Question 1

Sheakley Industries is considering expanding its current line of business and has developed the following expected cash flows for the project.Should this project be accepted based on the discounting approach to the modified internal rate of return if the discount rate is 13.4 percent? Why or why not?

Accepted Answer

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Question 2

Based on the profitability index rule, should a project with the following cash flows be accepted if the discount rate is 14 percent? Why or why not?

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Question 3

A project has an initial cost of $6,500.The cash inflows are $900, $2,200, $3,600, and $4,100 over the next four years, respectively.What is the payback period?

Accepted Answer

To calculate the payback period, we need to find out how long it takes for the cash inflows to recover the initial cost. We can do this by subtracting the cash inflows from the initial cost until we reach zero.

Year 1: $6,500 - $900 = $5,600
Year 2: $5,600 - $2,200 = $3,400
Year 3: $3,400 - $3,600 = -$200 (payback period)

Therefore, the payback period is 2 years + ($200/$3,600) = 2.94 years, which is closest to option C.

Question 4

The Green Fiddle is considering a project that will produce sales of $87,000 a year for the next 4 years.The profit margin is estimated at 6 percent.The project will cost $90,000 and will be depreciated straight-line to a book value of zero over the life of the project.The firm has a required accounting return of 11 percent.This project should be _____ because the AAR is _____ percent.

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Question 5

J&J Enterprises is considering an investment that will cost $318,000.The investment produces no cash flows for the first year.In the second year, the cash inflow is $47,000.This inflow will increase to $198,000 and then $226,000 for the following two years, respectively, before ceasing permanently.The firm requires a 15.5 percent rate of return and has a required discounted payback period of three years.Should the project be accepted? Why or why not?

Accepted Answer

The project should be rejected because it never pays back on a discounted basis.

Question 6

What is the profitability index for an investment with the following cash flows given a 14.5 percent required return?

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Question 7

Home Décor & More is considering a proposed project with the following cash flows.Should this project be accepted based on the combination approach to the modified internal rate of return if both the discount rate and the reinvestment rate are 16 percent? Why or why not?

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Question 8

The Square Box is considering two projects, both of which have an initial cost of $35,000 and total cash inflows of $50,000.The cash inflows of project A are $5,000, $10,000, $15,000, and $20,000 over the next four years, respectively.The cash inflows for project B are $20,000, $15,000, $10,000, and $5,000 over the next four years, respectively.Which one of the following statements is correct if The Square Box requires a 13 percent rate of return and has a required discounted payback period of 3.5 years?

Accepted Answer

Project B should be accepted because it has higher cash inflows in the earlier years, allowing it to meet the discounted payback period requirement of 3.5 years more easily than Project A, given the 13 percent rate of return requirement. The discounted payback period calculates the time required to break even in present value terms, favoring cash flows that occur earlier.

Question 9

Alicia is considering adding toys to her gift shop.She estimates that the cost of inventory will be $7,500.The remodeling expenses and shelving costs are estimated at $1,800.Toy sales are expected to produce net cash inflows of $2,300, $2,900, $3,200, and $3,400 over the next four years, respectively.Should Alicia add toys to her store if she assigns a three-year payback period to this project? Why or why not?

Accepted Answer

The total initial investment is $7,500 (inventory) + $1,800 (remodeling and shelving) = $9,300. The cash inflows over the first three years are $2,300 + $2,900 + $3,200 = $8,400. By the end of the third year, Alicia has not yet recovered her initial investment of $9,300, indicating the payback period is longer than 3 years. To find the exact payback period, we note that by the end of the third year, Alicia still needs $900 ($9,300 - $8,400) to break even. With a cash inflow of $3,400 in the fourth year, the additional time needed to recover the full investment is $900 / $3,400 = 0.26 years. Therefore, the total payback period is 3 years + 0.26 years = 3.26 years, which exceeds her three-year payback period criterion.

Question 10

A project has an initial cost of $18,400 and produces cash inflows of $7,200, $8,900, and $7,500 over three years, respectively.What is the discounted payback period if the required rate of return is 16 percent?

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Question 11

Scott is considering a project that will produce cash inflows of $2,100 a year for 4 years.The project has a 12 percent required rate of return and an initial cost of $6,000.What is the discounted payback period?

