Question 1

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.

Accepted Answer

If a project's net present value is negative, it means that the project's expected cash inflows are not sufficient to cover the initial investment and generate a positive return. In this case, it's best to reject the project as it would lead to a loss. The other options such as decreasing the discount rate, calculating the profitability index, or determining the present value of the project cost won't change the fact that the project is not profitable.

Question 2

Which of the following should be assumed about a project that requires a $100,000 investment at time-period zero, then returns $20,000 annually for five years?
A)the NPV is negative
B)the NPV is zero
C)the profitability index is 1.0
D)the IRR is negative

Accepted Answer

The NPV is likely negative because the sum of the present values of the annual returns ($20,000 for five years) is unlikely to exceed the initial investment of $100,000, especially when considering the time value of money and a positive discount rate.

Question 3

Project A has an IRR of 20 percent while Project B has an IRR of 30 percent.Under which of the following situations might you be inclined to select Project A, assuming the projects to be mutually exclusive, lending projects?
A)Project A is more risky.
B)Project A requires a smaller initial investment.
C)Project A requires a larger initial investment.
D)Project A requires cash outflows in the final period.

Accepted Answer

If Project A requires a larger initial investment, it might be preferred if the scale of the investment is significant enough to generate more total value despite a lower IRR.

Question 4

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

Accepted Answer

Soft capital rationing implies internal restrictions set by the firm's management on the available budget for investment projects, which ideally should not impose additional costs on shareholders. It's a strategic decision to manage resources efficiently without directly impacting shareholder value through external financing costs or risks.

Question 5

When a Project's internal rate of return equals its opportunity cost of capital, then:
A)the project should be rejected.
B)the project has no cash inflows.
C)the net present value will be positive.
D)the net present value will be zero.

Accepted Answer

When a project's internal rate of return equals its opportunity cost of capital, the net present value will be zero. This means that the project is neither adding nor subtracting value from the firm, but is just earning the required rate of return. Therefore, the project can be considered acceptable, but not necessarily the best use of funds.

Question 6

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

Accepted Answer

The payback period rule tends to improperly reject long-lived projects because it only considers the time it takes to recover the initial investment and ignores any cash flows beyond the payback period. This can lead to the rejection of projects with positive net present values or profitability indexes. The other investment decision rules (net present value, internal rate of return, and profitability index) take into account all cash flows over the entire life of the project and thus are less likely to improperly reject long-lived projects.

Question 7

The investment timing decision is aimed at analyzing whether the:
A)cash flows occur at the beginning or end of a year.
B)payback period or NPV analysis should be used.
C)project is a borrowing or lending project.
D)investment should occur now or at some future point.

Accepted Answer

The investment timing decision involves analyzing whether the investment should be made now or at some future point. This decision is crucial as it affects the potential returns and risks associated with the investment. Factors that need to be considered when making this decision include the current economic climate, market trends, interest rates, and the availability of funds. Therefore, Option D is the best choice.

Question 8

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)net present value does not equal zero.
C)rate of return exceeds the cost of capital.
D)cash inflows exceed the initial cost.

Accepted Answer

A declining NPV with increasing discount rates indicates that the project's rate of return is lower than the cost of capital. If the project's rate of return (or internal rate of return) exceeds the cost of capital, then the project is still generating a positive return despite the increasing discount rates, making it acceptable. Therefore, choice C is the correct answer. However, choices A, B, and D do not necessarily guarantee project acceptability and are not the best choices.

Question 9

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.
B)invest now to maximize the NPV.
C)postpone until the opportunity cost reaches its lowest.
D)invest at the date that gives the highest NPV today.

Accepted Answer

The correct approach is to invest at the date that gives the highest Net Present Value (NPV) today. This method ensures that the investment maximizes the present value of future cash flows, taking into account the time value of money and opportunity costs.

Question 10

As the discount rate is increased, the NPV of a specific project will:
A)increase
B)decrease
C)remain constant
D)decrease to zero, and then remain constant

Accepted Answer

NPV is calculated by discounting future cash flows back to the present using a discount rate. As the discount rate is increased, the present value of those future cash flows decreases, which reduces the overall NPV. Therefore, the NPV of a specific project will decrease as the discount rate is increased.

Question 11

According to the NPV rule, all projects should be accepted if NPV is positive when discounted at the:
A)internal rate of return.
B)opportunity cost of capital.
C)risk-free interest rate.
D)accounting rate of return.

Accepted Answer

The NPV rule states that a project should be accepted if its net present value (NPV) is positive. The discount rate used to calculate the NPV should be the opportunity cost of capital, which is the rate of return that investors could earn by investing in another project with similar risk. Therefore, the correct answer is B. Choice letter A is incorrect because the internal rate of return (IRR) is the discount rate at which the NPV of the project is zero, and projects should be accepted if their IRR is higher than the opportunity cost of capital. Choice letter C is incorrect because the risk-free interest rate is used as a benchmark to evaluate the expected return of risky projects or investments, but it is not the discount rate used to calculate the NPV. Choice letter D is incorrect because the accounting rate of return (ARR) is a non-discounted measure of profitability that uses accounting income instead of cash flows, and it does not consider the time value of money or the opportunity cost of capital.

Question 12

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.

