Question 1

The money that a business spends in the course of business can be divided into two categories:

Accepted Answer

The answer of The money that a business spends in...

Question 2

A project is expected to last ten years with an initial cost of $10,000.00. Assuming the present value payback method produces a value of 7.25 years and there are no additional costs beyond the initial cost, the PI is ____.

Accepted Answer

Since the present value payback period is less than the project's life, it is profitable. Moreover, since the initial cost of the project is $10,000 and the present value payback period is less than the project life, the PV of future cash inflows should be greater than $10,000. Therefore, the project’s profitability index (PI) would be greater than 1.0.

Question 3

A project has an initial cost of $20,000.00 and no another costs throughout the life of the project. Assuming the project has a PI of 1.23, the IRR is ____.

Accepted Answer

The IRR (Internal Rate of Return) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. The Profitability Index (PI) is calculated by dividing the present value of future cash flows by the initial investment. A PI greater than 1 indicates that the NPV is positive, which happens when the IRR is greater than the discount rate used to calculate the NPV. Therefore, if a project has a PI of 1.23, it means the project is expected to generate a return greater than the cost of capital (discount rate), implying the IRR is greater than the discount rate.

Question 4

The first step in capital budgeting is to:

Accepted Answer

The first step in capital budgeting is to reduce the project to a series of cash flows, which involves estimating the total cash inflows and outflows associated with the project over its entire life. This is necessary to determine the profitability of the project and its potential to create value for the company.

Question 5

You are considering the following 2 mutually exclusive projects. Using the equivalent annual annuity method and a cost of capital of 10%, which project should be selected? (Round to nearest $)

Accepted Answer

The answer of You are considering the following 2 mutually...

Question 6

A project having a payback period of 4.73 years implies ____.

Accepted Answer

The payback period only tells us how long it takes for the initial investment to be recovered. It does not give any information about the NPV. Therefore, we cannot determine anything about the NPV based on the payback period alone.

Question 7

You are considering the following two mutually exclusive projects. Using the replacement chain approach and a cost of capital of 10%, calculate the NPV of Project A. (Round to nearest $)

Accepted Answer

The answer of You are considering the following two mutually...

Question 8

If a project's present value payback period equals the length of the project, then ____.

Accepted Answer

If the present value payback period equals the length of the project, it means that the project's cash inflows will fully recover the initial investment at the end of the project. This implies that the project's NPV is zero, which is calculated as the sum of the present value of cash inflows minus the present value of cash outflows. Option A is incorrect because a positive NPV indicates that the project is profitable, while option C is incorrect because a PI less than 1.0 implies that the project's benefits do not exceed the costs. Option D is redundant as it is already stated in the question stem.

Question 9

Projects fit into the following three categories:

Accepted Answer

Projects are commonly categorized into replacement (to replace old or inefficient assets), expansion (to increase capacity or enter new markets), and new ventures (to explore new opportunities or products).

Question 10

A project generates a revenue of $100.00 today for a service to be performed one year from today at a cost of $110.00. Which discount rate will make the NPV greater than zero?

Accepted Answer

To calculate the NPV, we need to discount the future cash flow at a specific rate. The formula for NPV is:

NPV = CF/(1+r)^n - C

Where CF is the cash flow, r is the discount rate, n is the time period, and C is the cost.

In this case, CF is $100, C is $110, and n is 1 year.

Using trial and error method:

At 8% APR, NPV = $100/(1+0.08) - $110 = -$4.63
At 9% APR, NPV = $100/(1+0.09) - $110 = -$3.67
At 10% APR, NPV = $100/(1+0.1) - $110 = -$2.73
At 11% APR, NPV = $100/(1+0.11) - $110 = -$1.81

Therefore, at 11% APR, the NPV becomes positive and greater than zero, indicating that this is the minimum discount rate required to make the project financially viable.

Question 11

If the IRR of a project is equal to the discount rate of the project then ____.

Accepted Answer

If the IRR of a project is equal to the discount rate of the project, it means that the NPV of the project is zero. This is because the discount rate is the rate at which the project's future cash flows are being discounted to their present value, and the IRR is the rate at which the project's NPV is equal to zero. Therefore, if the IRR is equal to the discount rate, the project's NPV is zero.

