Deck 9: Capital Budgeting Techniques

Question 1

An NPV profile is most helpful in dealing with what type of problem?

A)Difficulty in forecasting cash flows
B)The technical sophistication required to interpret NPV results
C)The fact that some projects may have multiple NPVs
D)Problems in estimating a firm's cost of capital
E)Making a decision about a project when recommendations from the payback and NPV calculations conflict

Answer 1

Problems in estimating a firm's cost of capital

Question 2

All of the following are steps in the capital budgeting process EXCEPT:

A)identifying opportunities.
B)the pre-audit.
C)evaluating opportunities.
D)the post audit.
E)implementing the project.

Answer 2

the pre-audit.

Question 3

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 cost of capital is 10%. What is the NPV for this investment?

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

Answer 3

$51,138

Question 4

Costner Inc. would like to introduce its new haircutting machine, the "terminator." The machine will cost $15,000 today. As a result of purchasing the machine, Costner expects to give 5,000 more haircuts for $8 each. In the first year, Costner will give 2,000 more haircuts, and in the second year Costner will give 3,000 more haircuts. What is the net present value (NPV)associated with purchasing the terminator if Costner's cost of capital is 9%? Round answer to the nearest whole dollar amount.

A)-$10,640
B)$19,879
C)$20,485
D)$19,380
E)-$19,879

Question 5

________ is the process of deciding which long-term investments or projects a firm will acquire using the long-term funds a firm has available.

A)Investment analysis
B)Capital budgeting
C)Capital marketing
D)Liability management
E)Corporate governance

Question 6

Pear Computer Corp. plans to introduce a new model called the Bartlett, whose sales are expected to grow rapidly until the computer becomes obsolete in five years. Net cash inflows to be realized at the end of the first year are $1 million, and they are expected to increase $1 million per year for each of the remaining 4 years. Cash outflows for production expenses are $3.5 million today and an additional $1.5 million at the end of the second year to increase capacity. If Pear's cost of capital is 10%, what is the project's NPV? Round to nearest whole dollar amount.

A)$9,412,700
B)$5,912,919
C)$6,173,452
D)$5,123,936
E)$8,998,418

Question 7

Analysts at Tabby Fur Storage predict that the net present value of a proposed new $10 million warehouse is $1 million. How should these findings be interpreted?

A)Although NPV is positive, its value is too low for such a large expenditure and as a result, the project should be rejected.
B)The project should be rejected because the NPV is less than the cost of the warehouse.
C)The project should be accepted because it will add value to the firm.
D)More information such as the payback period should be evaluated since the reliance on only one capital budgeting technique should be discouraged.
E)The project does not meet the acceptance criteria of the NPV method and should be rejected.

Question 8

An advantage of the net present value (NPV)method is that it:

A)does not employ time value of money techniques.
B)is easy to use when available capital or resources are limited.
C)does not rely on the cost of capital.
D)provides its users with a clear decision criterion.
E)provides a "bang for the buck" analysis for each project.

Question 9

An NPV profile:

A)graphs the NPV at a variety of discount rates.
B)graphs the NPV at a variety of internal rates of return.
C)graphs the NPV at a variety of modified internal rates of return.
D)graphs the payback period at a variety of discount rates.
E)compares the NPV and the IRR to determine which mutually exclusive projects should be accepted.

Question 10

Most errors committed in capital budgeting analysis occur during what stage?

A)Adjusting for the time value of money
B)Calculating net present value
C)Estimating relevant cash flows
D)Finding the payback period
E)Interpreting the results of the analysis

Question 11

On a purely theoretical basis, the NPV is the better approach to capital budgeting due to all the following reasons EXCEPT:

A)that it measures the benefits relative to the amount invested.
B)for the reasonableness of the reinvestment rate assumption.
C)that there may be multiple solutions for an IRR computation.
D)that it maximizes shareholder wealth.

Question 12

Which of the following statements is false?

A)The NPV will be positive if the IRR is less than the cost of capital.
B)If the multiple IRR problem does not exist, any independent project acceptable by NPV method will also be acceptable by the IRR method.
C)When IRR = k (the cost of capital), 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 13

The most widely used capital budgeting technique is:

A)the payback period.
B)net present value.
C)internal rate of return.
D)the profitability index.
E)modified internal rate of return.