Accepted Answer

The expected rate of return is another term for the internal rate of return (IRR) of a project. If the IRR exceeds the opportunity cost of capital, it means the project is generating returns greater than what can be earned on alternative investments with similar risk. This is a good indication that the project is profitable and should be undertaken. Therefore, the correct answer is C, the IRR to exceed the opportunity cost of capital.

Question 13

Which of the following statements is correct for a project with a positive NPV?
A)IRR exceeds the cost of capital.
B)Accepting the project has an indeterminate effect on shareholders.
C)The discount rate exceeds the cost of capital.
D)The profitability index equals one.

Accepted Answer

A positive NPV indicates that the project is expected to generate positive cash flows in excess of the required rate of return. IRR is the rate at which the project's NPV equals zero, so if the project has a positive NPV, the IRR must exceed the cost of capital. Therefore, statement A is correct. Statement B is incorrect because accepting a project with a positive NPV will generally have a positive effect on shareholders. Statement C is incorrect because the cost of capital is the required rate of return, so it cannot be less than the discount rate. Statement D is incorrect because the profitability index is calculated by dividing the present value of future cash flows by the initial investment, so it can be greater than one for projects with positive NPVs.

Question 14

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 flows.
D)Soft capital rationing budget.

Accepted Answer

The NPV represents the present value of the project's expected cash inflows minus the initial cost. If a positive-NPV project is rejected, it means that the company is giving up potential profits and shareholder wealth. Therefore, shareholders face an opportunity cost equal to the project's NPV.

Question 15

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.

Accepted Answer

A project can have multiple internal rates of return when there are changes in the sign of the cash flows (i.e. alternating positive and negative cash flows). This is because the formula for calculating internal rate of return involves finding the discount rate that makes the net present value of the cash flows equal to zero. When there are multiple changes in the sign of the cash flows, there can be multiple discount rates that satisfy this condition, resulting in multiple internal rates of return.

Question 16

In order for a manager to correctly decide to postpone an investment until one year into the future, the NPV of the investment should:
A)grow more rapidly than the IRR.
B)grow more rapidly than the cost of capital.
C)not decrease.
D)remain stable.

Accepted Answer

The correct decision to postpone an investment until one year into the future is when the NPV (Net Present Value) of the investment is expected to grow more rapidly than the cost of capital. This indicates that waiting will potentially yield a higher return than the current cost of investing the capital elsewhere.

Question 17

The "gold standard" of investment criteria refers to:
A)net present value.
B)internal rate of return.
C)payback period.
D)profitability index.

Accepted Answer

The "gold standard" of investment criteria is net present value (NPV), which takes into account the time value of money and provides a measure of the project's profitability in today's dollars. Internal rate of return (IRR), payback period, and profitability index (PI) are other popular investment criteria, but they do not always provide a clear picture of a project's profitability or value. NPV is considered the most accurate metric for evaluating investment opportunities.

Question 18

A Project's payback period is determined to be four years.If it is later discovered that additional cash flows will be generated in years five and six, then:
A)the Project's payback period will be reduced.
B)the Project's payback period will be increased.
C)the Project's payback period will be unchanged.
D)the discount rate must be known to determine whether the payback period changes.

Accepted Answer

The payback period is the time it takes for a project to recover its initial investment from its cash inflows. Additional cash flows beyond the payback period do not affect the calculation of the payback period itself, which is solely concerned with reaching the break-even point.

Question 19

The appropriate discount rate for a firm is:
A)the bank rate.
B)its opportunity cost of capital.
C)the prime rate.
D)its depreciation rate.

Accepted Answer

The appropriate discount rate for a firm is its opportunity cost of capital, which represents the return an investor could earn in the best available alternative investment of equal risk. It takes into account the cost of financing the investment with debt or equity, as well as the risk associated with the investment. The bank rate, prime rate, and depreciation rate are not appropriate discount rates for a firm as they do not account for the specific risk and opportunity cost of capital of the investment.

Question 20

When graphing NPV at different discount rates for mutually exclusive projects, the project with the lower IRR should be selected whenever:
A)the rate corresponding to the crossover NPV exceeds the opportunity cost of capital.
B)the rate corresponding to the crossover NPV is less than the opportunity cost of capital.
C)that IRR exceeds the opportunity cost of capital.
D)the NPV is negative when discounted at the IRR.

Accepted Answer

The answer of When graphing NPV at different discount rates...

Quiz 8: Net Present Value and Other Investment Criteria

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

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

Project A has an IRR of 20 percent while Project B has an IRR of 30 percent.Under which of the following situations might you be inclined to select Project A, assuming the projects to be mutually exclusive, lending projects?

soft capital rationing:

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

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

The investment timing decision is aimed at analyzing whether the:

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

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

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

According to the NPV rule, all projects should be accepted if NPV is positive when discounted at the:

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

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

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

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

In order for a manager to correctly decide to postpone an investment until one year into the future, the NPV of the investment should:

The "gold standard" of investment criteria refers to:

A Project's payback period is determined to be four years.If it is later discovered that additional cash flows will be generated in years five and six, then:

The appropriate discount rate for a firm is:

When graphing NPV at different discount rates for mutually exclusive projects, the project with the lower IRR should be selected whenever: