Question 1

Projects that produce a net present value of 0 should be accepted.

Accepted Answer

A net present value (NPV) of 0 indicates that the project's cash flows are exactly sufficient to repay the invested capital and provide the required rate of return. Accepting such projects means the investment would break even, meeting the minimum target return.

Question 2

When the internal rate of return is higher than the hurdle rate, a company should invest in the capital project.

Accepted Answer

When the internal rate of return (IRR) is higher than the hurdle rate (the minimum rate of return on a project that a company is willing to accept before starting a project), it indicates that the project is expected to generate returns greater than the company's minimum acceptable return, making it a financially viable investment.

Question 3

If the net present value of a project is positive, the profitability index will be greater than 1.0.

Accepted Answer

The profitability index is calculated by dividing the present value of future cash flows by the initial investment. If the net present value (NPV) is positive, it means the present value of future cash flows exceeds the initial investment, resulting in a profitability index greater than 1.0.

Question 4

If the internal rate of return on a project is greater than the project's cost of capital and the cash flows have only one sign change, the net present value of the project will be greater than $0.

Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. If the IRR is greater than the project's cost of capital, it means the project is expected to generate a return higher than the cost to finance it. Therefore, when discounting the cash flows at the cost of capital, the NPV will be positive, assuming there is only one sign change in the cash flows (from negative to positive, indicating an initial investment followed by returns).

Question 5

The difference between internal rate of return and modified internal rate of return is that internal rate of return has a more realistic assumption regarding reinvestment of cash flows from the project.

Accepted Answer

The Modified Internal Rate of Return (MIRR) assumes reinvestment at the project's cost of capital or a different rate, which is often more realistic than the IRR's assumption of reinvestment at the IRR itself.

Question 6

The mortgage broker says that your mortgage refinance has a payback period of one year and 3 months. This means that you will have the mortgage paid off in one year and three months.

Accepted Answer

The payback period in the context of a mortgage refinance typically refers to the amount of time it takes for the savings generated from the lower interest rate to cover the costs of refinancing, not the time it takes to pay off the entire mortgage.

Question 7

Project B is the better option at a discount rate of 9%.

Accepted Answer

The answer of Project B is the better option at...

Question 8

The profitability index (PI) formula is: PI = PV (cash outflows) / PV (cash inflows).

Accepted Answer

The correct formula for the Profitability Index (PI) is: PI = PV (cash inflows) / PV (cash outflows).

Question 9

The profitability index for an initial outlay of $15million and subsequent end-of-year cash inflows of $5, $5 and $10 million, respectively, if the discount rate is 15 percent is 1.12.

Accepted Answer

The profitability index (PI) is calculated by dividing the present value of future cash inflows by the initial investment. Using a discount rate of 15%, the present value (PV) of cash inflows is: PV = $5m / (1+0.15)^1 + $5m / (1+0.15)^2 + $10m / (1+0.15)^3 = $4.35m + $3.78m + $6.71m = $14.84m. The initial outlay is $15m, so PI = $14.84m / $15m = 0.99, not 1.12.

Question 10

The net present value and internal rate of return have different assumptions regarding cash flows. net present value assumes that all cash flows are reinvested at one consistent discount rate, while the internal rate of return assumes that all cash flows are reinvested at the internal rate of return (similar yielding investments).

Accepted Answer

The Net Present Value (NPV) method assumes that cash flows are reinvested at the discount rate, whereas the Internal Rate of Return (IRR) method assumes reinvestment at the IRR itself, leading to different assumptions about the reinvestment of cash flows.

Question 11

The discount rate used in calculating a project's net present value is the project's cost of capital.

Accepted Answer

The discount rate used in calculating a project's net present value (NPV) is indeed the project's cost of capital, as it reflects the return that investors expect from investing in the project.

Question 12

The same accept / reject decision is reached when looking at independent projects using net present value, internal rate of return, and the profitability index methods.

Accepted Answer

All three methods, Net Present Value (NPV), Internal Rate of Return (IRR), and Profitability Index (PI), are consistent in evaluating independent projects because they all fundamentally assess the project's value or efficiency in generating returns relative to its cost. If a project is deemed acceptable by one method (e.g., positive NPV), it will generally also be acceptable by the others (e.g., IRR greater than the cost of capital, PI greater than 1).

Question 13

The net present value and internal rate of return methods yield the same ranking when evaluating projects.

Accepted Answer

The net present value (NPV) and internal rate of return (IRR) methods can yield different project rankings due to differences in the distribution of cash flows over time and the projects' scale.

Question 14

When evaluating two mutually exclusive projects with a crossover rate of 7 percent and IRR _A< IRR _B we prefer Project A when the discount rate is greater than 7 percent.

Accepted Answer

When the discount rate is greater than the crossover rate, you prefer the project with the lower IRR among two mutually exclusive projects, which would be Project B in this case, not Project A.

Question 15

If a project has a positive net present value using a discount rate of 6%, the project's internal rate of return is greater than 6%.

Accepted Answer

The internal rate of return (IRR) is the discount rate at which the net present value (NPV) of a project equals zero. If a project has a positive NPV at a 6% discount rate, it means the project's IRR must be higher than 6% to bring the NPV down to zero.

Question 16

With contingent projects, one must be turned down even if the net present values of both are positive.

Accepted Answer

The answer of With contingent projects, one must be turned...

Question 17

The pure play approach involves estimating betas and the risk associated with an investment and the optimal financing by estimating the weighted average cost of capital of companies in an industry associated with the project.

Accepted Answer

The pure play approach involves estimating the beta (a measure of risk) for a project by looking at comparable companies (pure plays) in the same industry. This method helps in assessing the risk and the optimal financing mix by estimating the weighted average cost of capital (WACC) of these companies, which can then be applied to the project in question.

Question 18

List 3 of the 5 forces that Michael Porter identifies as critical factors that determine the profitability and attractiveness of investing in an industry.

Accepted Answer

The answer of List 3 of the 5 forces that...

Question 19

Calculate the net present value of a project with the following:
Initial outlay: $10 million
Year 1 expected cash flow $8 million
Year 2 expected cash flow $5 million
Year 3 expected cash flow $5 million
Project cost of capital = 10%

Accepted Answer

The answer of Calculate the net present value of a...

Question 20

Calculate the net present value of a project with the following:
Initial outlay: $15 million
Year 1 expected cash flow $5 million
Year 2 expected cash flow $5 million
Year 3 expected cash flow $8 million
Project cost of capital = 10%

Accepted Answer