Question 12

The following projects are all characterized by a single initial cash outflow (the initial investment) followed by a series of cash inflows. Rank them based on profitability index. $\begin{array}{lll} 
& \text { Irvestment } & \text { NPV } \
\text { Project A } & \$ 160,000 & \$ 30,000 \
\text { Project B } & \$ 120,000 & \$ 15,000 \
\text { Project C } & \$ 110,000 & \$ 25,000 \
\text { Project D } & \$ 200,000 & \$ 40,000
\end{array}$

Accepted Answer

The profitability index (PI) is calculated as (NPV + Initial Investment) / Initial Investment. Calculating for each project: A: 1.1875, B: 1.125, C: 1.2273, D: 1.2. Ranking them gives C, D, A, B.

Question 13

The future cash flows of a stand-alone capital project are: $\begin{array}{lllll}
\text { Year } & 0 & 1 & 2 & 3&4 \
\text { Cash flow } & (\$ 4,000) & \$ 1,500 & \$1,500 & \$ 1,500&\$1,500
\end{array}$ If the firm's cost of capital is 12%, which of the following statements is true?

Accepted Answer

The NPV is positive because the IRR is greater than the cost of capital (12%). The IRR is approximately 18.5%, which is the discount rate that makes the NPV of the cash flows equal to zero.

Question 14

Capital budgeting involves:

Accepted Answer

Capital budgeting involves the process of planning and justifying how capital dollars are spent on long-term projects. It involves evaluating and selecting projects based on their potential to generate cash flows and contribute to the overall growth and profitability of the company. B, C, and D are not accurate descriptions of capital budgeting.

Question 15

The projected cash flows for two mutually exclusive projects are as follows: $\begin{array}{lll}
\text { Year }&\text { Project A }&\text {  Project B } \0 & (\$ 150,000) & (\$ 200,000) \
1 & 80,000 & 40,000 \
2 & 60,000 & 50,000 \
3 & 50,000 & 50,000 \
4 & & 60,000 \
5 & & 50,000 \
6 & & 53,000
\end{array}$ If the firm's cost of capital is 10% and the equivalent annual annuity method is used to eliminate the disparity between the projects' lives, which project should be undertaken?

Accepted Answer

The answer of The projected cash flows for two mutually...

Question 16

What is the Equivalent Annual Annuity (EAA) of a project that has an initial outlay of $2,500 followed by cash inflows of $1,000, $3,000 and $5,000 in years 1, 2 & 3 respectively? Assume a cost of capital of 11%. (Round to nearest $)

Accepted Answer

The answer of What is the Equivalent Annual Annuity (EAA)...

Question 17

If a project has a negative NPV, then ____.

Accepted Answer

A negative NPV indicates that the project's expected cash outflows outweigh its expected cash inflows when discounted to their present value, meaning the project is not generating sufficient returns to cover its cost of capital. This implies a PI less than one, as the project is generating less value than it costs. The payback period and present value payback period do not directly reflect the project's profitability or value compared to its cost of capital, so A and B are incorrect.

Question 18

If a project has an initial cost of $50,000.00 and no other costs throughout the life of the project, what is the PI for the project given the NPV is $3,620.00?

Accepted Answer

PI (Profitability Index) = (Present value of future cash flows / Initial investment)

Given that the initial cost is $50,000 and the NPV is $3,620, we can calculate the present value of future cash flows as:

Present value of future cash flows = NPV + Initial investment = $3,620 + $50,000 = $53,620

Therefore, the PI can be calculated as:

PI = $53,620 / $50,000 = 1.072

The closest answer choice is B.

Question 19

Project A has annual cash flows of $200.00 for the next three years. Project B has annual cash flows of $100.00 for the next three years and then annual cash flows of $500.00 for the following four years. Assuming both projects have an initial cost of $500.00, which project is better based on the payback period criteria?

Accepted Answer

The payback period criteria is the amount of time it takes to recover the initial cost of the project from its cash flows. Project A has a payback period of 2.5 years ($500 initial cost / $200 annual cash flows). Project B has a payback period of 3 years for the first three years ($500 initial cost / $100 annual cash flows), and then an additional 2 years to recover the cost of the remaining cash flows ($500 initial cost / ($500 - $100) annual cash flows), for a total payback period of 5 years. Therefore, Project A has a shorter payback period and is the better choice based on this criteria.

Question 20

What is the IRR for a project that has an initial cost of $400.00 and produces a revenue of $452.00 one year from today? (Hint: calculate the return on the investment)

Accepted Answer

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

Quiz 10: Capital Budgeting