An investment is acceptable if its AAR is less than a target AAR.
B) An investment is acceptable if its AAR exceeds a target AAR.
C) An investment is acceptable if its AAR exceeds the firm's return on equity (ROE).
D) An investment is acceptable if its AAR is less than the firm's return on assets (ROA).

Accepted Answer

The average accounting return (AAR) rule states that an investment is considered acceptable if its AAR is greater than a specified target AAR, making it a benchmark for investment decisions.

Question 3

Ginny Trueblood is considering an investment which will cost her $120,000. The investment produces no cash flows for the first year. In the second year the cash inflow is $35,000. This inflow will increase to $55,000 and then $75,000 for the following two years before ceasing permanently. Ginny requires a 10 % rate of return and has a required discounted payback period of three years. Ginny should _____ this project because the discounted payback period is _____
A) Accept; 2.03 years.
B) Accept; 2.97 years.
C) Accept; 3.97 years.
D) Reject; 3.03 years.
E) Reject; 3.97 years.

Accepted Answer

The discounted payback period is 3.97 years, which exceeds Ginny's required period of three years, so she should reject the project.

Question 4

The profitability index (PI) rule can be best stated as:
A) An investment is acceptable if its PI is greater than one.
B) An investment is acceptable if its PI is less than one.
C) An investment is acceptable if its PI is greater than the internal rate of return (IRR).
D) An investment is acceptable if its PI is less than the net present value (NPV).
E) An investment is acceptable if its PI is less than its payback.

Accepted Answer

The profitability index (PI) rule states that an investment is considered acceptable if its PI is greater than one. This indicates that the present value of future cash flows is greater than the initial investment, suggesting a profitable investment.

Question 5

Capital budgeting decisions generally:
A) Have long-term effects on a firm.
B) Are of short-duration.
C) Are easy to revise once implemented.
D) Focus solely on whether or not a particular asset should be purchased.
E) Have minimal effects on a firm's operations.

Accepted Answer

Capital budgeting decisions are significant for a firm because they typically involve large expenditures, have long-term effects on the firm's operations, and are not easily reversible. These decisions can influence the firm's growth, profitability, and strategic direction for years to come.

Question 6

The net present value (NPV) rule can be best stated as:
A) An investment should be accepted if, and only if, the NPV is exactly equal to zero.
B) An investment should be rejected if the NPV is positive and accepted if it is negative.
C) An investment should be accepted if the NPV is positive and rejected if it is negative.
D) An investment with greater cash inflows than cash outflows, regardless of when the cash flows occur, will always have a positive NPV and therefore should always be accepted.
E) An investment should be accepted if it equals its depreciation value.

Accepted Answer

The NPV rule states that an investment is considered favorable and should be accepted if its NPV is positive, indicating that the present value of its cash inflows exceeds the present value of its cash outflows. Conversely, if the NPV is negative, the investment should be rejected.

Question 7

The internal rate of return (IRR) rule can be best stated as:
A) An investment is acceptable if its IRR is exactly equal to its net present value (NPV).
B) An investment is acceptable if its IRR is exactly equal to zero.
C) An investment is acceptable if its IRR is less than the required return, or else it should be rejected.
D) An investment is acceptable if its IRR exceeds the required return, or else it should be rejected.
E) An investment is acceptable if its IRR exceeds its depreciation rate.

Accepted Answer

The internal rate of return (IRR) rule states that an investment is considered acceptable if its IRR is greater than the required rate of return. The IRR is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. If the IRR is above the required return, it means the project is expected to generate a return higher than the cost of capital, making it a worthwhile investment.

Question 8

Shawn's Health Care is considering a project which will produce sales of $1.7 million a year for the next ten years. The profit margin is estimated at 8 %. The project will cost $2.9 million and will be depreciated straight-line to a zero book value over the life of the project. Shawn's has a required accounting return of 9 %. This project should be _____ because the AAR is _____.
A) Accepted; 8.44 %
B) Accepted; 9.38 %
C) Accepted; 9.82 %
D) Rejected; 8.44 %
E) Rejected; 9.38 %

Accepted Answer

The answer of Shawn's Health Care is considering a project...

