Deck 13: Capital Budgeting

Question 1

Which of the following statements is correct?

A) The discounted payback is generally shorter than the regular payback.
B) Any type of project might have multiple rates of return if the IRR is sufficiently high.
C) The NPV and IRR methods can lead to conflicting accept/reject decisions only if (1) mutually exclusive projects are being evaluated and (2) if the projects' NPV profiles cross at a rate less than the firm's required rate of return.
D) The NPV and IRR methods can lead to conflicting accept/reject decisions only if (1) mutually exclusive projects are being evaluated and (2) if the projects' NPV profiles cross at a rate greater than the firm's required rate of return.
E) None of the above is a correct statement.

Answer 1

The NPV and IRR methods can lead to conflicting accept/reject decisions only if (1) mutually exclusive projects are being evaluated and (2) if the projects' NPV profiles cross at a rate less than the firm's required rate of return.

Question 2

When a project's NPV exceeds zero,

A) The project will also be acceptable using payback criteria.
B) The IRR should be calculated to insure that the project's projected rate of return exceeds the required rate of return.
C) The project should be accepted without any further consideration, assuming we are confident that the cash flows and the required rate of return have been properly estimated.
D) Only answers a and c are correct.
E) None of the above is correct.

Answer 2

The project should be accepted without any further consideration, assuming we are confident that the cash flows and the required rate of return have been properly estimated.

Question 3

Risk in a revenue producing project can best be adjusted for by

A) Ignoring it.
B) Adjusting the discount rate upward for increasing risk.
C) Adjusting the discount rate downward for increasing risk.
D) Picking a risk factor equal to the average discount rate.
E) Reducing the NPV by 10 percent for risky projects.

Answer 3

Adjusting the discount rate upward for increasing risk.

Question 4

Which of the following statements is correct?

A) Because discounted payback takes account of the required rate of return, a project's discounted payback is normally shorter than its regular payback.
B) The NPV and IRR methods use the same basic equation, but in the NPV method the discount rate is specified and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found.
C) If the required rate of return is less than the crossover rate for two mutually exclusive projects' NPV profiles, a NPV/IRR conflict will not occur.
D) If you are choosing between two projects which have the same life, and if their NPV profiles cross, then the smaller project will probably be the one with the steeper NPV profile.
E) If the required rate of return is relatively high, this will favor larger, longer-term projects over smaller, shorter-term alternatives because it is good to earn high rates on larger amounts over longer periods.

Question 5

The post-audit is used to

A) Improve cash flow forecasts.
B) Stimulate management to improve operations and bring results into line with forecasts.
C) Eliminate potentially profitable but risky projects.
D) All of the above are correct.
E) Only answers a and b are correct.

Question 6

When evaluating a new project, the firm should consider all of the following factors except:

A) Changes in working capital attributable to the project.
B) Previous expenditures associated with a market test to determine the feasibility of the project, if the expenditures have been expensed for tax purposes.
C) The current market value of any equipment to be replaced.
D) The resulting difference in depreciation expense if the project involves replacement.
E) All of the above should be considered.

Question 7

Which of the following statements is correct?

A) The NPV method assumes that cash flows will be reinvested at the required rate of return while the IRR method assumes reinvestment at the IRR.
B) The NPV method assumes that cash flows will be reinvested at the risk-free rate while the IRR method assumes reinvestment at the IRR.
C) The NPV method assumes that cash flows will be reinvested at the required rate of return while the IRR method assumes reinvestment at the risk-free rate.
D) The NPV method does not consider the inflation premium.
E) The IRR method does not consider all relevant cash flows, and particularly cash flows beyond the payback period.

Question 8

If the calculated NPV is negative, then which of the following must be true? The discount rate used is

A) Equal to the internal rate of return.
B) Too high.
C) Greater than the internal rate of return.
D) Too low.
E) Less than the internal rate of return.

Question 9

A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk.In evaluating this asset, the decision maker should

A) Increase the IRR of the asset to reflect the greater risk.
B) Increase the NPV of the asset to reflect the greater risk.
C) Reject the asset, since its acceptance would increase the risk of the firm.
D) Ignore the risk differential if the asset to be accepted would comprise only a small fraction of the total assets of the firm.
E) Increase the required rate of return used to evaluate the project to reflect the higher risk of the project.

Question 10

Which of the following capital budgeting methods might not consider the salvage value of a machine being considered for purchase?

A) Internal rate of return.
B) Net present value.
C) Payback.
D) Discounted payback.
E) Answers c and d are both correct.

Question 11

The present value of the expected net cash inflows for a project will most likely exceed the present value of the expected net profit after tax for the same project because

A) Income is reduced by taxes paid, but cash flow is not.
B) There is a greater probability of realizing the projected cash flow than the forecasted income.
C) Income is reduced by dividends paid, but cash flow is not.
D) Income is reduced by depreciation charges, but cash flow is not.
E) Cash flow reflects any change in net working capital, but sales do not.

Question 12

Which of the following is not discussed in the text as a method for analyzing risk in capital budgeting?

