Question 1

Find the IRR for a project costing $36,500 and returning $5,000 annually for the first four years, followed by $11,000 annually for three years.Hint: At a discount rate of 7 percent the Project's NPV is $2,458.91 and changes to -$1,966.86 at a discount rate of 10 percent.

Accepted Answer

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Question 2

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.

Accepted Answer

The payback period calculation does not involve discounting cash flows, so it effectively uses a discount rate of zero. This method simply measures how long it takes for the initial investment to be recovered through the project's cash inflows, without considering the time value of money.

Question 3

Which mutually exclusive project would you select, if both are priced at $1,000 and your discount rate is 15 percent; Project A with three annual cash flows of $1,000, or Project B, with three years of zero cash flow followed by three 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

Accepted Answer

Project A has a higher present value of cash flows when discounted at 15 percent compared to Project B. The cash flows from Project A come earlier, which means they are less affected by the discount rate compared to the delayed cash flows of Project B.

Question 4

Discuss three reasons why a firm may want to impose soft capital rationing.

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Question 5

Given a particular set of project cash flows, which of the following statements is correct?
A)there can be only one NPV for the project.
B)there can be only one IRR for the project.
C)there can be more than one NPV for the project.
D)there can be only one profitability index for the project.

Accepted Answer

There can be multiple NPVs for a project if the cash flows change sign multiple times. This is known as the multiple internal rate of return (IRR) problem. Therefore, statement (C) is correct. Statement (A) is incorrect because there can be multiple NPVs due to the timing and magnitude of cash flows. Statement (B) is incorrect for the same reason as statement (A) - there can be multiple IRRs. Statement (D) is incorrect because different discount rates can result in different profitability indices.

Question 6

ABC Corporation is experiencing hard capital rationing and will not be able to invest more than $1,000,000 this year.Develop a profitability index for the following four projects and state what would be selected: All four projects will last three years and the firm uses a 10 percent discount rate.
 $$\begin{array} { | c | c | c | } 
\hline \text { Project } & \text { Cost } & \text { Annual Inflows } \
\hline \text { A } & \$ 300,000 & \$ 130,000 \
\hline \text { B } & \$ 500,000 & \$ 220,000 \
\hline \text { C } & \$ 125,000 & \$ 60,000 \
\hline \text { D } & \$ 250,000 & \$ 100,000 \
\hline
\end{array}$$

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Question 7

You have been assigned to evaluate a project for your firm that requires an initial investment of $200,000, is expected to last for 10 years, and is expected to produce after-tax net cash flows of $44,503 per year.If your firm's required rate of return is 14 percent, should the project be accepted?

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Question 8

If two projects offer the same, positive NPV, then:
A)they also have the same IRR.
B)they have the same payback period.
C)they are mutually exclusive projects.
D)they add the same amount to the value of the firm.

Accepted Answer

Two projects offering the same positive NPV will add the same amount to the firm's value, as NPV directly measures the expected increase in wealth from undertaking the project. The other options (A, B, C) do not necessarily follow from having the same NPV, as IRR, payback period, and mutual exclusivity depend on other factors such as cash flow timing and scale.

Question 9

A new machine will cost $100,000 and generate after-tax cash inflows of $356,000 for four years.Find the NPV if the firm uses a 12 percent opportunity cost of capital.What is the IRR? What is the payback period?

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Question 10

Evaluate the following mutually exclusive projects using IRR as a selection criterion.Assuming the discount rate to be 14 percent, which project-if either-would be selected? Project A costs $50,000 and returns $15,000 after-tax annually.Project B costs $35,000 and returns $11,000 after-tax annually.Both projects last five years.

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Question 11

A project costing $20,000 generates cash inflows of $9,000 annually for the first three years, followed by cash outflows of $1,000 annually for two years.At most, this project has ______ different IRR(s).
A)One
B)Two
C)three
D)five

Accepted Answer

The project has different cash inflows and outflows, meaning it may have multiple IRRs. In this case, we have positive cash inflows of $9,000 for three years, and then negative cash outflows of $1,000 for two years. Therefore, there are two possible IRRs for this project: one for the first three years, and another for the next two years.

Question 12

One method that can be used to increase the NPV of a project is to decrease the:
A)project's payback.
B)project's cost of capital.
C)time until receipt of cash inflows.
D)number of project IRRs.

