Deck 8: Net Present Value and Other Investment Criteria

Question 1

Unlike using IRR, selecting projects according to their NPV will always lead to a correct accept-reject decision.

Answer 1

True

Question 2

The payback rule states that a project is acceptable if you get your money back within a specified period.

Answer 2

True

Question 3

A risky dollar is worth more than a safe one.

Answer 3

False

Question 4

As the opportunity cost of capital decreases, the net present value of a project increases.

Question 5

Projects with an NPV of zero decrease shareholders' wealth by the cost of the project.

Question 6

The IRR is the rate of return on the cash flows of the investment, also known as the opportunity cost of capital.

Question 7

Because of deficiencies associated with the payback method, it is seldom used in corporate financial analysis today.

Question 8

Soft rationing should never cost the firm anything.

Question 9

A project's payback period is the length of time necessary to generate an NPV of zero.

Question 10

For most managers, discounted cash-flow analysis is in fact the dominant tool for project evaluation.

Question 11

Both the NPV and the internal rate of return methods recognize that the timing of cash flows affects project value.

Question 12

When calculating IRR with a trial and error process, discount rates should be raised when NPV is positive.

Question 13

For mutually exclusive projects, the project with the higher IRR is the correct selection.

Question 14

When we compare assets with different lives, we should select the machine that has the lowest equivalent annual cost.

Question 15

The payback rule always makes shareholders better off.

Question 16

If a project has multiple IRRs, the highest one is assumed to be correct.

Question 17

When using a profitability index to select projects, a value of .63 is preferred over a value of 0.21.

Question 18

For many firms the limits on capital funds are "soft." By this we mean that the capital rationing is not imposed by investors.

Question 19

The payback period considers all project cash flows.

Question 20

When choosing among mutually exclusive projects, the choice is easy using the NPV rule. As long as at least one project has positive NPV, simply choose the project with the highest NPV.

Question 21

Which of the following projects would you feel safest in accepting? Assume the opportunity cost of capital to be 12% for each project.

A) "A" has a small, but negative, NPV.
B) "B" has a positive NPV when discounted at 10%.
C) "C's" cost of capital exceeds its rate of return.
D)"D" has a zero NPV when discounted at 14%.

Question 22

What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%?

A) $13,397.57
B) $14,473.44
C) $16,081.60
D)$33,748.58

Question 23

If the net present value of a project that costs $20,000 is $5,000 when the discount rate is 10%, then the:

A) project's IRR equals 10%.
B) project's rate of return is greater than 10%.
C) net present value of the cash inflows is $4,500.
D)project's cash inflows total $25,000.

Question 24

Firms that make investment decisions based on the payback rule may be biased toward rejecting projects:

A) with short lives.
B) with long lives.
C) with late cash inflows.
D)that have negative NPVs.

Question 25

The internal rate of return is most reliable when evaluating:

A) a single project with alternating cash inflows and outflows over several years.
B) mutually exclusive projects of differing sizes.
C) a single project with only cash inflows following the initial cash outflow.
D)a single project with cash outflows at time 0 and the final year and inflows in all other time periods.

Question 26

What is the maximum amount a firm should pay for a project that will return $15,000 annually for 5 years if the opportunity cost is 10%?

A) $24,157.65
B) $56,861.80
C) $62,540.10
D)$48,021.19

Question 27

The decision rule for net present value is to:

A) accept all projects with cash inflows exceeding the initial cost.
B) reject all projects with rates of return exceeding the opportunity cost of capital.
C) accept all projects with positive net present values.
D)reject all projects lasting longer than 10 years.

Question 28

When a project's internal rate of return equals its opportunity cost of capital, then the:

A) project should be rejected.
B) project has no cash inflows.
C) net present value will be positive.
D)net present value will be zero.

Question 29

Which one of the following changes will increase the NPV of a project?

A) A decrease in the discount rate
B) A decrease in the size of the cash inflows
C) An increase in the initial cost of the project
D)A decrease in the number of cash inflows

Question 30

When you are considering whether to replace an aging machine with a new one, you should compare the annual cost of operating the old one with the equivalent annual annuity of the new one.

Question 31

Which one of the following statements is correct for a project with a positive NPV?

A) The IRR must be greater than 0.
B) Accepting the project has an indeterminate effect on shareholders.
C) The discount rate exceeds the cost of capital.
D)The profitability index equals 1.

Question 32

One method that can be used to increase the NPV of a project is to decrease the:

A) project's payback period.
B) profitability index.
C) time until the receipt of cash inflows.
D)number of project IRRs.

Question 33

A project's opportunity cost of capital is:

A) the foregone return from investing in the project.
B) the return earned by investing in the project.
C) equal to the average return on all company projects.
D)designed to be less than the project's IRR.

Question 34

What is the maximum that should be invested in a project at time zero if the inflows are estimated at $50,000 annually for 3 years, and the cost of capital is 9%?

A) $101,251.79
B) $109,200.00
C) $126,564.73
D)$130,800.00

Question 35

When you have to choose between projects with different lives, you should put them on an equal footing by computing the equivalent annual annuity or benefit of the two projects.