Question 14

The ultimate goal of capital budgeting analysis is to select projects that:

A)maximize shareholder wealth.
B)cost the most funds.
C)lower operating expenses.
D)increase sales and market share.
E)enable managers to keep their jobs.

Question 15

If only one capital budgeting technique could be used to evaluate a project, which of the following would be the most preferred?

A)Payback
B)IRR
C)MIRR
D)Profitability index
E)NPV

Question 16

The NPV method assumes that cash inflows are reinvested at the:

A)internal rate of return.
B)firm's cost of capital.
C)average yield on corporate bonds.
D)average yield from an equity index fund.
E)risk-adjusted hurdle rate.

Question 17

According to the net present value technique, a project is considered acceptable if:

A)the sum of all cash inflows and outflows is positive.
B)the difference between all discounted cash inflows and outflows exceeds zero.
C)it lowers costs below an acceptable hurdle rate.
D)its rate of return is greater than the firm's cost of capital.
E)it returns the initial investment faster than competing projects.

Question 18

The primary problem with the NPV technique of capital budgeting is:

A)that many people without a background in financial theory may not understand it.
B)that there is no adjustments for risk.
C)an unclear decision rule.
D)the fact that it ignores the time value of money.
E)that it uses unorthodox time value of money techniques.

Question 19

Two projects each require a current cash expenditure of $10,000. Project A will generate cash inflows of $2,000 per year for the next twelve years. Project B is expected to return $6,000 in 1 year, $4,000 at the end of year 2, and $3,000 in 3 years. Which project should be selected if funds are unavailable to finance both and capital costs are 6%?

A)Project B because it has a shorter payback period.
B)Project B because it has a higher IRR
C)Project A because it has a higher IRR
D)Project A because it has a higher NPV
E)Project B because it has a higher NPV

Question 20

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% 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 21

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)Profitability Index

Question 22

Going Postal Service Inc. is considering an upgrade of its sorting machines. The cost of the project is $10,000 per machine and the improvement is expected to save $5,000 each year, beginning one year after the adoption of the project and continuing for a total of 5 years. If Going's cost of capital is 10%, is the project acceptable? Round answer to the nearest whole dollar.

A)Yes, the NPV = $15,000
B)Yes, the NPV = 15%
C)No, the NPV = -$8,954
D)Yes, the NPV = +$8,954
E)No, the NPV = 8%

Question 23

Bernhard Stroh is the Master Brewer at the Lion's Head Brewery. Bernhard has the approval to brew a new beer, but can't decide which: 1)a wheat beer; or 2)a pale ale. Both beers require an initial investment of $1,000,000. The operating cash flows for each project are shown in the table. Lion's Head shareholders required a rate of return of 10%. The Wheat project has an IRR of 15.36% and the Ale project has an IRR of 15.89%. Which project should Bernhard choose (and why)? $$\begin{array} { | c | c | c | } \hline \text { Year } & \text { Wheat } & \text { Ale } \\\hline 0 & - 1,000,000 & - 1,000,000 \\\hline 1 & 200,000 & 900,000 \\\hline 2 & 1,100,000 & 300,000 \\\hline\end{array}$$

A)Choose the Ale project because its IRR is greater.
B)Choose the Ale because its NPV is higher.
C)Choose the Wheat because its NPV is higher.
D)Choose the Wheat because it generates more operating cash flows.
E)Choose either because they both have the same NPV.