A) Sensitivity analysis.
B) Beta, or CAPM, analysis.
C) Monte Carlo simulation.
D) Scenario analysis.
E) All of the above are discussed in the text as methods of analyzing risk in capital budgeting.

Question 13

Which of the following statements is most correct?

A) Sunk costs should be ignored in capital budgeting.
B) Opportunity costs should be ignored in capital budgeting.
C) Externalities should be ignored in capital budgeting.
D) Answers a, b, and c are all correct.
E) Answers a, b, and c are all incorrect.

Question 14

Assume a project has normal cash flows (i.e., the initial cash flow is negative, and all other cash flows are positive).Which of the following statements is most correct?

A) All else equal, a project's IRR increases as the required rate of return declines.
B) All else equal, a project's NPV increases as the required rate of return declines.
C) All else equal, a project's IRR is unaffected by changes in the required rate of return.
D) Answers a and b are both correct.
E) Answers b and c are both correct.

Question 15

Which of the following statements is correct?

A) Capital budgeting analysis for expansion and replacement projects is essentially the same because the types of cash flows involved are the same.
B) In estimating supplemental operating cash flows for the purpose of capital budgeting, interest payments should not be included since the effects of these payments are already included in the rate of return the firm is required to earn from its investments.
C) When equipment is sold, companies receive a tax credit as long as the salvage value is less than the initial cost of the equipment.
D) All of the above answers are correct.
E) None of the above answers is correct.

Question 16

Which of the following statements is correct?

A) If a firm's stockholders are well diversified, we know from theory and from studies of market behavior that corporate risk is not important.
B) Undiversified stockholders, including the owners of small businesses, are more concerned about corporate risk than market risk.
C) Empirical studies of the determinants of required rates of return (r) have found that only market risk affects stock prices.
D) Market risk is important but does not have a direct effect on stock price because it only affects beta.

Question 17

Which of the following is not a cash flow that results from the decision to accept a project?

A) Changes in working capital.
B) Shipping and installation costs.
C) Sunk costs.
D) Opportunity costs.
E) Externalities.

Question 18

Which of the following statements is correct?

A) Capital budgeting analysis for expansion and replacement projects is essentially the same because the types of cash flows involved are the same.
B) The replacement decision involves an analysis of two independent projects where the relevant cash flows include the initial investment, additional depreciation, and the terminal value.
C) The change in working capital for a project is the difference between the required increase in current assets and the spontaneous increase in current liabilities and is always positive.
D) The supplemental operating cash flow for capital budgeting includes return on invested capital, which is net income, and return of part of invested capital, which is depreciation.
E) When a firm implements a project which requires an increase in working capital, both the increase in current assets and current liabilities must be financed.

Question 19

A major disadvantage of the payback period method is that it

A) Is useless as a risk indicator.
B) Ignores cash flows beyond the payback period.
C) Does not directly account for the time value of money.
D) All of the above are correct.
E) Only answers b and c are correct.

Question 20

The underlying cause of ranking conflicts between the NPV and IRR methods is differing

A) Initial cost.
B) Reinvestment rate assumption.
C) Cash flow timing.
D) Profitability indices.
E) All of the above comprise the underlying cause of ranking conflicts.

Question 21

The internal rate of return of a capital investment

A) Changes when the required rate of return changes.
B) Is equal to the annual net cash flows divided by one half of the project's cost when the cash flows are an annuity.
C) Must exceed the required rate of return in order for the firm to accept the investment.
D) Is similar to the yield to maturity on a bond.
E) Answers c and d are both correct.

Question 22

Which of the following statements is false?

A) The NPV will be positive if the IRR is less than the required rate of return.
B) If the multiple IRR problem does not exist, any independent project acceptable by the NPV method will also be acceptable by the IRR method.
C) When IRR = r (the required rate of return), NPV = 0.
D) The IRR can be positive even if the NPV is negative.
E) The NPV method is not affected by the multiple IRR problem.

Question 23

Which of the following statements is correct?

A) An asset that is sold for less than book value at the end of a project's life will generate a loss for the firm and will cause an actual cash outflow attributable to the project.
B) Only incremental cash flows are relevant in project analysis and the proper incremental cash flows are the reported accounting profits because they form the true basis for investor and managerial decisions.
C) It is unrealistic to expect that increases in net working capital that are required at the start of an expansion project are simply recovered at the project's completion.Thus, these cash flows are included only at the start of a project.
D) Equipment sold for more than its book value at the end of a project's life will increase income and, despite increasing taxes, will generate a greater cash flow than if the same asset is sold at book value.
E) All of the above are false.

Question 24

Two mutually exclusive projects each have a cost of $10,000.The total, undiscounted cash flows from Project L are $15,000, while the undiscounted cash flows from Project S total $13,000.Their NPV profiles cross at a discount rate of 10 percent.Which of the following statements best describes this situation?