Question 36

When a manager does not accept a positive-NPV project, shareholders face an opportunity cost in the amount of the:

A) project's initial cost.
B) project's NPV.
C) project's discounted cash inflows.
D)soft capital rationing budget.

Question 37

The modified internal rate of return can be used to correct for:

A) negative NPV calculations.
B) multiple internal rates of return.
C) undefined payback periods.
D)borrowing projects.

Question 38

What should occur when a project's net present value is determined to be negative?

A) The discount rate should be decreased.
B) The profitability index should be calculated.
C) The present value of the project cost should be determined.
D)The project should be rejected.

Question 39

As the discount rate is increased, the NPV of a specific project will:

A) increase.
B) decrease.
C) remain constant.
D)decrease to zero, then remain constant.

Question 40

If the opportunity cost of capital for a lending project exceeds the project's IRR, then the project has a(n):

A) positive NPV.
B) negative NPV.
C) acceptable payback period.
D)positive profitability index.

Question 41

What is the minimum number of years in which an investment costing $210,000 must return $65,000 per year at a discount rate of 13% in order to be an acceptable investment?

A) 8.69 years
B) 5.37 years
C) 7.51 years
D)4.46 years

Question 42

What is the IRR for a project that costs $100,000 and provides annual cash inflows of $30,000 for 6 years starting one year from today?

A) 19.91%
B) 16.67%
C) 15.84%
D)22.09%

Question 43

A project can have as many different internal rates of return as it has:

A) cash inflows.
B) cash outflows.
C) periods of cash flow.
D)changes in the sign of the cash flows.

Question 44

As long as the NPV of a project declines smoothly with increases in the discount rate, the project is acceptable if its:

A) internal rate of return is positive.
B) payback period is greater than one.
C) rate of return exceeds the cost of capital.
D)cash inflows equal the initial cost.

Question 45

When projects are mutually exclusive, selection should be made according to the project with the:

A) longer life.
B) larger initial size.
C) highest IRR.
D)highest NPV.

Question 46

Which mutually exclusive project would you select, if both are priced at $1,000 and your required return is 15%: Project A with three annual cash flows of $1,000; or Project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually?

A) Project A
B) Project B
C) You are indifferent since the NPVs are equal.
D)Neither project should be selected.

Question 47

Why may the IRR criterion lead to an incorrect decision when applied to mutually exclusive projects?

A) The NPVs of mutually exclusive projects cross over at some discount rate.
B) Cash flows cannot be discounted when considering mutually exclusive projects.
C) Mutually exclusive projects produce negative IRR values.
D)Mutually exclusive projects have multiple IRRs.

Question 48

Evaluate the following project using an IRR criterion, based on an opportunity cost of 10%: C₀ = -$6,000, C₁ = $3,300, C₂ = $3,300.

A) Accept; because the IRR exceeds the opportunity cost
B) Reject; because the opportunity cost exceeds the IRR
C) Accept; because the opportunity cost exceeds the IRR
D)Reject; because the IRR exceeds the opportunity cost

Question 49

When will you be indifferent between two mutually exclusive projects of similar size?

A) When the required return on the projects is equal to the crossover discount rate
B) When the time period of the projects are equal
C) When both projects have only cash inflows following the initial cash outflow
D)When both projects have IRR's that exceed the crossover discount rate

Question 50

How many IRRs are possible for the following set of cash flows? CF₀ = -$1,000, C₁ = $500, C₂ = -$300, C₃ = $1,000, C₄ = $200.

A) One
B) Two
C) Three
D)Four

Question 51

What is the NPV for the following project cash flows at a discount rate of 15%? C₀ = ($1,000), C₁ = $700, C₂ = $700.

A) ($308.70)
B) ($138.00)
C) $138.00
D)$308.70

Question 52

If a project costs $72,000 and returns $18,500 per year for 5 years, what is its IRR?

A) 8.98%
B) 7.39%
C) 8.50%
D)7.67%

Question 53

You are analyzing a project that is equivalent to borrowing money. This project's:

A) NPV graph rises as discount rates decrease.
B) initial cash flow is an outflow of funds.
C) value increases when the cost of capital increases.
D)acceptance requires its IRR to exceed the cost of capital.

Question 54

When mutually exclusive projects have different lives, the project that should be selected will have the:

A) highest IRR.
B) longest life.
C) lowest equivalent annual cost.
D)highest NPV, discounted at the opportunity cost of capital.

Question 55

When managers select correctly from among mutually exclusive projects, they:

A) may give up rate of return for NPV.
B) may give up NPV for rate of return.
C) have a tendency to select the largest project.
D)focus on the payback method to avoid conflicting signals.

Question 56

A project costing $20,000 generates cash inflows of $9,000 annually for the first 3 years, followed by cash outflows of $1,000 annually for 2 years. At most, this project has ______ different IRR(s).

A) one
B) two
C) three
D)five

Question 57

What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years?