Question 24

What is the NPV of the Boeing 787 Dreamliner project? The Boeing 787-8 can carry 230 passengers up to 8,200 nautical miles at a cruising speed of mach 0.85. The Dreamliner is more comfortable for passengers because of higher cabin humidity. Boeing completed construction on its final assembly plant at time t = 0 for a total cost of $7B. Boeing has secured orders for 865 aircraft over the next five years (t = 1 to t = 5)for total proceeds of $138.4B ($160M per aircraft). The cost of building each plane is $140M. Assume that cash flows (sales and costs)occur at the end of each year starting one year after the assembly plant was completed. The project cash flows are shown in the table, below. What is the NPV of the project if Boeing's cost of capital is 10%? Calculate the NPV as of time t=0. (Round answer to the nearest million). $$\begin{array} { | c | c | c | c | c | c | } \hline \text { Year } & \begin{array} { c } \text { Capital } \\\text { Investment }\end{array} & \text { Annual Sales } & \begin{array} { c } \text { Annual } \\\text { Revenues }\end{array} & \text { Annual Costs } & \text { Cash Flows } \\\hline \mathrm { t } = 0 & \$ 7,000 \mathrm { M } & & & & - 7,000 \\\hline \mathrm { t } = 1 & & 173 & 27,680 & 24,220 & 3,460 \\\hline \mathrm { t } = 2 & & 173 & 27,680 & 24,220 & 3,460 \\\hline \mathrm { t } = 3 & & 173 & 27,680 & 24,220 & 3,460 \\\hline \mathrm { t } = 4 & & 173 & 27,680 & 24,220 & 3,460 \\\hline \mathrm { t } = 5 & & 173 & 27,680 & 24,220 & 3,460 \\\hline\end{array}$$

A)$6,116M
B)$8,069M
C)$8,780M
D)$8,967M
E)$13,116M

Question 25

The least desirable capital budgeting technique from a theoretical standpoint is:

A)the payback method.
B)net present value.
C)the profitability index.
D)the internal rate of return.
E)the modified internal rate of return.

Question 26

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:

A)-$1,000
B)$0
C)$1,000
D)$1.25

Question 27

Unsophisticated capital budgeting techniques do not:

A)examine the size of the initial outlay.
B)use net profits as a measure of return.
C)explicitly consider the time value of money.
D)take into account an unconventional cash flow pattern.

Question 28

Fritz Walther, the CEO of Carl Walther Sportwaffen GmbH, is choosing between two mutually exclusive projects: 1)the Walther PBJ; and 2)the Walther PPK. Both projects involve an investment of $100,000. The operating cash flows for each project are shown in the table. The opportunity cost of capital is 10%. The PBJ project has an IRR of 11.65% and the PPK project has an IRR of 12.27%. Which project should Fritz choose (and why)? $$\begin{array} { | c | c | c | } \hline \text { Year } & \text { PBJ } & \text { PPK } \\\hline 0 & - 100,000 & - 100,000 \\\hline 1 & 40,000 & 90,000 \\\hline 2 & 80,000 & 25,000 \\\hline\end{array}$$

A)Choose the PPK project because its IRR is greater.
B)Choose the PPK because its NPV is higher.
C)Choose the PBJ because its NPV is higher.
D)Choose the PPK because it generates more operating cash flows.
E)Choose either because they both have the same NPV.

Question 29

What is the NPV of the F-22 Raptor project? The Lockheed Martin/Boeing F-22 Raptor is a stealth fighter aircraft. It was designed primarily as an air superiority fighter, but it is also capable of ground attack and other roles. Lockheed Martin Aeronautics is the prime contractor and is responsible for the majority of the airframe, weapon systems and final assembly. Lockheed Martin invested over $10B on design and manufacturing for the aircraft. Assume that those investments were paid for on Jan 1, 2003. Each aircraft will be sold for $350M and the variable cost of building each airplane is $300M. Assume that 70 aircraft will be sold each year for 5 years. Assume that revenues and costs occur at year-end. (So 2003 revenues and costs are incurred on Dec 31, 2003. See the table of cash flows, below.)What is the NPV of the project if Lockheed-Martin's cost of capital is 10%? (Assume that there are no taxes.) $$\begin{array} { | c | c | c | c | } \hline \text { Date } & \text { Investments } & \text { Revenues } & \text { Costs } \\\hline \text { Jan. } 1,2003 & \$ 10 \mathrm {~B} & & \\\hline \text { Dec. } 31,2003 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2004 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2005 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2006 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2007 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline\end{array}$$

A)$3,500,000
B)$3,267,754
C)$5,243,412
D)$13,267,75
E)$82,874,276

Question 30

In 1967, Lockheed planned to build a wide-bodied passenger aircraft called the L-1011 Tri Star airbus. The pre-production phase of the Tri Star project was planned to end in 1971 and total $1B. Lockheed planned to sell 35 aircraft per year for six years between 1972 and 1977 with an operating profit of $2M per aircraft. This sales forecast was aggressive as it represented a market share of 45% of the world market for wide-bodied aircraft (which was forecast to be about 80 aircraft per year). By 1971 the company was in financial distress and had to seek a government bailout.
At the end of 1967, Lockheed had 11.3 million shares outstanding which traded at $70 per share. If the market had known the NPV of the L-1011 project at that time, then what would the stock price have been?

A)Larger than $70; hard to tell without more information
B)Much less than $70, as the project clearly had a large, negative NPV
C)About $70; the NPV of the project was close to zero
D)$70; the NPV of a project does not affect the stock price

Question 31

Marlin Liquidators is considering the purchase of a new $175,000 crane. If Marlin expects the cash inflows to be $45,000 after the first year, $76,000 after the second year, and $80,000 after the third year, what is the NPV if the cost of capital is 15%? Round answer to the nearest whole dollar amount.

A)+$149,196
B)+$26,000
C)+$18,800
D)-$25,801
E)-$18,800

Question 32

All of the following are considered to be disadvantages of using the payback method except the fact that it:

A)ignores the time value of money.
B)has no clearly defined decision rule.
C)does not consider cash flows that occur beyond the payback period.
D)does not adjust for risk.
E)does not provide a good measure of the project's liquidity.

Question 33

Two projects being considered are mutually exclusive and have the following projected cash flows: $$\begin{array} { | c | c | c | } \hline \text { Year } & \text { Project A } & \text { Project B } \\\hline 0 & - \$ 50,000 & - \$ 50,000 \\\hline 1 & \$ 15,625 & 0 \\\hline 2 & \$ 15,625 & 0 \\\hline 3 & \$ 15,625 & 0 \\\hline 4 & \$ 15,625 & 0 \\\hline 5 & \$ 15,625 & \$ 99,500 \\\hline\end{array}$$ If the required rate of return on these projects is 10%, which would be chosen and why?

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

Question 34

What is the payback period for the Airbus A380 project? The Airbus A380 is the largest civilian aircraft ever built. It can carry 555 passengers on two decks. Initial project investments were $13B. Assume that the initial investment was paid on Dec 31, 2008. Assume that Airbus will produce 60 aircraft per year for five years. Each aircraft will be sold for $230M and total operating costs are 75% of revenues. Assume that revenues and costs occur at year-end with the first revenues (and costs)occurring on Dec 31, 2009. Ignore taxes and assume that there are no terminal year cash flows. Select the earliest year such that the initial investments are completely paid off.

A)3 years
B)4 years
C)5 years
D)The project is not paid off in this time frame.
E)Need the cost of capital to answer this question.

Question 35

Sara Flea Collar Inc. is evaluating an overseas expansion that will cost $1 million and is expected to generate the following cash flows: year 1: -$250,000; year 2: +$450,000; year 3: +$550,000; and year 4: +$800,000. What is the payback period?

A)3.00 years
B)3.13 years
C)3.31 years
D)3.75 years
E)4.00 years

Question 36

The ________ is the exact amount of time it takes the firm to recover its initial investment.

A)average rate of return
B)internal rate of return
C)net present value
D)payback period

Question 37

What is the payback period of the F-22 Raptor project? The Lockheed Martin/Boeing F-22 Raptor is a stealth fighter aircraft. It was designed primarily as an air superiority fighter, but it is also capable of ground attack and other roles. Lockheed Martin Aeronautics is the prime contractor and is responsible for the majority of the airframe, weapon systems and final assembly. Lockheed Martin invested over $10B on design and manufacturing for the aircraft. Assume that those investments were paid for on Jan 1, 2003. Each aircraft will be sold for $350M and the variable cost of building each airplane is $300M. Assume that 70 aircraft will be sold each year for 5 years. Assume that revenues and costs occur uniformly throughout the year. What is the payback period of the project? $$\begin{array} { | c | c | c | c | } \hline \text { Date } & \text { Investments } & \text { Revenues } & \text { Costs } \\\hline \text { Jan. } 1,2003 & - \$ 10 \mathrm {~B} & & \\\hline \text { Dec. } 31,2003 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2004 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2005 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2006 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2007 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline\end{array}$$

A)5 months
B)2.86 years
C)3.45 years
D)3.39 years
E)7.8 years

Question 38

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 increase 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 39