A) The NPV and IRR methods will select the same project if the required rate of return is greater than 10 percent; for example, 18 percent.
B) The NPV and IRR methods will select the same project if the required rate of return is less than 10 percent; for example, 8 percent.
C) To determine if a ranking conflict will occur between the two projects the required rate of return is needed as well as an additional piece of information.
D) Project L should be selected at any required rate of return, because it has a higher IRR.
E) Project S should be selected at any required rate of return, because it has a higher IRR.

Question 25

Projects L and S each have an initial cost of $10,000, followed by a series of positive cash inflows.Project L has total, undiscounted cash inflows of $16,000, while S has total undiscounted inflows of $15,000.Further, at a discount rate of 10 percent, the two projects have identical NPVs.Which project's NPV will be more sensitive to changes in the discount rate? (Hint: Projects with steeper NPV profiles are more sensitive to discount rate changes.)

A) Project S.
B) Project L.
C) Both projects are equally sensitive to changes in the discount rate since their NPVs are equal at all required rates of return.
D) Neither project is sensitive to changes in the discount rate, since both have NPV profiles which are horizontal.
E) The solution cannot be determined unless the timing of the cash flows is known.

Question 26

Which of the following rules are essential to successful cash flow estimates, and ultimately, to successful capital budgeting?

A) The return on invested capital is the only relevant cash flow.
B) Only incremental cash flows are relevant to the accept/reject decision.
C) Total cash flows are relevant to capital budgeting analysis and the accept/reject decision.
D) All of the above are correct.
E) Only answers a and b are correct.

Question 27

Which of the following statements is correct?

A) A relatively risky future cash outflow should be evaluated using a relatively low discount rate.
B) If a firm's managers want to maximize the value of the stock, they should concentrate exclusively on projects' market, or beta, risk.
C) If a firm evaluates all projects using the same required rate of return to determine NPVs, then the riskiness of the firm as measured by its beta will probably decline over time.
D) If a firm has a beta which is less than 1.0, say 0.9, this would suggest that its assets' returns are negatively correlated with the returns of most other firms' assets.
E) The above statements are all false.

Question 28

Which of the following statements is most correct?

A) Sensitivity analysis is incomplete because it fails to consider the range of likely values of key variables as reflected in their probability distributions.
B) In comparing two projects using sensitivity analysis, the one with the steeper lines would be considered less risky, because a small error in estimating a variable, such as unit sales, would produce only a small error in the project's NPV.
C) The primary advantage of simulation is that it provides a very accurate point estimate of a project's NPV.
D) One important benefit of simulation analysis as compared to scenario analysis, is that once the analysis is complete, it provides a clear accept/reject decision rule.
E) Answers c and d are both correct.

Question 29

In theory, the decision maker should view market risk as being of primary importance.However, within-firm, or corporate, risk is relevant to a firm's

A) Well-diversified stockholders, because it may affect debt capacity and operating income.
B) Management, because it affects job stability.
C) Creditors, because it affects the firm's credit worthiness.
D) All of the above are correct.
E) Only answers a and c are correct.

Question 30

Which of the following statements is correct?

A) Neither "stand-alone" nor "within-firm" risk takes account of diversification, either by stockholders or by the firm.
B) If a project's expected returns are highly correlated with returns on the market, this will tend to reduce the project's market risk.
C) Monte Carlo simulation analysis and sensitivity analysis are similar, but sensitivity analysis is generally harder to use because it requires knowledge of the probability distributions associated with the input variables.
D) Sensitivity analysis requires a project's beta coefficient, which can be obtained by either the "pure play" or the "accounting beta" method.
E) If we are choosing between two mutually exclusive projects which have only costs (no revenues), the riskier one should be evaluated with a lower required rate of return.

Question 31

Which of the following statements is correct?

A) In a capital budgeting analysis where part of the funds used to finance the project are raised as debt, failure to include interest expense as a cost when determining the project's supplemental operating cash flows will lead to an upward bias in the NPV.
B) The preceding statement would be true if "upward" were replaced with "downward."
C) The existence of "externalities" reduces the NPV to a level below the value that would exist in the absence of externalities.
D) If one of the assets that would be used by a potential project is already owned by the firm, and if that asset could be leased to another firm if the project is not undertaken, then the net rent that could be obtained should be charged as a cost (initial investment outlay) to the project under consideration.
E) The rent referred to in statement d is a sunk cost, and as such it should be ignored.

Question 32

If the firm is being operated so as to maximize shareholder wealth, and if our basic assumptions concerning the relationship between risk and return are true, then which of the following should be true?

A) If the beta of the asset is larger than the firm's beta, then the required return on the asset is less than the required return on the firm.
B) If the beta of the asset is smaller than the firm's beta, then the required return on the asset is greater than the required return on the firm.
C) If the beta of the asset is greater than the corporate beta prior to the addition of that asset, then the corporate beta after the purchase of the asset will be smaller than the original corporate beta.
D) If the beta of an asset is larger than the corporate beta prior to the addition of that asset, then the required return on the firm will be greater after the purchase of that asset than prior to its purchase.
E) None of the above is a true statement.