Accepted Answer

The discounted payback period is the time it takes for the discounted cash flows to pay back the initial investment. To find this, we discount each cash inflow at the required rate of return (12% in this case) and then cumulatively add these discounted cash flows until they equal or exceed the initial investment. Year 1: $2,100 / (1 + 0.12)^1 = $1,875.00Year 2: $2,100 / (1 + 0.12)^2 = $1,674.11Year 3: $2,100 / (1 + 0.12)^3 = $1,495.10Year 4: $2,100 / (1 + 0.12)^4 = $1,335.09Cumulative discounted cash flows:End of Year 1: $1,875.00End of Year 2: $3,549.11 ($1,875.00 + $1,674.11)End of Year 3: $5,044.21 ($3,549.11 + $1,495.10)End of Year 4: $6,379.30 ($5,044.21 + $1,335.09)The initial investment of $6,000 is recovered between Year 3 and Year 4. To find the exact time, we interpolate between these two years. The amount needed to recover at the start of Year 3 is $6,000 - $3,549.11 = $2,450.89. The amount available in Year 3 is $1,495.10, leaving $2,450.89 - $1,495.10 = $955.79 to be recovered in Year 4. The fraction of the year needed to recover this in Year 4 is $955.79 / $1,335.09 ≈ 0.72.Therefore, the discounted payback period is approximately 3 years + 0.72 = 3.72 years.

Question 12

You are considering two independent projects with the following cash flows.The required return for both projects is 16 percent.Given this information, which one of the following statements is correct?

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Question 13

Cool Water Drinks is considering a proposed project with the following cash flows.Should this project be accepted based on the combined approach to the modified internal rate of return if both the discount rate and the reinvestment rate are 12.6 percent? Why or why not?

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Question 14

You would like to invest in the following project.  Sis, your boss, insists that only projects returning at least $1.06 in today's dollars for every $1 invested can be accepted.She also insists on applying a 14 percent discount rate to all cash flows.Based on these criteria, you should:

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Question 15

It will cost $6,000 to acquire an ice cream cart.Cart sales are expected to be $3,600 a year for three years.After the three years, the cart is expected to be worthless as the expected life of the refrigeration unit is only three years.What is the payback period?

Accepted Answer

Payback period = $6,000/$3,600 = 1.67 years

Question 16

You are considering a project with an initial cost of $7,500.What is the payback period for this project if the cash inflows are $1,100, $1,640, $3,800, and $4,500 a year over the next four years, respectively?

Accepted Answer

The payback period is calculated by adding the cash inflows each year until the initial investment is recovered. Here, the cumulative cash inflows are: Year 1: $1,100, Year 2: $1,100 + $1,640 = $2,740, Year 3: $2,740 + $3,800 = $6,540, and Year 4: $6,540 + $4,500 = $11,040. The initial investment of $7,500 is recovered between Year 3 and Year 4. To find the exact payback period: $7,500 - $6,540 = $960 to be recovered in Year 4. $960/$4,500 = 0.213 years. Adding this to the 3 years gives a payback period of 3.21 years.

Question 17

A project has an initial cost of $32,000 and a 3-year life.The company uses straight-line depreciation to a book value of zero over the life of the project.The projected net income from the project is $1,200, $2,300, and $1,800 a year for the next 3 years, respectively.What is the average accounting return?

Accepted Answer

The average accounting return (AAR) is calculated as the average net income divided by the average book value. The initial cost is $32,000, and it depreciates to $0 over 3 years, so the average book value is $32,000/2 = $16,000 (since it's a straight-line depreciation to zero, the midpoint value is used). The average net income over the 3 years is ($1,200 + $2,300 + $1,800) / 3 = $1,766.67. Therefore, AAR = ($1,766.67 / $16,000) * 100 = 11.04 percent.

Question 18

Blue Water Systems is analyzing a project with the following cash flows.Should this project be accepted based on the discounting approach to the modified internal rate of return if the discount rate is 14 percent? Why or why not?

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Question 19

You are considering an investment with the following cash flows.If the required rate of return for this investment is 15.5 percent, should you accept the investment based solely on the internal rate of return rule? Why or why not?

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Question 20

An investment has the following cash flows and a required return of 13 percent.Based on IRR, should this project be accepted? Why or why not?

Accepted Answer

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Quiz 9: Making Capital Investment Decisions