What is the NPV of the Airbus A380 project? The Airbus A380 is the largest civilian aircraft ever built. It can carry 555 passengers on two decks. Initial project investments were $13B. Assume that the initial investment was paid on Dec 31, 2008. Assume that Airbus will produce 60 aircraft per year for five years. Each aircraft will be sold for $230M and total operating costs are 75% of revenues. Assume that revenues and costs occur at year-end with the first revenues (and costs)occurring on Dec 31, 2009. What is the NPV of the project if Airbus' cost of capital is 11%? Calculate the NPV as of Dec 31, 2008. Ignore taxes and assume that there are no terminal year cash flows.

A)-$2.799B
B)-$0.249B
C)$0.078B
D)$2.751B
E)$25.253B

Question 40

The ________ method to analyze cash flows associated with a project does not consider the time value of money.

A)payback period
B)net present value (NPV)
C)profitability index (PI)
D)internal rate of return (IRR)
E)modified internal rate of return

Question 41

Your company is planning to open a new gold mine which will cost $3 million to build, with the expenditure occurring at the end of the year three years from today. The mine will bring year-end after-tax cash inflows of $2 million at the end of the two succeeding years, and then it will cost $.5 million to close down the mine at the end of the 3rd year of operation. What is the project's IRR?

A)14.36%
B)10.17%
C)17.42%
D)12.70%
E)21.53%

Question 42

According to the internal rate of return method, a firm should accept a project if the ________.

A)internal rate of return is less than the cost of capital
B)internal rate of return exceeds the cost of capital
C)cost of capital exceeds the internal rate of return
D)internal rate of return exceeds the firm's cost of debt
E)internal rate of return exceeds the firm's cost of equity

Question 43

The New Watch Times is considering a new printing press to increase its productive capacity. If the cost of the press is $500,000 and the relevant cash flows from the project are $75,000 per year over the next ten years, what is the payback period?

A)6.00 years
B)6.50 years
C)7.00 years
D)6.67 years
E)7.50 years

Question 44

Perhaps the greatest disadvantage of using the IRR method to evaluate investment opportunities is:

A)dealing with uncertain cash flows from the project.
B)the assumption that all cash flows from the project will be reinvested at the IRR.
C)the inability to calculate most IRRs without a computer.
D)the need to compare IRR with the firm's cost of capital which cannot be estimated precisely.
E)the fact that the technique does not account for risk.

Question 45

An insurance firm agrees to pay you $3,310 at the end of 20 years if you pay a premium 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 46

Genuine Products Inc. requires a new machine. Two companies have submitted bids, and you have been assigned to the task of choosing one of the machines. Cash flow analysis indicates the following: $$\begin{array} { | c | c | c | } \hline \text { Year } & \text { Machine A } & \text { Machine B } \\\hline 0 & - \$ 2,000 & - \$ 2,000 \\\hline 1 & \$ 0 & \$ 832 \\\hline 2 & \$ 0 & \$ 832 \\\hline 3 & \$ 0 & \$ 832 \\\hline 4 & \$ 3,877 & \$ 832 \\\hline\end{array}$$ What is the internal rate of return for each machine?

A)IRRa=16%; IRRb= 20%
B)IRRa= 24%; IRRb= 20%
C)IRRa= 18%; IRRb= 16%
D)IRRa= 18%; IRRb= 24%
E)IRRa= 24%; IRRb= 26%

Question 47

A project requires an investment outlay of $100 immediately. The project will generate after-tax cash flows of $50 one year from now and $60 two years from now. What is the IRR of the project?