Question 33

Which of the following statements is correct?

A) Large costs occur at the end of nuclear power plants' lives because these plants have to be closed down, and shutdown costs are high due to the difficulty of handling radioactive materials.For this reason, it is possible that a nuclear plant project could have two IRRs.
B) If the Federal Reserve Board lowered interest rates, this would, other things held constant, tend to favor short-term as opposed to long-term projects.
C) For NPV versus IRR ranking conflicts to occur, the projects under consideration must have NPV profiles which cross one another.Crossing profiles can occur only if the two projects differ in the size of the required investment outlay.
D) All of the above statements are false.

Question 34

Assume that you are comparing two mutually exclusive projects.Which of the following statements is most correct?

A) The NPV and IRR rules will always lead to the same decision unless one or both of the projects are "non-conventional" in the sense of having only one change of sign in the cash flow stream, i.e., one or more initial cash outflows (the investment) followed by a series of cash inflows.
B) If a conflict exists between the NPV and the IRR, the conflict can always be eliminated by dropping the IRR and replacing it with the payback period.
C) There will be a meaningful (as opposed to irrelevant) conflict only if the projects' NPV profiles cross, and even then, only if the required rate of return is to the left of (or lower than) the discount rate at which the crossover occurs.
D) Statements a, b, and c are all true.
E) None of the above is a correct statement.

Question 35

Which of the following is not considered a relevant concern in determining incremental cash flows for a new product?

A) The use of factory floor space which is currently unused but available for production of any product.
B) Revenues from the existing product that would be lost as a result of some customers switching to the new product.
C) Shipping and installation costs associated with preparing the machine to be used to produce the new product.
D) The cost of a product analysis completed in the previous tax year and specific to the new product.
E) None of the above (All are relevant concerns in estimating relevant cash flows attributable to a new product project.)

Question 36

Which of the following methods involves calculating an average beta for firms in a similar business and then applying that beta to determine the beta of its own project?

A) Risk premium method.
B) Pure play method.
C) Accounting beta method.
D) CAPM method.
E) Answers b and c are both correct.

Question 37

Which of the following constitutes an example of a cost which is not incremental, and therefore not relevant in an accept/reject decision?

A) A firm has a parcel of land that can be used for a new plant site or, alternatively, can be used to grow watermelons.
B) A firm can produce a new cleaning product that will generate new sales, but some of the new sales will be from customers who switch from another product the company currently produces.
C) A firm orders and receives a piece of new equipment which is shipped across the country and requires $25,000 in installation and set-up costs.
D) All of the above are not examples of incremental cash flows.
E) Answers a, b, and c are examples of incremental, and therefore relevant, cash flows.

Question 38

Suppose the firm's required rate of return is stated in nominal terms, but the project's expected cash flows are expressed in real dollars.In this situation, other things held constant, the calculated NPV would

A) Be correct.
B) Be biased downward.
C) Be biased upward.
D) Possibly have a bias, but it could be upward or downward.
E) More information is needed; otherwise, we can make no reasonable statement.

Question 39

Monte Carlo simulation

A) Can be useful for estimating a project's stand-alone risk.
B) Is capable of using probability distributions for variables as input data instead of a single numerical estimate for each variable.
C) Produces both an expected NPV (or IRR) and a measure of the riskiness of the NPV or IRR.
D) All of the above.
E) Only answers a and b are correct.

Question 40

Regarding the net present value of a replacement decision, which of the following statements is false?

A) The present value of the after-tax cost reduction benefits resulting from the new investment is treated as an inflow.
B) The after-tax market value of the old equipment is treated as an inflow at t = 0 (initial investment outlay).
C) The present value of depreciation expenses on the new equipment, multiplied by the tax rate, is treated as an inflow.
D) Any loss on the sale of the old equipment is multiplied by the tax rate and is treated as an outflow at t = 0 (initial investment outlay).
E) An increase in net working capital is treated as an outflow when the project begins (initial investment outlay) and as an inflow when the project ends (terminal cash flow).

Question 41

Tapley Acquisition Inc.is considering the purchase of Target Company.The acquisition would require an initial investment of $190,000, but Tapley's after-tax net cash flows would increase by $30,000 per year and remain at this new level forever.Assume the required rate of return is 15 percent.Should Tapley buy Target?

A) Yes, because the IRR < the required rate of return (r).
B) Yes, because the NPV = $30,000.
C) Yes, because the NPV = $10,000.
D) No, because r > IRR.
E) No, because NPV < 0.

Question 42

The Target Copy Company is contemplating the replacement of its old printing machine with a new model costing $60,000.The old machine, which originally cost $40,000, has 6 years of expected life remaining and a current book value of $30,000 versus a current market value of $24,000.Target's corporate tax rate is 40 percent.If Target sells the old machine at market value, what is the initial investment outlay (after-tax) for the new printing machine?