Question 9

Which one of the following methods of analysis is most applicable to those situations where small dollar, short-term, independent projects are evaluated by low level managers on a daily basis?
A) Net present value.
B) Internal rate of return.
C) Accounting rate of return.
D) Payback.
E) Profitability index.

Accepted Answer

The payback method is most suitable for evaluating small dollar, short-term, independent projects on a daily basis by low-level managers because it is simple and focuses on how quickly the initial investment can be recovered, which is often a priority in such scenarios.

Question 10

The discounted payback rule can be best stated as:
A) An investment is acceptable if its discounted payback period is greater than some pre-specified number of years.
B) An investment should be accepted if the discounted payback is positive and rejected if it is negative.
C) An investment should be rejected if the discounted payback is positive and accepted if it is negative.
D) An investment is acceptable if its discounted payback period is less than some pre-specified number of years.

Accepted Answer

The discounted payback rule states that an investment is considered acceptable if the period it takes for the discounted cash flows to pay back the initial investment is less than a pre-specified number of years. This method takes into account the time value of money by discounting the cash flows, unlike the simple payback period method.

Question 11

Which of the following decision rules has the advantage that the information needed for the calculation is readily available?
A) Net present value
B) Internal rate of return
C) Average accounting return
D) Payback period
E) Discounted payback

Accepted Answer

The average accounting return (AAR) uses accounting information that is typically readily available from financial statements, making it easier to calculate compared to other methods that require cash flow projections or discount rates.

Question 12

The payback method:
A) Entails difficult computations.
B) Is prejudiced towards short-term projects.
C) Always applies a ten year cut-off point for cash flows.
D) Adjusts for the risk level inherent in a project.
E) Is generally used only for large projects.

Accepted Answer

The payback method is biased towards short-term projects because it focuses on how quickly the initial investment can be recovered, without considering the cash flows that occur after the payback period.

Question 13

Which of the following decision rules is best for evaluating projects for which cash flows beyond a specified point in time, and the time value of money, can both be ignored?
A) Payback.
B) Net present value.
C) Average accounting return.
D) Profitability index.
E) Internal rate of return.

Accepted Answer

The Payback method is best for evaluating projects when cash flows beyond a specified point in time and the time value of money can both be ignored, as it simply measures the time it takes for the initial investment to be repaid by the project's cash inflows, without discounting those cash flows.

Question 14

The payback period is defined as the length of time it requires for an investment to generate sufficient cash flows to recoup:
A) The required rate of return on the investment.
B) The initial cost of the investment.
C) All of the initial cost plus the ongoing maintenance costs of the fixed assets required by the investment.
D) Both the initial cost of the investment and the amount needed to provide the required rate of return.
E) The future value of the initial cost of the investment.

Accepted Answer

The payback period is specifically defined as the duration it takes for an investment to generate enough cash flows to recover the initial cost of the investment. It does not account for the required rate of return, ongoing maintenance costs, or the future value of the initial investment.

Question 15

The payback rule can be best stated as:
A) An investment is acceptable if its calculated payback period is less than some pre-specified number of years.
B) An investment should be accepted if the payback is positive and rejected if it is negative.
C) An investment should be rejected if the payback is positive and accepted if it is negative.
D) An investment is acceptable if its calculated payback period is greater than some pre-specified number of years.
E) An investment is acceptable if its calculated payback period is equal to its deprecation useful life.

Accepted Answer

The payback rule states that an investment is considered acceptable if the period it takes to recover the initial investment is less than a predetermined number of years. This rule focuses on the time it takes for cash inflows to repay the initial investment cost.