A)5.39%
B)6.39%
C)10.39%
D)12.39%
E)14.39%

Question 48

What is the payback period for the Boeing 787 Dreamliner project? The Boeing 787-8 can carry 230 passengers up to 8,200 nautical miles at a cruising speed of mach 0.85. The Dreamliner is more comfortable for passengers because of higher cabin humidity. Boeing completed construction of its final assembly plant in Everett Washington in December 2007 at a total cost of $7B. Boeing has secured sales of 865 aircraft over the period 2008-2012 for total proceeds of $138.4B ($160M per aircraft). The cost of building each plane is $140M. Assume that sales (and costs)occur in December of each year. Assume that sales are spread evenly across the five years from 2008-2012. The project cash flows are shown in the table, below. What is the payback period for the project? Ignore taxes. $$\begin{array} { | c | c | c | c | c | c | } \hline \text { Year } & \begin{array} { c } \text { Capital } \\\text { Investment }\end{array} & \text { Annual Sales } & \begin{array} { c } \text { Annual } \\\text { Revenues }\end{array} & \text { Annual Costs } & \text { Cash Flows } \\\hline 2007 & - \$ 7,000 \mathrm { M } & & & & - \$ 7,000 \\\hline 2008 & & 173 & \$ 27,680 & \$ 24,220 & \$ 3,460 \\\hline 2009 & & 173 & \$ 27,680 & \$ 24,220 & \$ 3,460 \\\hline 2010 & & 173 & \$ 27,680 & \$ 24,220 & \$ 3,460 \\\hline 2011 & & 173 & \$ 27,680 & \$ 24,220 & \$ 3,460 \\\hline 2012 & & 173 & \$ 27,680 & \$ 24,220 & \$ 3,460 \\\hline\end{array}$$

A)2 months
B)2.02 years
C)3.4 years
D)7 years
E)24 years

Question 49

A project requires a current expenditure of $300 and expects to generate $100 cash inflows at the end of each of the next 5 years. What conclusion can be drawn from examining an NPV profile for this project?

A)Accept the project if the cost of capital exceeds 20%
B)Accept the project if the cost of capital is below 20%
C)Reject the project if the cost of capital exceeds 10%
D)Reject the project if the cost of capital exceeds 7%
E)Reject the project if the cost of capital exceeds 5%

Question 50

A firm is evaluating a proposal which has an initial investment of $35,000 and has cash flows of $10,000 in year 1, $20,000 in year 2, and $10,000 in year 3. The payback period of the project is:

A)1 year.
B)2 years.
C)between 1 and 2 years.
D)between 2 and 3 years.

Question 51

All of the following are weaknesses of the payback period EXCEPT:

A)a disregard for cash flows after the payback period.
B)only an implicit consideration of the timing of cash flows.
C)the difficulty of specifying the appropriate payback period.
D)it uses cash flows, not accounting profits.

Question 52

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)Errors in calculating the discount rate.

Question 53

Among the reasons many firms DON'T use the payback period as a guideline in capital investment decisions are all of the following EXCEPT:

A)it gives consideration to the timing of cash flows.
B)it uses an appropriate measure of risk.
C)it recognizes cash flows which occur after the payback period.
D)it is easy to calculate.

Question 54

If the ________ is greater than or equal to the ________, the project should be accepted.

A)IRR; NPV
B)cost of capital; IRR
C)IRR; cost of capital
D)NPV; IRR
E)NPV; discount rate

Question 55

In comparing the internal rate of return and net present value methods of evaluation,

A)Internal Rate of Return is theoretically superior, but financial managers prefer Net Present Value.
B)Financial managers prefer net present value, because it measures benefits relative to the costs.
C)Financial mangers prefer net present value, because it is presented as a rate of return.
D)Net Present Value is not theoretically superior, but financial mangers prefer to use it anyway.

Question 56

The internal rate of return may be defined as the:

A)percentage increase in the value of an investment over its useful life.
B)the minimum return required by investors to hold a firm's securities.
C)the discount rate at which a project's NPV is negative.
D)the discount rate at which a project's NPV equals zero.
E)the maximum rate of return expected from a project.

Question 57

What is the IRR for a project with a current cost of $7,000 that is expected to produce cash inflows of $1,000 at the end of each of the next 10 years? Round answer to the nearest whole percent.

A)10%
B)8%
C)7%
D)11%
E)6%

Question 58

Some firms use the payback period as a decision criterion or as a supplement to sophisticated decision techniques, because:

A)it explicitly considers the time value of money.
B)it can be viewed as a measure of risk exposure.
C)the determination of payback is an objectively determined criteria.
D)it can take the place of the net present value approach.

Question 59

What is the internal rate of return for a project that requires a current cash outlay of $15,187 and is expected to generate cash inflows of $5,000 at the end of each of the next four years?