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Question 13

If projects A and B are independent, which of the following is true?
A)Value (A + B) > value (A) + value (B)
B)Value (A + B) < value (A) + value (B)
C)Value (A + B) = value (A) + value (B)
D)Value (A + B) - value (B) > value (A)

Accepted Answer

If two projects are independent, their values are simply additive. Therefore, the value of A plus the value of B equals the value of A+B, making option C the correct choice.

Question 14

Calculate the payback period for each of the following projects, then comment on the advisability of selection based on the payback period criterion in contrast to NPV: Project A has a cost of $15,000, returns $4,000 after-tax the first year and this amount increases by $1,000 annually over the five-year life; Project B costs $15,000 and returns $13,000 after-tax the first year, followed by four years of $2,000 per year.The firm uses a 10 percent discount rate.

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Question 15

The use of NPV as an investment criterion is said to be more reliable than using IRR.Discuss potential problems with the use of IRR, and how to reconcile the two methods' results.

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Question 16

Calculate the NPV for a project costing $200,000 and providing $20,000 annually for 40 years.The discount rate is 8 percent.By how much would the NPV change if the inflows were reduced to 30 years? Describe the implications of both answers.

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Question 17

A firm uses the profitability index to select between two mutually exclusive investments.If no capital rationing has been imposed, which project should be selected?
A)select the project with the higher profitability index.
B)select the project with the lower profitability index.
C)without capital rationing, both projects can be selected.
D)without capital rationing, select by NPV method.

Accepted Answer

Without capital rationing, the focus should be on selecting the project that adds the most value to the firm, which is determined by the Net Present Value (NPV) method. The profitability index is more useful when capital is limited.

Question 18

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.

Accepted Answer

The time-zero cash flow is positive for borrowing projects (since the borrower receives funds) and negative for lending projects (since the lender provides funds).

Question 19

Suppose a project requires an initial investment of $1,000 and it will yield $1,050 one year later.The NPV of the project is:
A)equal to $50.
B)less than 0 if the discount rate is less than 5 percent.
C)zero if the discount rate is equal to 5 percent.
D)positive if the discount rate is greater than 5 percent.

Accepted Answer

The NPV (Net Present Value) is calculated as the present value of cash inflows minus the initial investment. If the project yields $1,050 one year later from a $1,000 investment, the NPV is zero when the discount rate is 5% because the $50 gain exactly offsets the time value of money at that rate.

Question 20

Firms that make investment decisions based upon the payback rule may be biased toward rejecting projects:
A)with short lives.
B)with long lives.
C)with early cash inflows.
D)that have negative NPVs.

Accepted Answer

The payback rule, which focuses on how quickly an investment can be recouped, tends to bias firms against projects with long lives because it does not consider the benefits that accrue after the payback period.

Quiz 8: Net Present Value and Other Investment Criteria

Find the IRR for a project costing $36,500 and returning $5,000 annually for the first four years, followed by $11,000 annually for three years.Hint: At a discount rate of 7 percent the Project's NPV is $2,458.91 and changes to -$1,966.86 at a discount rate of 10 percent.

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

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

Discuss three reasons why a firm may want to impose soft capital rationing.

Given a particular set of project cash flows, which of the following statements is correct?

You have been assigned to evaluate a project for your firm that requires an initial investment of $200,000, is expected to last for 10 years, and is expected to produce after-tax net cash flows of $44,503 per year.If your firm's required rate of return is 14 percent, should the project be accepted?

If two projects offer the same, positive NPV, then:

A new machine will cost $100,000 and generate after-tax cash inflows of $356,000 for four years.Find the NPV if the firm uses a 12 percent opportunity cost of capital.What is the IRR? What is the payback period?

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

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

If projects A and B are independent, which of the following is true?

The use of NPV as an investment criterion is said to be more reliable than using IRR.Discuss potential problems with the use of IRR, and how to reconcile the two methods' results.

Calculate the NPV for a project costing $200,000 and providing $20,000 annually for 40 years.The discount rate is 8 percent.By how much would the NPV change if the inflows were reduced to 30 years? Describe the implications of both answers.

A firm uses the profitability index to select between two mutually exclusive investments.If no capital rationing has been imposed, which project should be selected?

Borrowing and lending projects usually can be distinguished by whether:

Suppose a project requires an initial investment of $1,000 and it will yield $1,050 one year later.The NPV of the project is:

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