Question 1

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 the difference between the present value of cash inflows and the present value of cash outflows. In this case, the initial investment of $5,000 is a cash outflow, while the present value of cash flows is $4,000. If the required rate of return is greater than the discount rate used to determine the present value of the cash flows, then the NPV will be negative. Therefore, the NPV calculation would be:

NPV = -$5,000 + $4,000 = -$1,000

Thus, the best choice is A) -$1,000.

Question 2

What is the NPV for the following 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 cost. The total inflows are $6,700,000, so NPV = $6,700,000 - $5,000,000 = $1,700,000.

Question 3

What is the NPV for the following project if its cost of capital is 15 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

The NPV is calculated by discounting the cash inflows at the cost of capital and subtracting the initial investment. The NPV is negative, approximately ($137,053).

Question 4

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 5

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

Accepted Answer

This statement accurately describes the internal rate of return (IRR) as a capital budgeting technique. The IRR is the discount rate at which the present value of a project's cash inflows equals the present value of its cash outflows. It is a sophisticated technique because it takes into account the time value of money and considers all of the project's cash flows, not just the initial investment and final payoff.

Question 6

The investment operating schedule is the difference between an investment's net operating profit after taxes and the cost of funds used to finance the investment, which is found by multiplying the dollar amount of the funds used to finance the investment by the firm's weighted average cost of capital.

Accepted Answer

The description provided is for the concept of Economic Value Added (EVA), not the "investment operating schedule." EVA measures a company's financial performance by calculating the value created beyond the required return of the company's shareholders.

Question 7

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

Accepted Answer

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

Question 8

If its IRR is greater than 0 percent, a project should be accepted.

Accepted Answer

A project should be accepted if its IRR is greater than the required rate of return or cost of capital, not just greater than 0 percent.

Question 9

What is the NPV for the following 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

To calculate the NPV, we need to discount each of the cash flows to their present value using the cost of capital of 12%. Using the formula for NPV, we get:

NPV = -Initial Cost + PV of Cash Flow Year 1 + PV of Cash Flow Year 2 + PV of Cash Flow Year 3 + PV of Cash Flow Year 4

NPV = -$5,000,000 + $1,606,958 + $1,564,537 + $1,200,254 - $3,692,085

NPV = -$1,320,336

Therefore, the NPV of the project is -$1,320,336, which means the project is not profitable and should not be undertaken. Option A is the correct answer, and no other choices are correct.

Question 10

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

Accepted Answer

The IRR (Internal Rate of Return) is indeed the compound annual rate of return that a firm can expect to earn if they invest in a project and receive the estimated cash inflows.

Question 11

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

Accepted Answer

The projects with the highest net present values should be accepted. In this case, Projects 1 and 2 have positive net present values, while Project 3 has a negative net present value. Therefore, the firm should accept Projects 1 and 2 and reject Project 3. Option A is the correct answer.

Question 12

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

Accepted Answer

The technique described is called the Internal Rate of Return (IRR), not Net Present Value (NPV). NPV calculates the difference between the present value of inflows and outflows, while IRR finds the discount rate that makes them equal.

Question 13

A firm would 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 expected cash inflows and outflows would cancel each other out, resulting in no gain or loss. However, the project would maintain the current wealth of the firm's owners. Therefore, the firm would still accept the project as it does not decrease their wealth.

Question 14

If its IRR is greater than $0.00, a project should be accepted.

Accepted Answer

A project should be accepted if its IRR is greater than the required rate of return or the cost of capital, not just greater than $0.00.

Question 15

An internal rate of return greater than the cost of capital guarantees that the firm earns at least its required return. Investing in such an project would enhance the market value of the firm and therefore the wealth of its owners.

Accepted Answer

When the internal rate of return is greater than the cost of capital, it means the project is generating returns higher than the cost of borrowing. This surplus generates a return for the shareholders, thus enhancing the market value of the firm and the wealth of the owners.

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

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 called the cost of capital. This is the required rate of return that a company needs to earn in order to maintain its current value and satisfy its investors. It reflects the cost of financing the project through a combination of debt and equity, and is often used as a benchmark for evaluating investment opportunities. The other options listed, internal rate of return, interest rate, and compound rate, are relevant factors in financial analysis, but they do not determine the minimum required return for a project to maintain the firm's value.

Question 18

Sophisticated capital budgeting techniques do not

Accepted Answer

Sophisticated capital budgeting techniques do not use net profits as a measure of return because net profits do not take into account the time value of money or the risk associated with the investment. Instead, they use more comprehensive metrics such as net present value (which explicitly considers the time value of money), internal rate of return (which implicitly considers the time value of money), and discounted cash flow analysis (which takes into account an unconventional cash flow pattern).

Question 19

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 20

If its IRR is greater than the cost of capital, a project should be accepted.

Accepted Answer

If the internal rate of return (IRR) of a project is greater than the cost of capital, it means that the project is generating returns that exceed its cost of financing. Therefore, accepting the project would create value for the company and increase its overall profitability. On the other hand, if the IRR is less than the cost of capital, it would imply that the project is not generating enough returns to cover its financing costs, and accepting it would decrease the company's profitability.

Quiz 10: Capital Budgeting Techniques