Question 1

The minimum return that must be earned on a project in order to leave the firm's value unchanged is ________.

Accepted Answer

The minimum return that must be earned on a project in order to leave the firm's value unchanged is the cost of capital. This is because the cost of capital is the minimum rate of return that a company must earn on its investments in order to satisfy its investors and maintain its current stock price.

Question 2

An internal rate of return greater than the cost of capital guarantees that the firm will earn at least its required return.

Accepted Answer

If the internal rate of return is greater than the cost of capital, it means the project is generating returns higher than what the firm needs to earn to satisfy its investors. Therefore, the firm will earn at least its required return.

Question 3

If a project's IRR is greater than the cost of capital,the project should be rejected.

Accepted Answer

If a project's IRR is greater than the cost of capital, it is considered a profitable project and should be accepted.

Question 4

What is the NPV for a project if its cost of capital is 0 percent and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1,$1,900,000 in year 2,$1,700,000 in year 3,and $1,300,000 in year 4?

Accepted Answer

When the cost of capital is 0 percent, the NPV is simply the sum of the cash inflows minus the initial investment. Summing the inflows gives $1,800,000 + $1,900,000 + $1,700,000 + $1,300,000 = $6,700,000. Subtracting the initial investment of $5,000,000 from this sum gives an NPV of $1,700,000.

Question 5

The IRR is the compounded annual rate of return that a firm will earn if it invests in a project and receives the estimated cash inflows.

Accepted Answer

This is the definition of Internal Rate of Return (IRR).

Question 6

The IRR is the discount rate that equates the NPV of an investment opportunity with $0.

Accepted Answer

This is the definition of the internal rate of return (IRR).

Question 7

Which of the following is an advantage of NPV?

Accepted Answer

NPV takes into account the time value of investors' money, which means it considers the fact that money today is worth more than the same amount of money in the future due to the effects of inflation and potential investment returns. This makes NPV a more accurate measure of a project's profitability compared to other methods that do not consider the time value of money.

Question 8

What is the NPV for a project whose cost of capital is 15 percent and initial after-tax cost is $5,000,000 and is expected to provide after-tax operating cash inflows of $1,800,000 in year 1,$1,900,000 in year 2,$1,700,000 in year 3,and $1,300,000 in year 4?

Accepted Answer

The answer of What is the NPV for a project...

Question 9

A sophisticated capital budgeting technique that can be computed by solving for the discount rate that equates the present value of a project's inflows to the present value of its outflows is called net present value.

Accepted Answer

The description provided refers to the Internal Rate of Return (IRR), not the Net Present Value (NPV). NPV is calculated by discounting the cash flows at a specific rate and then subtracting the initial investment.

Question 10

A firm is evaluating an investment proposal which has an initial investment of $5,000 and cash flows presently valued at $4,000.The net present value of the investment is ________.

Accepted Answer

The net present value (NPV) is calculated by subtracting the initial investment from the present value of cash flows. Here, NPV = $4,000 - $5,000 = -$1,000.

Question 11

If a project's IRR is greater than zero,the project should be accepted.

Accepted Answer

A project's IRR should be compared to the cost of capital or the required rate of return. If the IRR is greater than the cost of capital, then the project should be accepted. An IRR greater than zero simply means the project is expected to generate some return, but that return may still be insufficient if it is below the cost of capital.

Question 12

A firm is evaluating three capital projects.The net present values for the projects are as follows:  The firm should ________.

Accepted Answer

The firm should accept projects with positive NPVs.

Project 1: NPV = $880,000 
Project 2: NPV = $740,000 
Project 3: NPV = -$100,000

Therefore, the firm should accept projects 1 and 2 which have positive NPVs and reject project 3 which has a negative NPV. Hence the answer is A).

Question 13

A firm can accept a project with a net present value of zero because ________.

Accepted Answer

A project with a net present value of zero means that the project's cash inflows and outflows are equal, resulting in no added wealth or earnings for the firm's owners. However, accepting the project would still maintain the current level of wealth for the firm's owners, making it a viable option.

Question 14

What is the NPV for a project if its cost of capital is 12 percent and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1,$1,900,000 in year 2,$1,700,000 in year 3,and ($1,300,000)in year 4?

Accepted Answer

Calculating the present value of the after-tax cash flows:
Year 1: $1,800,000/(1+0.12)^1 = $1,607,143
Year 2: $1,900,000/(1+0.12)^2 = $1,435,772
Year 3: $1,700,000/(1+0.12)^3 = $1,150,357
Year 4: ($1,300,000)/(1+0.12)^4 = ($684,269)

NPV = -$5,000,000 + $1,607,143 + $1,435,772 + $1,150,357 - $684,269 = -$1,494,336

Therefore, the best choice is A, as the NPV is negative, indicating that the project does not generate enough value to cover its cost of capital.

Question 15

The internal rate of return (IRR)is defined as the discount rate that equates the net present value with the initial investment associated with a project.

Accepted Answer

The internal rate of return (IRR) is defined as the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.

Question 16

Table 10.2 
-Given the information in Table 10.2 and 15 percent cost of capital,
(a)compute the net present value.
(b)should the project be accepted?

Accepted Answer

The answer of Table 10.2 
-Given the information in Table...

Question 17

Table 10.1 
-Given the information in Table 10.1 and 15 percent cost of capital,
(a)compute the net present value.
(b)should the project be accepted?

Accepted Answer

The answer of Table 10.1 
-Given the information in Table...

Question 18

If a project's IRR is greater than 0 percent,the project should be accepted.

Accepted Answer

A project's IRR should be compared to the cost of capital or the required rate of return, not just 0 percent. If the IRR exceeds the cost of capital, then the project can be considered for acceptance.

Question 19

What is the profitability index of a project that has an initial cash outflow of $600,an inflow of $250 for the next 3 years and a cost of capital of 10 percent?

Accepted Answer

To calculate the profitability index, we need to sum up the present value of all the cash inflows and divide that by the initial cash outflow.

PV of inflows = $250/(1+10%) + $250/(1+10%)^2 + $250/(1+10%)^3 = $610.09

Profitability index = PV of inflows / Initial cash outflow
= $610.09 / $600
= 1.036

Therefore, the answer is C. The profitability index of the project is 1.036, which means that for every dollar invested, the project will return $1.036. This is greater than 1, which makes the project a good investment.

Question 20

A sophisticated capital budgeting technique that can be computed by solving for the discount rate that equates the present value of a project's inflows to the present value of its outflows is called internal rate of return.

Accepted Answer

The statement accurately describes the internal rate of return (IRR) capital budgeting technique.

Quiz 10: Capital Budgeting Techniques