Question 1

Aroma Candles,Inc.is evaluating a project with the following cash flows.Calculate the IRR of the project.(Round to the nearest whole percentage. )

Accepted Answer

The answer of Aroma Candles,Inc.is evaluating a project with the...

Question 2

Whenever the IRR on a project equals that project's required rate of return,

Accepted Answer

When the IRR on a project equals that project's required rate of return, it means that the project is just meeting its minimum required rate of return. Therefore, the NPV of the project will be exactly zero, indicating that the present value of the future cash flows generated by the project equals the initial cost of the project. This is because if the NPV were positive, the IRR would be higher than the required rate of return, and if the NPV were negative, the IRR would be lower than the required rate of return. Therefore, the correct answer is (A) the NPV equals 0.

Question 3

A new forklift under consideration by Home Warehouse requires an initial investment of $100,000 and produces annual cash flows of $50,000,$40,000,and $30,000.Which of the following will not change if the required rate of return is increased from 10% to 12%.

Accepted Answer

The internal rate of return (IRR) will not change because it is based solely on the cash inflows and outflows of the investment and not on the required rate of return. However, the net present value (NPV), profitability index (PI), and modified internal rate of return (MIRR) will all change as these are affected by changes in the required rate of return.

Question 4

The director of capital budgeting of South Park Development Corporation is evaluating a project that will cost $200,000;it is expected to last for 10 years and produce after-tax cash flows,including depreciation,of $44,503 per year.If the firm's cost of capital is 14% and its tax rate is 40%,what is the project's IRR?

Accepted Answer

To calculate the Internal Rate of Return (IRR) of the project, we need to find the discount rate that makes the present value of the cash inflows equal to the initial investment of $200,000.

Using a financial calculator or Excel, we find that the IRR of the project is 18.16%. Since this is higher than the cost of capital of 14%, the project is acceptable and will add value to the firm.

Therefore, the best choice is C) 18%.

Question 5

Which of the following series of cash flows could have more than one IRR? (Negative cash flows are in parentheses. )

Accepted Answer

Series of cash flows with at least one negative cash flow, like option B, can have more than one IRR. This is because the negative cash flow can be financed in different ways, which will affect the calculation of the IRR. Options A, C, and D have all positive cash flows, so they can only have one IRR.

Question 6

Kannan Enterprise has a project with an initial outlay of $40,000,followed by three years of annual incremental cash flows of $35,000.The terminal cash flow of the project is $10,000.Assuming a discount rate of 10%,which of the following is the correct equation to solve for the IRR of the project?

Accepted Answer

The IRR is found by setting the present value of cash inflows equal to the initial outlay. The correct equation discounts each cash flow by (1+IRR) raised to the power of the year number.

Question 7

MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000.The project will generate after-tax cash flows of $33,100 in Year 1,$31,500 in Year 2,and $31,200 in Year 3.Assume that the firm's proper rate of discount is 10% and that the firm's tax rate is 40%.What is the project's payback?

Accepted Answer

The payback period is the time it takes for the project to recover its initial investment from its cash inflows. Here, the cumulative cash flow at the end of Year 1 is $33,100, at the end of Year 2 is $64,600 ($33,100 + $31,500), and at the end of Year 3 is $95,800 ($64,600 + $31,200). The initial investment of $75,000 is recovered between Year 2 and Year 3. To find the exact payback period: at the end of Year 2, $64,600 has been recovered, leaving $10,400 ($75,000 - $64,600) to be recovered in Year 3. The cash flow in Year 3 is $31,200, so the fraction of the year needed to recover the remaining $10,400 is $10,400 / $31,200 = 0.33 years. Therefore, the total payback period is 2 years + 0.33 years = 2.33 years.

Question 8

Project Ell requires an initial investment of $50,000 and the produces annual cash flows of $30,000,$25,000,and $15,000.Project Ess requires an initial investment of $60,000 and then produces annual cash flows of $25,000 per year for the next ten years.The company ranks projects by their payback periods.

Accepted Answer

The payback period for Ell is calculated by dividing the initial investment of $50,000 by the annual cash flows of $30,000, $25,000, and $15,000. The payback period for Ell is 2 years and 8 months.

The payback period for Ess is calculated by dividing the initial investment of $60,000 by the annual cash flow of $25,000. The payback period for Ess is 2 years and 6 months.

Since Ell has a shorter payback period than Ess, Ell will be ranked higher than Ess according to the payback method. Choice D is the correct answer.

Question 9

Aroma Candles,Inc.is evaluating a project with the following cash flows.The project involves a new product that will not affect the sales of any other project.Which two methods would always lead to the same accept/reject decision for this project,regardless of the discount rate.

Accepted Answer

The answer of Aroma Candles,Inc.is evaluating a project with the...

Question 10

Use the following information to answer the following question(s).
Below are the expected after-tax cash flows for Projects Y and Z.Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.
 
-Payback for Project Y is:

Accepted Answer

The answer of Use the following information to answer the...

Question 11

Use the following information to answer the following question(s).
Below are the expected after-tax cash flows for Projects Y and Z.Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.
 
-What is payback for Project Z?

Accepted Answer

Payback for Project Z is two years, which means that the original investment will be recovered in two years from the start of the project. This is a relatively short payback period, making it a good investment option. Option B would be even better, but it is not available. Options C and D are not correct because Project Z will eventually pay back the investment, so there is a payback period.

Question 12

MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000.The project will generate after-tax cash flows of $33,100 in Year 1,$31,500 in Year 2,and $31,200 in Year 3.Assume that the appropriate discount rate is 10% and that the firm's tax rate is 40%.What is the project's discounted payback period?