Question 16

All else equal, the payback period for a project will decrease whenever the:
A) Initial cost increases.
B) Required return for a project increases.
C) Assigned discount rate decreases.
D) Cash inflows are moved forward in time.
E) Duration of a project is lengthened.

Accepted Answer

Moving cash inflows forward in time means the project receives its cash sooner, thus reducing the time it takes to pay back the initial investment.

Question 17

When the present value of the cash inflows exceeds the initial cost of a project, then the project should be:
A) Accepted because the internal rate of return is positive.
B) Accepted because the profitability index is greater than 1.
C) Accepted because the profitability index is negative.
D) Rejected because the internal rate of return is negative.
E) Rejected because the net present value is negative.

Accepted Answer

When the present value of cash inflows exceeds the initial cost of a project, it means the project generates a return greater than the cost, leading to a profitability index greater than 1, indicating the project is financially viable and should be accepted.

Question 18

The __________ decision rule is considered the "best" in principle.
A) Internal rate of return.
B) Payback period.
C) Average accounting return.
D) Net present value.
E) Profitability index.

Accepted Answer

The Net Present Value (NPV) decision rule is considered the "best" in principle because it directly measures the increase in value to the firm, taking into account the time value of money and all cash flows associated with the investment.

Question 19

Which one of the following statements concerning net present value (NPV) is correct?
A) An investment should be accepted if, and only if, the NPV is exactly equal to zero.
B) An investment should be accepted only if the NPV is equal to the initial cash flow.
C) An investment should be accepted if the NPV is positive and rejected if it is negative.
D) An investment with greater cash inflows than cash outflows, regardless of when the cash flows occur, will always have a positive NPV and therefore should always be accepted.
E) Any project that has positive cash flows for every time period after the initial investment should be accepted.

Accepted Answer

NPV is calculated by summing the present value of all cash inflows and outflows of a project. If the NPV is positive, it means that the project's expected cash inflows are higher than its expected cash outflows, and therefore the project is expected to generate a profit. On the other hand, if the NPV is negative, it means that the project's expected cash outflows are higher than its expected cash inflows, and therefore the project is expected to generate a loss. Therefore, an investment should be accepted if the NPV is positive and rejected if it is negative.

Question 20

Which one of the following statements is correct concerning the payback period?
A) An investment is acceptable if its calculated payback period is less than some pre-specified period of time.
B) An investment should be accepted if the payback is positive and rejected if it is negative.
C) An investment should be rejected if the payback is positive and accepted if it is negative.
D) An investment is acceptable if its calculated payback period is greater than some pre-specified period of time.
E) An investment should be accepted any time the payback period is less than the discounted payback period, given a positive discount rate.

Accepted Answer

The payback period is a capital budgeting method that calculates the time required for an investment to generate cash flows to recover its initial cost. An investment is considered acceptable if its payback period is less than a pre-specified period, as this indicates a quicker recovery of the invested funds.

Quiz 9: Net Present Value and Other Investment Criteria

An investment's average net income divided by its average book value defines the average:

The average accounting return (AAR) rule can be best stated as:

The profitability index (PI) rule can be best stated as:

Capital budgeting decisions generally:

The net present value (NPV) rule can be best stated as:

The internal rate of return (IRR) rule can be best stated as:

Which one of the following methods of analysis is most applicable to those situations where small dollar, short-term, independent projects are evaluated by low level managers on a daily basis?

The discounted payback rule can be best stated as:

Which of the following decision rules has the advantage that the information needed for the calculation is readily available?

The payback method:

Which of the following decision rules is best for evaluating projects for which cash flows beyond a specified point in time, and the time value of money, can both be ignored?

The payback period is defined as the length of time it requires for an investment to generate sufficient cash flows to recoup:

The payback rule can be best stated as:

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

When the present value of the cash inflows exceeds the initial cost of a project, then the project should be:

The __________ decision rule is considered the "best" in principle.

Which one of the following statements concerning net present value (NPV) is correct?

Which one of the following statements is correct concerning the payback period?