Question 1

Given the following cash flows for project A: C0 = -1000, C1 = +600 ,C2 = +400, and C3 =
+1500, calculate the payback period.

Accepted Answer

In year 1, the cash flow is +600, which reduces the initial investment of -1000 to -400. In year 2, the cash flow is +400, reducing the remaining balance of -400 to 0. The payback period is therefore 2 years.

Question 2

The survey of CFOs indicates that IRR method is used for evaluating investment projects by:

Accepted Answer

The survey indicates that 76% of firms use the IRR method for evaluating investment projects.

Question 3

The net present value of a project depends upon:

Accepted Answer

The net present value (NPV) of a project depends strictly on the project's expected cash flows and the opportunity cost of capital. The NPV rule suggests that a company should invest in projects with positive NPV, as these projects are expected to generate higher returns than the opportunity cost of capital. The choice of accounting method or the manager's tastes and preferences do not affect the NPV of a project.

Question 4

Which of the following investment rules does not use the time value of the money concept?

Accepted Answer

The payback period does not use the concept of time value of money. It only calculates the amount of time required to recover the initial investment. However, net present value and internal rate of return both use time value of money to assess the present value of future cash flows.

Question 5

Which of the following investment rules may not use all possible cash flows in its calculations?

Accepted Answer

The payback period rule only considers the cash flows up to the point where the initial investment is repaid. It does not take into account any cash flows beyond that point. Therefore, it may not use all possible cash flows in its calculations. In contrast, NPV and IRR use all possible cash flows in their calculations.

Question 6

The following are measures used by firms when making capital budgeting decisions except:

Accepted Answer

The P/E ratio is a measure of a company's stock valuation and is not typically used in capital budgeting decisions, which focus on evaluating potential investments or projects. The other options listed (payback period, internal rate of return, and net present value) are commonly used measures in capital budgeting decisions.

Question 7

Which of the following statements regarding the discounted payback period rule is true?

Accepted Answer

The discounted payback rule takes into account the time value of money by using a discounted cash flow approach.

Question 8

Internal rate of return (IRR) method is also called:

Accepted Answer

The IRR method is also known as the discounted cash-flow rate of return method because it calculates the rate of return that makes the net present value of future cash flows equal to zero. Option A is incorrect because the discounted payback period method does not take into account the time value of money. Option C is incorrect because the modified internal rate of return method adjusts for the reinvestment of cash flows, while the IRR method assumes that cash flows are reinvested at the same rate as the initial investment. Option D is incorrect because there is an appropriate answer to the question.

Question 9

Given the following cash flows for project Z: C0 = -1,000, C1 = 600, C2 = 720 and C3 =
2000, calculate the discounted payback period for the project at a discount rate of 20%.

Accepted Answer

Discounted cash flows:
C0 = -1000
C1 = 500
C2 = 480
C3 = 1333.33

Using the formula for discounted payback period:
Payback period = Year before full recovery + (Unrecovered cost at start of year / Cash flow during year)

Year before full recovery = 2
Unrecovered cost at start of year 3 = 1200
Cash flow during year 3 = 2000

Payback period = 2 + (1200/2000) = 2.6 years

Since the discounted payback period is between 2 and 3 years, the closest option is B) 2 years.

Question 10

Suppose a firm has a $100 million in excess cash. It could:

Accepted Answer

All options are valid uses of excess cash: investing in positive NPV projects, paying dividends, or acquiring another firm.

Question 11

The payback period rule accepts all projects for which the payback period is:

Accepted Answer

The payback period rule accepts all projects for which the payback period is less than the cut-off value, indicating that the project will generate cash inflows in a shorter time period than expected. A longer payback period would result in a higher risk for the investor, as there is a greater uncertainty in the future cash flows. Therefore, a shorter payback period is preferred, making option B the best choice. Options A, C, and D are incorrect as they do not accurately reflect the payback period rule.

Question 12

The main advantage of the payback rule is:

Accepted Answer

The main advantage of the payback rule is that it is simple to use, making it a quick way to evaluate potential investments. However, it does not take into account the time value of money, which is a significant disadvantage. Therefore, while it may be a useful initial screening tool, it should not be relied on as the sole method of investment analysis.

Question 13

If the NPV of project A is + $120, and that of project B is -$40 and that of project C is +
$40, what is the NPV of the combined project?

Accepted Answer

The answer of If the NPV of project A is...

Question 14

The cost of a new machine is $250,000. The machine has a 3-year life and no salvage value. If the cash flow each year is equal to 40% of the cost of the machine, calculate the payback period for the project:

Accepted Answer

The annual cash flow is 40% of $250,000, which is $100,000. The payback period is the time it takes for the cash flows to cover the initial investment. After 2 years, $200,000 is recovered, and after 2.5 years, the full $250,000 is recovered.

Question 15

If the NPV of project A is + $30 and that of project B is + $60, then the NPV of the combined project is:

Accepted Answer

The answer of If the NPV of project A is...

Question 16

Which of the following investment rules has value adding-up property?

Accepted Answer

The net present value method has value adding-up property, which means that the total net present value of a series of investments is equal to the sum of the net present values of each individual investment. This property enables decision-makers to make choices that result in maximizing the total net present value of a project, which is the goal of most investment decisions. The payback period method, book rate of return method, and internal rate of return method do not have value adding-up property.

Question 17

If the net present value (NPV) of project A is + $100, and that of project B is + $60, then the net present value of the combined project is:

Accepted Answer

To find the net present value of the combined project, we add the net present values of project A and project B. 
NPV of combined project = NPV of project A + NPV of project B 
NPV of combined project = $100 + $60 
NPV of combined project = $160 
Therefore, the net present value of the combined project is +$160, which corresponds to choice C.

Question 18

The following are disadvantages of using the payback rule except:

Accepted Answer

This question asks for the disadvantage(s) of using the payback rule. Options A, B, and D all state valid disadvantages of the payback rule, but option C states an advantage instead of a disadvantage. Therefore, the best choice is option C.

Question 19

You are given a job to make a decision on project X, which is composed of three independent projects A, B, and C which have NPVs of + $70, -$40 and + $100, respectively. How would you go about making the decision about whether to accept or reject the project?

Accepted Answer

We should break up the project into its components and accept projects A and C while rejecting project B. This is because projects A and C have positive NPVs, while project B has a negative NPV. By accepting projects A and C and rejecting project B, we will maximize the overall NPV of the project.

Question 20

The survey of CFOs indicates that NPV method is always, or almost always, used for evaluating investment projects by:

Accepted Answer

According to the survey of CFOs, 75% of firms always or almost always use NPV method for evaluating investment projects.

Quiz 5: Net Present Value and Other Investment Criteria

Given the following cash flows for project A: C0 = -1000, C1 = +600 ,C2 = +400, and C3 = +1500, calculate the payback period.