Question 1

What is the discounted payback period of a project whose profitability index is higher than 1?

Accepted Answer

If the profitability index is higher than 1, it means that the present value of future cash flows is greater than the initial investment. This means that the project will generate enough cash flows to pay back the initial investment before the end of the project lifetime, and therefore, the discounted payback period will be less than the project lifetime.

Question 2

Consider a ten-year project that costs $40,000 today, which is expected to generate $6,000 at the end of the second year and then the cash flows will increase by $1,000 for three years and then stagnate for the rest of the project life.The cost of capital is 8%.What is discounted payback period?

Accepted Answer

The answer of Consider a ten-year project that costs $40,000...

Question 3

Consider a ten-year project that costs $40,000 today, which is expected to generate $6,000 at the end of the second year and then the cash flows will increase by $1,000 for three years and then stagnate for the rest of the project life.The cost of capital is 8%.What is the project's IRR?

Accepted Answer

The project's IRR is calculated by finding the discount rate that makes the net present value (NPV) of the cash flows equal to zero. The cash flows are $6,000 at the end of year 2, $7,000 at the end of year 3, $8,000 at the end of year 4, $9,000 at the end of year 5, and $9,000 for the remaining years until year 10. Solving for the IRR using these cash flows results in approximately 11.17%.

Question 4

What is the discounted payback period of a project whose NPV is negative?

Accepted Answer

The discounted payback period is the length of time it takes for the discounted cash inflows to equal the initial investment. If the NPV is negative, it means that the initial investment exceeds the discounted cash inflows. Therefore, the discounted payback period will be longer than the project lifetime. Choice C is the only option that reflects this.

Question 5

What is the project's NPV if it requires an initial cash outlay of $50,000 and pays $8,000 per year indefinitely? Assume the appropriate discount rate is 15%.Ignore income taxes for this question.

Accepted Answer

The answer of What is the project's NPV if it...

Question 6

Consider a project that requires an investment of $22,500 today and pays $5,250 per year for ten years.What is the payback period of the project? Assume the cost of capital is 12%.

Accepted Answer

The payback period is calculated by dividing the initial investment by the annual cash inflow. $22,500 / $5,250 = 4.29 years.

Question 7

Suppose project Acquisition and project Merger are mutually exclusive.Project Acquisition requires an initial cash outlay of $50,000 and is expected to provide after-tax cash flows of $15,000 in year 1, $25,000 in year 2, $20,000 in year 3, and $15,000 in year 4.Project Merger requires an initial cash outlay of $75,000 and is expected to provide after-tax cash flows of $20,000 in year 1, $28,000 in year 2, $35,000 in year 3, and $20,000 in year 4.The appropriate discount rate is 12%.What is the crossover rate?

Accepted Answer

The crossover rate is the discount rate at which the NPVs of the two projects are equal. To find the crossover rate, we can set the NPV of Project Acquisition equal to the NPV of Project Merger and solve for the discount rate.The NPV of Project Acquisition is:NPV = -50,000 + 15,000/(1+r) + 25,000/(1+r)^2 + 20,000/(1+r)^3 + 15,000/(1+r)^4The NPV of Project Merger is:NPV = -75,000 + 20,000/(1+r) + 28,000/(1+r)^2 + 35,000/(1+r)^3 + 20,000/(1+r)^4Setting the two NPVs equal to each other, we get:-50,000 + 15,000/(1+r) + 25,000/(1+r)^2 + 20,000/(1+r)^3 + 15,000/(1+r)^4 = -75,000 + 20,000/(1+r) + 28,000/(1+r)^2 + 35,000/(1+r)^3 + 20,000/(1+r)^4Simplifying, we get:25,000 = 20,000/(1+r) + 3,000/(1+r)^2 + 15,000/(1+r)^3 + 5,000/(1+r)^4Using a financial calculator, we can solve for the discount rate that makes the two NPVs equal. The crossover rate is approximately 4.30%.

Question 8

Use the following statements to answer this question:
I.The payback period is always longer than the discounted payback period.
II.Both the discounted payback and payback period ignore cash flows beyond the cut-off period.

Accepted Answer

I is correct because the discounted payback period considers the time value of money, which results in a shorter payback period compared to the payback period. II is also correct because both methods only consider cash flows up to the cut-off period.

Question 9

What is the IRR of a project that requires an initial cash outlay of $12,345 and is expected to generate cash flows of $3,600 a year for three years and then $4,200 a year for two more years? Assume the tax rate is zero.

Accepted Answer

To calculate the IRR, we need to find the discount rate that makes the present value of the cash inflows equal to the initial cash outlay.

Using a financial calculator or Excel, we can find that the IRR of this project is 16.20%. Therefore, the best choice is C.

Question 10

Consider a ten-year project that costs $40,000 today, which is expected to generate $6,000 at the end of the second year and then the cash flows will increase by $1,000 for three years and then stagnate for the rest of the project life.The cost of capital is 8%.What is the project's NPV?

Accepted Answer

The project's NPV is calculated by discounting each cash flow back to the present value using the cost of capital (8%) and summing them up, then subtracting the initial investment. The cash flows are $6,000 at year 2, $7,000 at year 3, $8,000 at year 4, $9,000 at year 5, and $9,000 from year 6 to year 10. The correct NPV is $7,162.69.

Question 11

What is the discounted payback period of a project whose NPV is positive?

Accepted Answer

The discounted payback period is the time it takes for the cumulative discounted cash flows to equal the initial investment. If the NPV is positive, it means the project is expected to generate more cash inflows than outflows. Therefore, the discounted payback period will be less than the project lifetime because the project is generating positive cash flows earlier than the end of the project lifetime.

Question 12

Which of the following methods does not consider the time value of the money?

Accepted Answer

Payback period does not consider the time value of the money, as it only looks at the length of time it takes to recoup an investment rather than the present value of future cash flows. Net present value and internal rate of return both take into account the time value of money by discounting future cash flows to their present value.

Question 13

Rank the following four independent investment projects using IRR.Ranking choices are shown from highest IRR to lowest IRR:

Accepted Answer

The answer of Rank the following four independent investment projects...

Question 14

Consider a project that requires an investment of $28,000 today and generates after-tax cash flows of $10,000 per year for the next four years.The appropriate discount rate is 15%.What are the NPV and IRR for this investment?

Accepted Answer

The answer of Consider a project that requires an investment...

Question 15

What is the payback period of a project whose NPV is positive?

Accepted Answer

If a project has a positive NPV, it means that the project is profitable and should be accepted. Therefore, the payback period should be less than the project lifetime as the project will pay back its initial investment before the end of its lifetime.

Question 16

A company is considering two mutually exclusive projects Adept and Boffo.Project Adept requires an initial investment of $100,000 and is expected to generate after-tax cash flows of $45,000 per year for three years.Project Boffo requires an initial investment of $150,000 and is expected to generate after-tax cash flows of $50,000 per year for four years.The appropriate discount rate is 10%.What is the crossover rate for projects Adept and Boffo?

Accepted Answer

To find the crossover rate, we need to find the discount rate at which the net present value (NPV) of both projects is equal.

NPV for Project Adept: 
Year 1: $45,000/(1+10%)^1 = $40,909
Year 2: $45,000/(1+10%)^2 = $37,172
Year 3: $45,000/(1+10%)^3 = $33,793
NPV = -$100,000 + $40,909 + $37,172 + $33,793 = $11,874

NPV for Project Boffo:
Year 1: $50,000/(1+10%)^1 = $45,455
Year 2: $50,000/(1+10%)^2 = $41,322
Year 3: $50,000/(1+10%)^3 = $37,566
Year 4: $50,000/(1+10%)^4 = $34,155
NPV = -$150,000 + $45,455 + $41,322 + $37,566 + $34,155 = $8,498

We can use a financial calculator or excel to find the discount rate at which the NPVs of both projects are equal. The crossover rate is approximately 7.77%.

Therefore, Project Boffo is the best choice since it has a higher NPV and generates more cash flows over a longer period of time.

Question 17

Consider a five-year project that costs $20,000 today, which is expected to generate $6,000 at the end of the second year and then the cash flows will increase by $1,000 per year for each of the remaining years.The cost of capital is 8%.What are the NPV and IRR for this project?

Accepted Answer

To calculate the NPV, we need to discount each cash flow to the present value using the cost of capital of 8%.

The cash flow for year 0 is -$20,000 (the cost of the project).

The cash flow for year 1 is $0 (there is no cash flow in the first year).

The cash flow for year 2 is $6,000.

The cash flow for year 3 is $7,000.

The cash flow for year 4 is $8,000.

The cash flow for year 5 is $9,000.

Using the formula for calculating NPV:

NPV = CF0 + (CF1 / (1+r)^1) + (CF2 / (1+r)^2) + ... + (CFn / (1+r)^n)

where CF0 is the cash flow at time 0, r is the discount rate (or cost of capital), and CF1 to CFn are the cash flows in years 1 to n.

NPV = -$20,000 + ($6,000 / (1+0.08)^2) + ($7,000 / (1+0.08)^3) + ($8,000 / (1+0.08)^4) + ($9,000 / (1+0.08)^5)

NPV = -$20,000 + $5,098.04 + $5,402.43 + $5,611.43 + $5,717.45

NPV = $2,706.35

To calculate the IRR, we need to find the discount rate that makes the NPV equal to zero. This can be done using a trial-and-error approach or an Excel formula such as IRR.

Using Excel, we can calculate the IRR by inputting the cash flows (negative for the initial investment) into a column and then using the IRR formula:

=IRR(B1:B6)

where B1 to B6 are the cells containing the cash flows.

The calculated IRR is 11.93%.

Therefore, the best choice is B because it has the highest NPV among the answer choices and the IRR is higher than the cost of capital, indicating that the project is expected to generate a return greater than the cost of capital.

Question 18

What is the approximate IRR of a project that requires an investment of $9,900 today and will generate $1,500 per year for ten years and an additional $10,000 at the end of the tenth year?

Accepted Answer

The answer of What is the approximate IRR of a...

Question 19

Which of the following capital budgeting analysis methods may not use all possible cash flows in its calculations?

Accepted Answer

The payback method only considers the initial investment and the cash inflows received up to the point where the initial investment is recovered. It does not take into account the cash flows beyond the payback period, so it may not use all possible cash flows in its calculations. NPV and IRR, on the other hand, consider all cash flows over the entire life of the project.

Question 20

What is the payback period of a project that requires an initial cash outlay of $16,000 and provides cash flows of $4,500 in year 1, $5,500 in year 2, $6,500 in year 3, and $7,500 in year 4? Assume the appropriate discount rate is 10%.

Accepted Answer

The answer of What is the payback period of a...

Quiz 13: Capital Budgeting, Risk Considerations, and Other Special Issues