Accepted Answer

The discounted payback period is calculated by discounting the future cash flows back to their present value and then determining how long it takes for these discounted cash flows to pay back the initial investment. Here's the calculation:1. Discount the cash flows at the 10% discount rate:   - Year 1: $33,100 / (1 + 0.10)^1 = $30,090.91   - Year 2: $31,500 / (1 + 0.10)^2 = $26,033.06   - Year 3: $31,200 / (1 + 0.10)^3 = $23,283.192. Calculate the cumulative discounted cash flows:   - End of Year 1: $30,090.91   - End of Year 2: $30,090.91 + $26,033.06 = $56,123.97   - End of Year 3: $56,123.97 + $23,283.19 = $79,407.163. Determine the payback period:   - The initial investment of $75,000 is recovered between Year 2 and Year 3. To find the exact time, we see that at the end of Year 2, we have recovered $56,123.97. We need to recover the remaining $18,876.03 ($75,000 - $56,123.97) in Year 3. The discounted cash flow in Year 3 is $23,283.19, so we calculate the fraction of the year needed to recover the remaining amount: $18,876.03 / $23,283.19 ≈ 0.81 years.Adding this to the 2 years, the discounted payback period is approximately 2.81 years.

Question 13

Frazier Fudge has a project with an initial outlay of $40,000,followed by three years of annual incremental cash flows of $35,000.The terminal cash flow of the project is $10,000.Assuming a cost of capital of 10%,calculate the MIRR of the project.

Accepted Answer

MIRR is calculated as the IRR of the terminal value of the project's cash flows, divided by the IRR of the initial investment. In this case, the terminal value of the project's cash flows is $10,000, and the IRR of the initial investment is 10%. Therefore, the MIRR of the project is 10% / 10% = 100%.

Question 14

We-Know-Widgets,Inc.is analyzing a project that requires an initial investment of $10,000,followed by cash inflows of $1,000 in Year 1,$4,000 in Year 2,and $15,000 in Year 3.The cost of capital is 10%.What is the profitability index of the project?

Accepted Answer

The profitability index (PI) is calculated as the present value of future cash inflows divided by the initial investment. The present value of cash inflows is $1,000/(1+0.10)^1 + $4,000/(1+0.10)^2 + $15,000/(1+0.10)^3 = $909.09 + $3,305.79 + $11,282.64 = $15,497.52. The PI is $15,497.52 / $10,000 = 1.55.

Question 15

The owner of a small construction business has asked you to evaluate the purchase of a new front end loader.You have determined that this investment has a large,positive,NPV,but are afraid that your client will not understand the method.A good alternative method in this circumstance might be

Accepted Answer

The payback method is a simple and easy-to-understand method for evaluating investment projects. It calculates the length of time required for an investment to recuperate its initial cost. This method does not provide information on the profitability of the investment, but it can help the owner of the small construction business to understand how quickly they can recover their initial investment in the front end loader. Additionally, it may provide some confidence in the investment decision, as a shorter payback period suggests that the investment is less risky.

Question 16

Use the following information to answer the following question(s).
Below are the expected after-tax cash flows for Projects Y and Z.Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.
 
-Discounted payback for Project Y is:

Accepted Answer

Discounted payback period accounts for the time value of money and is the time it takes for the present value of cash inflows to cover the initial investment. In this case, it is 3.14 years.

Question 17

You are considering investing in a project with the following year-end after-tax cash flows:
Year 1: $5,000
Year 2: $3,200
Year 3: $7,800
If the initial outlay for the project is $12,113,compute the project's IRR.

Accepted Answer

The answer of You are considering investing in a project...

Question 18

Analysis of a machine indicates that it has a cost of $5,375,000.The machine is expected to produce cash inflows of $1,825,000 in Year 1;$1,775,000 in Year 2;$1,630,000 in Year 3;$1,585,000 in Year 4;and $1,650,000 in Year 5.What is the machine's IRR?

Accepted Answer

To find the IRR, we need to calculate the discount rate at which the present value of cash inflows equals the cost of the machine. Using a financial calculator or spreadsheet, the IRR for this machine is approximately 17.81%. Therefore, choice B is the correct answer.

Question 19

The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000 per year in Years 1 through 4,$35,000 per year in Years 5 through 9,and $40,000 in Year 10.This investment will cost the firm $150,000 today,and the firm's cost of capital is 10%.Assume cash flows occur evenly during the year,1/365th each day.What is the discounted payback period for this investment?

Accepted Answer

The discounted payback period is the time it takes for the present value of cash flows to cover the initial investment. By discounting each cash flow at 10% and summing them, the investment is recovered in approximately 4.86 years.

Question 20

Project H requires an initial investment of $100,000 and produces annual cash flows of $50,000,$40,000,and $30,000.Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000,$40,000,and $50,000.The projects are mutually exclusive.The company accepts projects with payback periods of 3 years or less.

Accepted Answer

To determine which project(s) to accept, we first need to calculate the payback period for each project. The payback period is the amount of time it takes for the initial investment to be fully recouped by the annual cash flows.

For Project H:
Year 1: $50,000
Year 2: $40,000
Year 3: $30,000

Payback period = 3 years

For Project T:
Year 1: $30,000
Year 2: $40,000
Year 3: $50,000

Payback period = 3 years

Since both projects have a payback period of 3 years or less, we need to next compare their profitability using the net present value (NPV) method or internal rate of return (IRR) method. However, since we are only given the initial investment and cash flows for each project and not the required rate of return or discount rate, we are unable to perform this calculation. Therefore, the best choice based on the given information is to accept Project H since it meets the company's criteria for payback period.

Quiz 11: Investment Decision Criteria