A)12.0%
B)11.5%
C)12.3%
D)14.1%
E)13.0%

Question 60

Comparing net present value and internal rate of return analysis:

A)always result in the same ranking of projects.
B)always result in the same accept/reject decision.
C)may give different accept/reject decisions.
D)is only necessary on mutually exclusive projects.

Question 61

A project costs $1,000 today and is expected to produce cash inflows of $800 at the end of each of the next two years. If the firm's cost of capital is 10%, what is the modified internal rate of return? Round answer to the nearest whole percent.

A)30%
B)23%
C)13%
D)21%
E)33%

Question 62

What is the IRR of the F-22 Raptor project? The Lockheed Martin/Boeing F-22 Raptor is a stealth fighter aircraft. It was designed primarily as an air superiority fighter, but it is also capable of ground attack and other roles. Lockheed Martin Aeronautics is the prime contractor and is responsible for the majority of the airframe, weapon systems and final assembly. Lockheed Martin invested over $10B on design and manufacturing for the aircraft. Assume that those investments were paid for on Jan 1, 2003. Each aircraft will be sold for $350M and the variable cost of building each airplane is $300M. Assume that 70 aircraft will be sold each year for 5 years. Thus annual revenues are $24.5B and annual costs are $21B. Assume that revenues and costs occur at year-end with the first year of operating cash flows occurring on Dec 31, 2003. Lockheed-Martin's cost of capital is 10% and the NPV of the project is $3.268B. What is the IRR of the project?(Assume that there are no taxes.) $$\begin{array} { | c | c | c | c | } \hline \text { Date } & \text { Investments } & \text { Revenues } & \text { Costs } \\\hline \text { Jan. } 1,2003 & - \$ 10 \mathrm {~B} & & \\\hline \text { Dec. } 31,2003 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2004 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2005 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2006 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline \text { Dec. } 31,2007 & & \$ 24.5 \mathrm {~B} & \$ 21 \mathrm {~B} \\\hline\end{array}$$

A)7.24%
B)8.50%
C)9.76%
D)10.50%
E)22.11%

Question 63

Your lawyer presents you with a three year investment. You must invest $1,000 immediately, but you are promised after-tax cash flows of $600 after one year and another $600 after two years. What is the IRR of the investment? (Round answer to nearest percent).

A)10%
B)11%
C)12%
D)13%
E)14%

Question 64

The major advantage provided by the profitability index is it:

A)eliminates the need to estimate the firm's cost of capital.
B)reduces the forecast error of cash flow estimates.
C)provides a better measure of the effects of a project on shareholder wealth than NPV.
D)is useful as an aid in raking projects from best to worst.
E)is easier to calculate than NPV.

Question 65

What is the Profitability Index of the Airbus A380 project? The Airbus A380 is the largest civilian aircraft ever built. It can carry 555 passengers on two decks. Initial project investments were $13B. Assume that the initial investment was paid on Dec 31, 2008. Assume that Airbus will produce 60 aircraft per year for five years. Each aircraft will be sold for $230M and total operating costs are 75% of revenues. Assume that revenues and costs occur at year-end with the first revenues (and costs)occurring on Dec 31, 2009. Assume that Airbus' cost of capital is 11%. Calculate the Profitability Index as of Dec 31, 2008. Assume that there are no terminal year cash flows.

A)0.935
B)0.981
C)0.995
D)1.333
E)1.981

Question 66

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 cost of capital is 14% and its tax rate is 40%, what is the projected IRR?

A)8%
B)14%
C)18%
D)-5%
E)12%

Question 67

What is the profitability index of a project that has a current cost of $100,000 and expected cash flows of $50,000 at the end of each of the next 7 years if the cost of capital is 20%?

A).001
B).018
C)1.80
D)1.18
E)1.25

Question 68

An investment of $1,000 will return $60 annually forever. What is its internal rate of return?

A)6%
B)0.60%
C)16.67%
D)60%
E)Cannot be determined.

Question 69

The modified internal rate of return corrects which problem inherent in IRR?

A)Adjustments for scale differences
B)Difficulty in ranking projects
C)Differing risk attributes of projects
D)Incorporates the time value of money
E)It allows for reinvestment of cash inflows from the project at the firm's cost of capital.