A) −$22,180
B) −$30,000
C) −$33,600
D) −$36,000
E) −$40,000

Question 43

The Ace Company is considering investing in a piece of property which costs $105,000.The property will return a constant cash flow forever.If the firm's required rate of return is 9 percent and the corporate tax rate is 40 percent, what is the minimum after-tax cash flow that would make the investment acceptable to Ace?

A) $15,942
B) $10,831
C) $9,450
D) $2,375
E) $5,000

Question 44

An insurance firm agrees to pay you $3,310 at the end of 20 years if you pay premiums of $100 per year at the end of each year of the 20 years.Find the internal rate of return to the nearest whole percentage point.

A) 9%
B) 7%
C) 5%
D) 3%
E) 11%

Question 45

Michigan Mattress Company is considering the purchase of land and the construction of a new plant.The land, which would be bought immediately (at t = 0), has a cost of $100,000 and the building, which would be erected at the end of the first year (t = 1), would cost $500,000.It is estimated that the firm's after-tax cash flow will be increased by $100,000 starting at the end of the second year, and that this incremental flow would increase at a 10 percent rate annually over the next 10 years.What is the approximate payback period?

A) 2 years
B) 4 years
C) 6 years
D) 8 years
E) 10 years

Question 46

Louisiana Enterprises, an all-equity firm, is considering a new capital investment.Analysis has indicated that the proposed investment has a beta of 0.5 and will generate an expected return of 7 percent.The firm currently has a required return of 10.75 percent and a beta of 1.25.The investment, if undertaken, will double the firm's total assets.If r_RF = 7 percent and the market return is 10 percent, should the firm undertake the investment? (Choose the best answer.)

A) Yes; the expected return of the asset (7%) exceeds the required return (6.5%).
B) Yes; the beta of the asset will reduce the risk of the firm.
C) No; the expected return of the asset (7%) is less than the required return (8.5%).
D) No; the risk of the asset (beta) will increase the firm's beta.
E) No; the expected return of the asset is less than the firm's required return, which is 10.75%.

Question 47

The Oneonta Chemical Company is evaluating two mutually exclusive pollution control systems.Since the company's revenue stream will not be affected by the choice of control systems, the projects are being evaluated by finding the PV of each set of costs.The firm's required rate of return is 13 percent, and it adds or subtracts 3 percentage points to adjust for project risk differences.System A is judged to be a high-risk project (it might end up costing much more to operate than is expected).The appropriate risk-adjusted discount rate that should be used to evaluate System A is

A) 10%; this might seem illogical at first, but it correctly adjusts for risk where outflows, rather than inflows, are being discounted.
B) 13%; the firm's required rate of return should not be adjusted when evaluating outflow only projects.
C) 16%; since A is more risky, its cash flows should be discounted at a higher rate, because this correctly penalizes the project for its high risk.
D) Somewhere between 10% and 16%, with the answer depending on the riskiness of the relevant inflows.
E) Indeterminate, or, more accurately, irrelevant, because for such projects we would simply select the process that meets the requirements with the lowest required investment.

Question 48

The capital budgeting director of Sparrow Corporation is evaluating a project which costs $200,000, is expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year.If the firm's required rate of return is 14 percent and its tax rate is 40 percent, what is the project's IRR?

A) 8%
B) 14%
C) 18%
D) −5%
E) 12%

Question 49

You have recently accepted a one year employment term by a firm.The firm has given you the option of receiving your salary as a lump sum value of $30,000 at the end of the year or as 12 monthly payments of $2,400 starting one month after you start work.If your relevant discount rate is 2 percent per month, then which salary options would you prefer? (Ignore taxes, risk, and consumption needs.) Choose the best answer.

A) The lump sum payment, since it has the larger future value.
B) Monthly payments, since you do not have to wait so long to receive your money.
C) Either one, since they have the same present value.
D) The lump sum payment, since it has the larger present value.
E) Monthly payments, since it has the larger present value.

Question 50

Phoenix Products Inc.requires a new machine to produce a part for a solar air conditioner.Two companies have submitted bids, and you have been assigned the task of choosing one of the machines.Cash flow analysis indicates the following: If the required rate of return for Phoenix Products is 5 percent, which of the following is the most valid statement?

A) The NPV_A < NPV_B, therefore accept Machine B.
B) The NPV_A > NPV_B, therefore accept Machine A.
C) The IRR_A > IRR_B, therefore accept Machine A.
D) The IRR_A < IRR_B, therefore accept Machine B.
E) Take neither A nor B since the required rate of return is greater than the internal rate of return

Question 51

The Seattle Corporation has been presented with an investment opportunity which will yield end of year 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 required rate of return is 10 percent.What is the NPV for this investment?

A) $135,984
B) $18,023
C) $219,045
D) $51,138
E) $92,146

Question 52

If a typical U.S.company uses the same discount rate to evaluate all projects, the firm will most likely become

A) Riskier over time, and its value will decline.
B) Riskier over time, and its value will rise.
C) Less risky over time, and its value will rise.
D) Less risky over time, and its value will decline.
E) There is no reason to expect its risk position or value to change over time as a result of its use of a single discount rate.