A) 0.57%
B) 1.21%
C) 5.69%
D)12.10%

Question 58

If the IRR for a project is 15%, then the project's NPV would be:

A) negative at a discount rate of 10%.
B) positive at a discount rate of 20%.
C) negative at a discount rate of 20%.
D)positive at a discount rate of 15%.

Question 59

When managers cannot determine whether to invest now or wait until costs decrease later, the rule should be to:

A) postpone until costs reach their lowest level.
B) invest now to maximize the NPV.
C) postpone until the opportunity cost reaches its lowest level.
D)invest at the date that provides the highest NPV today.

Question 60

Given a particular set of project cash flows, which one of the following statements must be correct?

A) There can be only one NPV for the project, even with multiple discount rates.
B) There can be only one IRR for the project.
C) There can be more than one IRR for the project.
D)There can be only one profitability index for the project, even with multiple discount rates.

Question 61

Use of a profitability index to evaluate mutually exclusive projects in the absence of capital rationing:

A) will provide the same rankings as an NPV criterion.
B) will maximize NPV, but not IRR.
C) can result in misguided selections.
D)is technically impossible.

Question 62

For mutually exclusive projects, the IRR can be used to select the best project:

A) by calculating the modified internal rate of return.
B) by calculating the IRR based on incremental cash flows.
C) by using the discount rate to calculate the IRR.
D)never. IRR cannot be utilized for mutually exclusive projects.

Question 63

Which of the following statements is true for a project with a $20,000 initial cost, cash inflows of $5,800 per year for 6 years, and a discount rate of 15%?

A) Its payback period is 3.45 years.
B) Its NPV is $2,094.
C) Its IRR is 17.85%.
D)Its profitability index is 0.104.

Question 64

The profitability index selects projects based on the:

A) highest net discounted value at time zero.
B) highest internal rate of return.
C) largest dollar investment per rate of return.
D)largest return per dollar invested.

Question 65

A project with an IRR that is less than the opportunity cost of capital should be:

A) accepted for all project types.
B) accepted for all lending projects.
C) accepted for all borrowing projects.
D)rejected for all projects.

Question 66

Which one of the following should be assumed about a project that requires a $100,000 investment at time zero, then returns $20,000 annually for 5 years?

A) The NPV is negative.
B) The NPV is zero.
C) The profitability index is 1.0.
D)The IRR is negative.

Question 67

Borrowing and lending projects usually can be distinguished by whether:

A) they have positive or negative IRRs.
B) the time-zero cash flow is positive or negative.
C) their IRR increases as the discount rate increases.
D)their rate of return is high or low.

Question 68

Which of the following investment decision rules tends to improperly reject long-lived projects?

A) Net present value
B) Internal rate of return
C) Payback period
D)Profitability index

Question 69

Which of the following investment criteria takes the time value of money into consideration?

A) Net present value only
B) Profitability index and net present value only
C) Internal rate of return and net present value only
D)Profitability index, internal rate of return, and net present value

Question 70

If a project's expected rate of return exceeds its opportunity cost of capital, one would expect:

A) the profitability index to exceed 1.0.
B) the opportunity cost of capital to be too low.
C) the IRR to exceed the opportunity cost of capital.
D)the NPV to be zero.

Question 71

What is the profitability index for a project costing $40,000 and returning $15,000 annually for 4 years at an opportunity cost of capital of 12%?

A) 0.139
B) 0.320
C) 0.500
D)0.861

Question 72

When calculating a project's payback period, cash flows are discounted at:

A) the opportunity cost of capital.
B) the internal rate of return.
C) the risk-free rate of return.
D)a discount rate of zero.

Question 73

When hard capital rationing exists, projects may be accurately evaluated by use of:

A) the payback period.
B) mutually exclusive IRRs.
C) a profitability index.
D)borrowing, rather than lending, projects.

Question 74

Which one of the following best illustrates the problem imposed by capital rationing?

A) Accepting projects with the highest NPVs first
B) Accepting projects with the highest IRRs first
C) Bypassing projects that have positive NPVs
D)Bypassing projects that have zero IRRs

Question 75

If a project has a cost of $50,000 and a profitability index of .4, then:

A) its cash inflows are $70,000.
B) the present value of its cash inflows is $20,000.
C) its IRR is 20%.
D)its NPV is $20,000.

Question 76

The opportunity cost of capital is equal to:

A) the discount rate that makes the project NPV equal zero.
B) the return offered by other projects of equal risk.
C) a project's internal rate of return.
D)the average rate of return for a firm's projects.

Question 77

Soft capital rationing:

A) is costly to shareholders.
B) is used to evaluate mutually exclusive projects.
C) should be costless to the shareholders of the firm.
D)solves the problem of investment timing.

Question 78

The ratio of net present value to initial investment is known as the:

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

Question 79

The "gold standard" of investment criteria refers to the:

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

Question 80

Soft capital rationing is imposed upon a firm from _____ sources, while hard capital rationing is imposed from _____ sources.

A) internal; external
B) internal; internal
C) external; internal
D)external; external