Question 1

Would you invest in a project that has a net investment of $14,600 and a single net cash flow of $24,900 in 5 years, if your required rate of return was 12 percent?

Accepted Answer

NPV = $24,900(0.567) - $14,600 = -$481.70

Question 2

When evaluating international capital expenditure projects, the analyst may compute the present value of the net cash flows in the local currency and then .

Accepted Answer

The answer of When evaluating international capital expenditure projects, the...

Question 3

Entrepreneurial firms with a net worth of less than $1 million tend to prefer the method for evaluating capital expenditures.

Accepted Answer

Entrepreneurial firms with a net worth of less than $1 million tend to prefer the payback method for evaluating capital expenditures because it is a simple and straightforward method. Payback method helps entrepreneurs to calculate how long it will take to recover the invested amount, and it is easy to understand for individuals with less financial knowledge. It is also useful when funds are limited, and a quick return on investment is necessary to keep the business running. Other methods like NPV and IRR require more complex financial analysis, and Profitability index is more appropriate for comparing different investment opportunities. Therefore, Payback method is the best choice for entrepreneurial firms with a limited net worth.

Question 4

What is the net present value of a project that requires a net investment of $76,000 and produces net cash flows of $22,000 per year for 7 years? Assume the cost of capital is 15 percent.

Accepted Answer

NPV = $22,000(4.160) - $76,000 = $15,520

Question 5

An investment project requires a net investment of $100,000 and is expected to generate annual net cash inflows of $25,000 for 6 years.The firm's cost of capital is 12 percent.Determine the profitability index for this project.

Accepted Answer

PI = [$25,000(PVIFA₀.₁₂,₆)]/$100,000 = [$25,000(4.111)]/$100,000 = 1.028

Question 6

Using the profitability index, which of the following mutually exclusive projects should be accepted?
Project A: NPV = $6,000;NINV = $50,000
Project B: NPV = $10,000;NINV = $120,000
Project C: NPV = $8,000;NINV = $80,000

Accepted Answer

PIA = $56/$50 = 1.12
PIB = $130/$120 = 1.08
PIC = $88/$80 = 1.1
Therefore, choose project A

Question 7

Capital expenditures levels tend (in real terms) during periods of relatively high inflation than during low inflation times.

Accepted Answer

During periods of high inflation, the cost of capital increases, and uncertainty about future costs and revenues can lead businesses to reduce capital expenditures.

Question 8

What is the internal rate of return for a project that has a net investment of $150,000 and net cash flows of $40,000 for 5 years?

Accepted Answer

PVIFAᵣ,₅ = $150,000/$40,000 = 3.750, therefore, IRR is between 10% and 11% (from Table IV)

Question 9

An investment project requires a net investment of $100,000.The project is expected to generate annual net cash inflows of $28,000 for the next 5 years.The firm's cost of capital is 12 percent.Determine the payback period for the project.

Accepted Answer

PB = $100,000/$28,000 = 3.57 years

Question 10

GoFlo is a small growing firm that is considering the purchase of another truck to serve GoFlo's expanding customer base.The new truck will cost $21,000 and should generate annual net cash flows of $6,000 over the truck's 5-year life.What is the payback period for this project?

Accepted Answer

PB = $21,000/$6,000 = 3.5 years

Question 11

The reasons that the amount and timing of the net cash flows to the foreign subsidiary and parent may differ include:

Accepted Answer

All of the choices (subsidized loans, differential tax rates, and legal and political constraints on cash remittance) can affect the amount and timing of the net cash flows to the foreign subsidiary and parent. For example, a foreign subsidiary may receive subsidized loans with lower interest rates, which could result in more cash inflows for the subsidiary but not necessarily for the parent. Additionally, differential tax rates can affect the amount and timing of cash flows between the subsidiary and parent. Lastly, legal and political constraints on cash remittance, such as restrictions on currency exchange and repatriation of funds, impact the timing of cash flows between the subsidiary and parent. Therefore, all of the choices could be the reasons for the differences in the amount and timing of net cash flows.

Question 12

A project requires a net investment of $450,000.It has a profitability index of 1.25 based on the firm's 12 percent cost of capital.Determine the net present value of the project.

Accepted Answer

PI = PV of NCF/NINV = 1.25 = PV of NCF/$450,000
PV of NCF = $562,500
NPV = PV of NCF - NINV = $562,500 - $450,000 = $112,500

Question 13

Sigma is thinking about purchasing a new clam digger for $14,000.The expected net cash flows resulting from the digger are $9,000 in year 1, $7,000 in the 2nd year, $5,000 in the 3rd year, and $3,000 in the 4th year.Should Sigma purchase this digger if its cost of capital is 12 percent?

Accepted Answer

NPV = $9,000(0.893) + $7,000(0.797) + $5,000(0.712) + $3,000(0.636) - $14,000 = $5,084

Question 14

The Atlantic Company plans to open a new branch office in a suburban area.The building will cost $200,000 and will be depreciated (on a straight-line basis) over a 20 year life to a $0 estimated salvage value.Equipment for the building will cost an additional $100,000.This equipment has a 20-year life and will be depreciated on a straight-line basis to a $0 estimated salvage value.The branch office is expected to generate additional before tax net income of $30,000 per year.The tax rate is 40 percent and the cost of capital is 12 percent.Compute the net present value for the project.

Accepted Answer

NPV = $300,000/20 = 15,000
$30,000 × .60 = 18,000
$33,000(PVIFA₀.₁₂,₂₀) - $300,000 = -$53,523

Question 15

An investment project requires a net investment of $100,000.The project is expected to generate annual net cash inflows of $28,000 for the next 5 years.The firm's cost of capital is 12 percent.Determine the net present value for the project.

Accepted Answer

NPV = 28,000(PVIF₀.₁₂,₅) - 100,000 = $28,000(3.605) - 100,000 = $940

Question 16

What is the internal rate of return for a project that has a net investment of $76,000 and net cash flows of $20,507 per year for 7 years?

Accepted Answer

PVIFAᵣ,₇ = $76,000/$20,507 = 3.706
Therefore, IRR = 19% from Table IV

Question 17

Generally, the existence of a(n) option reduces the downside risk of a project and should be considered in project analysis.

Accepted Answer

Abandonment options allow a company to abandon a project if it does not perform as expected or if market conditions change. Including this option in project analysis helps to reduce the downside risk of a project, making it a valuable consideration.

Question 18

Turntec is considering replacing an automatic shuttle machine that has a book value of $2,000 and a $0 market value with a more efficient machine that will cost $24,000.The annual net cash flows from the new equipment are expected to be $6,000 for the next 6 years.What is the net present value of this project? Assume the firm's cost of capital is 12 percent and its marginal tax rate is 40 percent.

Accepted Answer

NPV = -$24,000 + $2000(.4) + $6,000(4.111) = $1,466

Question 19

What is the internal rate of return for a project that has a net investment of $14,600 and a single net cash flow of $25,750 in 5 years?

Accepted Answer

PVIFᵣ,₅ = $14,600/$25,750 = 0.567
Therefore, IRR = 12% from Table II

Question 20

An investment project requires a net investment of $100,000.The project is expected to generate annual net cash inflows of $28,000 for the next 5 years.The firm's cost of capital is 12 percent.Determine the internal rate of return for the project (to the nearest tenth of one percent).

Accepted Answer

$100,000/$28,000 = 3.571
From Table IV, PVIFAᵣ,₅ = 3.571, which falls between 3.605 (12%) and 3.517 (13%).
r = 12.38% (calculator) or 12.4% (rounded)

Quiz 10: Capital Budgeting: Decision Criteria and Real Option Considerations