Question 53

Your assistant has just completed an analysis of two mutually exclusive projects.You must now take her report to a board of directors meeting and present the alternatives for the board's consideration.To help you with your presentation, your assistant also constructed a graph with NPV profiles for the two projects.However, she forgot to label the profiles, so you do not know which line applies to which project.Of the following statements regarding the profiles, which one is most reasonable?

A) If the two projects have the same investment cost, and if their NPV profiles cross once in the upper right quadrant, at a discount rate of 40 percent, this suggests that a NPV versus IRR conflict is not likely to exist.
B) If the two projects' NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical sense (that is, a conflict which will affect the actual investment decision).
C) If one of the projects has a NPV profile which crosses the X-axis twice, hence the project appears to have two IRRs, your assistant must have made a mistake.
D) Whenever a conflict between NPV and IRR exist, then, if the two projects have the same initial cost, the one with the steeper NPV profile probably has less rapid cash flows.However, if they have identical cash flow patterns, then the one with the steeper profile probably has the lower initial cost.
E) If the two projects both have a single outlay at t = 0, followed by a series of positive cash inflows, and if their NPV profiles cross in the lower left quadrant, then one of the projects should be accepted, and both would be accepted if they were not mutually exclusive.

Question 54

Lloyd Enterprises has a project which has the following cash flows: The required rate of return is 10 percent.What is the project's discounted payback?

A) 1.8763 years
B) 2.0000 years
C) 2.3333 years
D) 2.4793 years
E) 2.6380 years

Question 55

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 required rate of return is 10 percent.Assume cash flows occur evenly during the year, 1/365th each day.What is the payback period for this investment?

A) 5.23 years
B) 4.86 years
C) 4.00 years
D) 6.12 years
E) 4.35 years

Question 56

Two projects being considered are mutually exclusive and have the following projected cash flows: If the required rate of return on these projects is 10 percent, which would be chosen and why?

A) Project B because of higher NPV.
B) Project B because of higher IRR.
C) Project A because of higher NPV.
D) Project A because of higher IRR.
E) Neither, because both have IRRs less than the required return.

Question 57

As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows: If Denver's required rate of return is 15 percent, you would choose?

A) Neither project.
B) Project X, since it has the higher IRR.
C) Project Z, since it has the higher NPV.
D) Project X, since it has the higher NPV.
E) Project Z, since it has the higher IRR.

Question 58

Carolina Insurance Company, an all-equity life insurance firm, is considering the purchase of a fire insurance company.If the purchase is made, Carolina will be 50 percent larger than before.Currently, Carolina's stock has a beta of 1.2 and the return required is 15.2 percent.The fire insurance company is expected to generate a return of 20 percent with a beta of 2.5.If the risk-free rate is 8 percent and the market risk premium is 6 percent, should Carolina make the investment?

A) No; the expected return is less than the required return.
B) No; the IRR is less than the appropriate required rate of return.
C) Yes; the IRR is greater than the appropriate required rate of return.
D) Yes; the expected return is greater than the required return.
E) Yes; the project's risk/return combination lies above the SML.

Question 59

Which of the following statements is correct?

A) Sensitivity analysis is used frequently in capital budgeting analysis.Its big advantage is that because it shows correlations between changes in input variables and NPV, it accounts for within-firm risk.
B) Other things held constant, the lower the correlation between a project's returns and returns on the market, the less risky the project.
C) In judging the relative stand-alone risks of a set of projects, the projects' standard deviations of NPV are a better measure than their coefficients of variation.
D) One can run a regression of returns on a project versus returns on the firm's other assets, get a beta coefficient, and use this beta as a measure of the project's market risk.
E) One can run a regression of returns on a project versus returns on the stock market, get a beta coefficient, and use this beta as a measure of the project's within-firm risk.

Question 60

If a company uses the same discount rate for evaluating all projects, which of the following results is likely?

A) Accepting poor, high-risk projects.
B) Rejecting good, low-risk projects.
C) Accepting only good, low risk projects.
D) Accepting no projects.
E) Answers a and b are both correct.

Question 61

Real Time Systems Inc.is considering the development of one of two mutually exclusive new computer models.Each will require a net investment of $5,000.The cash flow figures for each project are shown below: Model B, which will use a new type of laser disk drive, is considered a high-risk project, while Model A is of average risk.Real Time adds 2 percentage points to arrive at a risk-adjusted discount rate when evaluating a high-risk project.The rate used for average risk projects is 12 percent.Which of the following statements regarding the NPVs for Models A and B is most correct?

A) NPV_A = $380; NPV_B = $1,815.
B) NPV_A = $197; NPV_B = $1,590.
C) NPV_A = $380; NPV_B = $1,590.
D) NPV_A = $5,380; NPV_B = $6,590.
E) None of the above statements is correct.

Question 62

You are considering the purchase of an investment that would pay you $5,000 per year for Years 1−5, $3,000 per year for Years 6−8, and $2,000 per year for Years 9 and 10.If you require a 14 percent rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?