Question 70

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

A)Equal to the IRR
B)Too high
C)Greater than the IRR
D)Too low
E)Less than the IRR

Question 71

Two projects being considered by a firm are mutually exclusive and have the following projected cash flows: $$\begin{array} { | c | c | c | } \hline \text { Year } & \text { Project A } & \text { Project B } \\\hline 0 & - \$ 100,000 & - \$ 100,000 \\\hline 1 & \$ 39,500 & 0 \\\hline 2 & \$ 39,500 & 0 \\\hline 3 & \$ 39,500 & \$ 133,000 \\\hline\end{array}$$ Which project(s)should be accepted?

A)A, because it has a shorter payback period.
B)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 72

Los Angeles Lumber Company (LALC)is considering a project with a cost of $1,000 at Time = 0 and inflows of $300 at the end of Years 1-5. LALC's cost of capital is 10%. What is the project's modified IRR (MIRR)?

A)10.0%
B)12.9%
C)15.2%
D)18.3%
E)20.7%

Question 73

A firm is evaluating two independent projects utilizing the internal rate of return technique. Project X has an initial investment of $80,000 and cash inflows at the end of each of the next five years of $25,000. Project Z has a initial investment of $120,000 and cash inflows at the end of each of the next four years of $40,000. The firm should:

A)accept both if their cost of capital is 15% at the maximum.
B)accept only Z if their cost of capital is 15% at the maximum.
C)accept only X if their cost of capital is 15% at the maximum.
D)reject both if their cost of capital is 12% at the maximum.

Question 74

When the net present value is negative, the internal rate of return is ________ the cost of capital.

A)greater than
B)greater or equal to
C)less than
D)equal to

Question 75

Which of the following statements is incorrect?

A)It is possible to compute multiple IRRs for a single project.
B)A problem with IRR is that it does not adjust for the scale of the project.
C)A NPV profile plots the relationship between the riskiness of a project and the associated NPVs.
D)The NPV and IRR always provide the same rankings for a set of possible projects.
E)IRR provides information in a form that is useful to managers.

Question 76

As the capital budgeting director for Chapel Hill Coffins Inc., you are evaluating construction of a new plant. The plant has a net cost of $5 million in Year 0 (today), and it will provide net cash inflows of $1 million at the end of Year 1, $1.5 million at the end of Year 2, and $2 million at the end of Years 3 through 5. Within what range is the plant's IRR?

A)14-15%
B)15-16%
C)16-17%
D)17-18%
E)18-19%

Question 77

Given the following net cash flows, determine the IRR of the project: (to the nearest whole percent) $$\begin{array} { | c | c | } \hline \text { Time } & \text { Net Cash Flow } \\\hline 0 & \$ 1,520 \\\hline 1 & - \$ 1,000 \\\hline 2 & - \$ 1,500 \\\hline 3 & \$ 500 \\\hline\end{array}$$

A)36%
B)32%
C)28%
D)24%
E)20%

Question 78

The Barby Division at Mattel Toys is considering the acquisition of a laser tattoo applicator that will be able to add custom-designed tattoos to the Barby doll. The machine costs $300M. The addition of tattoos to the iconic toy is expected to increase demand and raise free cash flow by $90 million over the next five years (at the end of each year). The machine has no anticipated resale value in five years. What is the project's IRR?

A)14.24%
B)15.24%
C)15.74%
D)16.24%
E)16.74%

Question 79

Alyeska salmon Inc., a large salmon canning firm operating out of Valdez, Alaska, has a new automated production line project it is considering. The project has a cost of $275,000 and is expected to provide after-tax annual cash flows of $73,306 for eight years. The firm's management is uncomfortable with the IRR reinvestment assumption and prefers the modified IRR approach. You have calculated a cost of capital for the firm of 12 percent. What is the project's MIRR?

A)15%
B)14%
C)12%
D)16%
E)17%

Question 80

For mutually exclusive projects the underlying cause of conflicts in ranking for projects by internal rate of return and net present value methods is:

A)the reinvestment rate assumption regarding cash flows.
B)that neither method explicitly considers the time value of money.
C)the assumption made by the IRR method that intermediate cash flows are reinvested at the cost of capital.
D)the assumption made by the NPV method that intermediate cash flows are invested at the internal rate of return