A) $15,819.27
B) $21,937.26
C) $32,415.85
D) $38,000.00
E) $52,815.71

Question 63

Given the following information, calculate the NPV of a proposed project: Cost = $4,000; estimated life = 3 years; initial decrease in accounts receivable = $1000, which must be restored at the end of the project's life; estimated salvage value = $1,000; net income before taxes and depreciation = $2,000 per year; method of depreciation = MACRS; tax rate = 40 percent; required rate of return = 18 percent.

A) $1,137
B) −$151
C) $137
D) $804
E) $544

Question 64

Whitney Crane Inc.has the following independent investment opportunities for the coming year: The IRRs for Project A and C, respectively, are:

A) 16% and 14%
B) 18% and 10%
C) 18% and 20%
D) 18% and 13%
E) 16% and 13%

Question 65

Arizona Rock, an all-equity firm, currently has a beta of 1.25, and r_RF = 7 percent and r_M = 14 percent.Suppose the firm sells 10 percent of its assets (beta = 1.25) and purchases the same proportion of new assets with a beta of 1.1.What will be the firm's new overall required rate of return, and what rate of return must the new assets produce in order to leave the stock price unchanged?

A) 15.645%; 15.645%
B) 15.75%; 14.7%
C) 15.645%; 14.7%
D) 15.75%; 15.645%
E) 14.75%; 15.75%

Question 66

Virus Stopper Inc., a supplier of computer safeguard systems, uses a required rate of return of 12 percent to evaluate average risk projects, and it adds or subtracts 2 percentage points to evaluate projects of more or less risk.Currently, two mutually exclusive projects are under consideration.Both have a cost of $200,000 and will last 4 years.Project A, a riskier-than-average project, will produce annual end of year cash flows of $71,104.Project B, of less than average risk, will produce cash flows of $146,411 at the end of Years 3 and 4 only.Virus Stopper should accept

A) B with a NPV of $10,001.
B) Both A and B because both have NPVs greater than zero.
C) B with a NPV of $8,042.
D) A with a NPV of $7,177.
E) A with a NPV of $15,968.

Question 67

Assume you are the director of capital budgeting for an all-equity firm.The firm's current required rate of return is 16 percent; the risk-free rate is 10 percent; and the market risk premium is 5 percent.You are considering a new project that has 50 percent more beta risk than your firm's assets currently have, i.e., its beta is 50 percent larger than the firm's existing beta.The expected return (IRR) on the new project is 18 percent.Should the project be accepted if beta risk is the appropriate risk measure? Choose the most correct statement.

A) Yes; its IRR is greater than the firm's required rate of return.
B) Yes; the project's risk-adjusted required return is less than its IRR.
C) No; a 50% increase in beta risk gives a risk-adjusted required return of 24%.
D) No; the project's risk-adjusted required return is 2 percentage points above its IRR.
E) No; the project's risk-adjusted required return is 1 percentage point above its IRR.

Question 68

An all-equity firm is analyzing a potential project which will require an initial, after-tax cash outlay of $50,000 and after-tax cash inflows of $6,000 per year for 10 years.In addition, this project will have an after-tax salvage value of $10,000 at the end of Year 10.If the risk-free rate is 6 percent, the return on an average stock is 10 percent, and the beta of this project is 1.50, then what is the project's NPV?

A) $13,210
B) $4,905
C) $7,121
D) −$6,158
E) −$12,879

Question 69

Scott Corporation's new project calls for an investment of $10,000.It has an estimated life of 10 years.The IRR has been calculated to be 15 percent.If cash flows are evenly distributed and the tax rate is 40 percent, what is the annual before-tax cash flow each year? (Assume depreciation is a negligible amount.)

A) $1,993
B) $3,321
C) $1,500
D) $4,983
E) $5,019

Question 70

Given the following information, what is the required cash outflow associated with the acquisition of a new machine; that is, in a project analysis, what is the initial investment outlay at t = 0?

A) −$8,980
B) −$6,460
C) −$5,200
D) −$6,840
E) −$12,020

Question 71

Mars Inc.is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually.Mars will use the MACRS accelerated method to depreciate the machine, and it expects to sell the machine at the end of its 5-year operating life for $10,000.The firm expects to be able to reduce net working capital by $15,000 when the machine is installed, but required working capital will return to the original level when the machine is sold after 5 years.Mars' marginal tax rate is 40 percent, and it uses a 12 percent required rate of return to evaluate projects of this nature.If the machine costs $60,000, what is the NPV of the project?

A) −$15,394
B) −$14,093
C) −$58,512
D) −$21,493
E) −$46,901

Question 72

Genuine Products Inc.requires a new machine.Two companies have submitted bids, and you have been assigned the task of choosing one of the machines.Cash flow analysis indicates the following: What is the internal rate of return for each machine?

A) IRR_A = 16%; IRR_B = 20%
B) IRR_A = 24%; IRR_B = 20%
C) IRR_A = 18%; IRR_B = 16%
D) IRR_A = 18%; IRR_B = 24%
E) IRR_A = 24%; IRR_B = 26%

Question 73

Two fellow financial analysts are evaluating a project with the following net cash flows: One analyst says that the project has an IRR of between 12 and 13%.The other analyst calculates an IRR of just under 800%, but fears his calculator's battery is low and may have caused an error.You agree to settle the dispute by analyzing the project cash flows.Which statement best describes the IRR for this project?

A) There is a single IRR of approximately 12.7 percent.
B) This project has no IRR, because the NPV profile does not cross the X axis.
C) There are multiple IRRs of approximately 12.7 percent and 787 percent.
D) This project has two imaginary IRRs.
E) There are an infinite number of IRRs between 12.5 percent and 790 percent that can define the IRR for this project.

Question 74

Alabama Pulp Company (APC) can control its environmental pollution using either "Project Old Tech" or "Project New Tech." Both will do the job, but the actual costs involved with Project New Tech, which uses unproved, new state-of-the-art technology, could be much higher than the expected cost levels.The cash outflows associated with Project Old Tech, which uses standard proven technology, are less risky⎯they are about as uncertain as the cash flows associated with an average project.APC's required rate of return for average risk projects normally is set at 12 percent, and the company adds 3 percent for high risk projects but subtracts 3 percent for low risk projects.The two projects in question meet the criteria for high and average risk, but the financial manager is concerned about applying the normal rule to such cost-only projects.You must decide which project to recommend, and you should recommend the one with the lower PV of costs.What is the PV of costs of the better project?

A) 2,521
B) 2,399
C) 2,457
D) 2,543
E) 2,422

Question 75

Klott Company encounters significant uncertainty with its sales volume and price in its primary product.The firm uses scenario analysis in order to determine an expected NPV, which it then uses in its budget.The base case, best case, and worse case scenarios and probabilities are provided in the table below.What is Klott's expected NPV, standard deviation of NPV, and coefficient of variation of NPV?

A) Expected NPV = $35,000; σ_NPV = 17,500; CV_NPV = 2.0.
B) Expected NPV = $35,000; σ_NPV = 11,667; CV_NPV = 0.33.
C) Expected NPV = $10,300; σ_NPV = 12,083; CV_NPV = 1.17.
D) Expected NPV = $13,900; σ_NPV = 8,476; CV_NPV = 0.61.
E) Expected NPV = $10,300; σ_NPV = 13,900; CV_NPV = 1.35.

Question 76

Stanton Inc.is considering the purchase of a new machine which will reduce manufacturing costs by $5,000 annually and increase earnings before depreciation and taxes by $6,000 annually.Stanton will use the MACRS method to depreciate the machine, and it expects to sell the machine at the end of its 5-year operating life for $10,000 before taxes.Stanton's marginal tax rate is 40 percent, and it uses a 9 percent required rate of return to evaluate projects of this type.If the machine's cost is $40,000, what is the project's NPV?

A) $1,014
B) $2,292
C) $7,550
D) $817
E) $5,040

Question 77

Two projects being considered are mutually exclusive and have the following projected cash flows: At what rate (approximately) do the NPV profiles of Projects A and B cross?

A) 6.5%
B) 11.5%
C) 16.5%
D) 20.0%
E) The NPV profiles of these two projects do not cross.

Question 78

Sun State Mining Inc., an all-equity firm, is considering the formation of a new division which will increase the assets of the firm by 50 percent.Sun State currently has a required rate of return of 18 percent, U.S.Treasury bonds yield 7 percent, and the market risk premium is 5 percent.If Sun State wants to reduce its required rate of return to 16 percent, what is the maximum beta coefficient the new division could have?

A) 2.2
B) 1.0
C) 1.8
D) 1.6
E) 2.0

Question 79

Two projects being considered by a firm are mutually exclusive and have the following projected cash flows: Based only on the information given, which of the two projects would be preferred, and why?

A) Project A, because it has a shorter payback period.
B) Project B, because it has a higher IRR.
C) Indifferent, because the projects have equal IRRs.
D) Include both in the capital budget, since the sum of the cash inflows exceeds the initial investment in both cases.
E) Choose neither, since their NPVs are negative.

Question 80

The Unlimited, a national retailing chain, is considering an investment in one of two mutually exclusive projects.The discount rate used for Project A is 12 percent.Further, Project A costs $15,000, and it would be depreciated using MACRS.It is expected to have an after-tax salvage value of $5,000 at the end of 6 years and to produce after-tax cash flows (including depreciation) of $4,000 for each of the 6 years.Project B costs $14,815 and would also be depreciated using MACRS.B is expected to have a zero salvage value at the end of its 6-year life and to produce after-tax cash flows (including depreciation) of $5,100 each year for 6 years.The Unlimited's marginal tax rate is 40 percent.What risk-adjusted discount rate will equate the NPV of Project B to that of Project A?

A) 15%
B) 16%
C) 18%
D) 20%
E) 12%