Question 1

Projects A and B require an initial investment of $48,000 and $98,000,respectively.The projects are mutually exclusive,and you know the smaller project has a positive NPV.Which one of these methods is probably the best method to use to determine which project to accept?

Accepted Answer

Incremental internal rate of return is the best method to use in this scenario because it directly compares the additional costs and benefits of one project over another, which is crucial in making a decision between mutually exclusive projects. It helps in understanding the return on the extra investment required for the larger project compared to the smaller one.

Question 2

An investment is acceptable if the profitability index (PI)of the investment is

Accepted Answer

The profitability index (PI) is a measure used to evaluate the attractiveness of an investment. If the PI is greater than one, it means that the present value of future cash flows is greater than the initial investment, indicating that the investment is expected to generate more value than it costs, thus making it acceptable.

Question 3

Two key weaknesses of the internal rate of return rule are the

Accepted Answer

The internal rate of return (IRR) rule can struggle with mutually exclusive projects because it may not account for differences in scale and timing of cash flows. Additionally, the multiple rate of return problem arises when a project has non-normal cash flows, leading to multiple IRRs, which complicates the decision-making process.

Question 4

Assume you are looking at a graph that relates the net present value of two mutually exclusive investment projects to various discount rates.Assume the projects have differing cash flows and finite lives.Which one of these statements accurately reflects this graph?

Accepted Answer

The NPV of an investment decreases as the discount rate increases because future cash flows are discounted more heavily. This relationship is inversely proportional, leading to lower NPV values at higher discount rates.

Question 5

Assume a project has normal cash flows.According to the accept/reject rules,the project should be accepted if the

Accepted Answer

According to the accept/reject rules, a project should be accepted if the IRR exceeds the required return. This is because the IRR represents the rate at which the project's future cash flows are discounted to arrive at the present value of those cash flows. If the IRR is greater than the required return, then the project is expected to generate a return greater than the opportunity cost of the capital invested in it. Therefore, the project should be accepted. The other options listed in the question are not correct because a project should be rejected if its PI is less than 1, its AAR is less than the required AAR, its payback period is greater than the life of the project, or its discounted payback period is greater than the life of the project.

Question 6

You are considering a project with conventional cash flows.The IRR is 12.6 percent,NPV is -$198,and the payback period is 2.87 years.Which one of the following statements is correct given this information?

Accepted Answer

Since the NPV is negative, the discount rate (or required rate of return) must be higher than the IRR of 12.6% for the NPV to be negative. This is because NPV decreases as the discount rate increases, and a positive IRR with a negative NPV indicates the discount rate exceeds the IRR.

Question 7

Assume a project has normal cash flows and a positive (non-zero)net present value.The project's

Accepted Answer

A positive net present value indicates that the project's expected cash inflows are greater than its expected cash outflows when discounted to the present at the required rate of return. This means that the internal rate of return (the discount rate at which the project's net present value equals zero) must be greater than the required rate of return. Thus, choice B is the correct answer. The profitability index (the ratio of the present value of the project's expected cash inflows to the present value of its expected cash outflows) would be greater than 1 for a project with a positive net present value. Costs cannot exceed benefits if the net present value is positive. The discounted payback period (the length of time it takes for the project's discounted cash inflows to equal its initial investment) may be less than or equal to the life of the project if the project has normal cash flows. The payback period (the length of time it takes for the project's expected cash inflows to equal its initial investment) may be less than or equal to the life of the project, but it does not necessarily have to equal the life of the project.

Question 8

Analysis using the profitability index

Accepted Answer

The profitability index is useful when investment funds are limited because it measures the bang for the buck, or the amount by which the present value of future cash inflows exceeds the initial cost of the investment per dollar of the investment. By prioritizing investments with a higher profitability index, limited funds can be allocated to those investments that provide the best return on investment.

Question 9

The average accounting return method

Accepted Answer

The average accounting return method ignores the timing of net income, which means that it does not take into account when the returns are earned. This can be a significant drawback in evaluating projects, as it fails to consider the time value of money. Therefore, the best choice is B.

Question 10

A project has an initial cost of $12,100 and cash flows of -$2,100,$5,800,$16,600,and -$800 for Years 1 to 4,respectively.How many IRRs will this project have?

Accepted Answer

The answer of A project has an initial cost of...

Question 11

Assume a project has an initial cost of $48,000 and will produce net income for 5 years.The project will use straight-line depreciation over the life of the project.The AAR of this project can be computed as

Accepted Answer

The Average Accounting Return (AAR) is calculated by dividing the average net income of the project by the average book value of the investment. Since the project uses straight-line depreciation, the average book value equals half of the initial cost. Therefore, the formula for AAR is:
(Sum of all net income / 5) / ($48,000 / 2) = (Sum of all net income / 5) / $24,000. 
This matches choice A.

Question 12

Uptown Developers is considering two projects.Project A consists of building a wholesale book outlet on the firm's downtown lot.Project B consists of building a sit-down restaurant on that same lot.The lot can only accommodate one of the projects.When trying to decide whether to build the book outlet or the restaurant,management should rely most heavily on the analysis results from which one of these methods?

Accepted Answer

Net present value (NPV) takes into account the time value of money and provides a more accurate measure of profitability compared to other methods such as payback and accounting rate of return. Therefore, management should rely most heavily on the analysis results from the NPV to make the decision of choosing between the two projects. The project with the higher NPV should be selected as it will generate higher returns and value for the company.

Question 13

The two most commonly used methods of capital budgeting analysis are the

Accepted Answer

The internal rate of return (IRR) and net present value (NPV) methods are the two most commonly used methods of capital budgeting analysis because they take into account the time value of money and provide a more accurate measure of profitability. The NPV calculates the present value of future cash flows minus the initial investment, while the IRR calculates the rate of return that makes the NPV zero. Both methods are widely used in corporate finance and investment analysis.

Question 14

When two projects can share the same economic resource,the projects are generally considered to be

Accepted Answer

When two projects can share the same economic resource, they are considered independent projects. This means that the outcome of one project does not affect the outcome of the other project. Mutually exclusive projects, on the other hand, cannot be pursued simultaneously because they require the same resource. Underfunded projects do not have sufficient funds to be completed, while inferior projects have lower profitability or return on investment compared to other projects. Financially equivalent projects have the same cost and benefit structure, making them interchangeable.

Question 15

Two mutually exclusive projects produce the same positive NPV at a discount rate of 11.34 percent.Both projects have 4-year lives.Project A has larger cash flows than Project B in the first 2 years.Given this information,you know that

Accepted Answer

If both projects have the same positive NPV at the given discount rate, then we would prefer the project with larger cash flows in the earlier years. However, we cannot determine which project that is based on the given information. Therefore, we conclude that one project will be preferred at rates less than 11.34 percent and the other will be preferred at higher rates, depending on the size and timing of cash flows in each project.

Question 16

The discount rate that makes the net present value of an investment exactly equal to zero is called the

Accepted Answer

The discount rate that makes the net present value of an investment exactly equal to zero is called the internal rate of return (IRR). It is considered one of the most important techniques for evaluating capital budgeting projects since it takes into account the time value of money and the cash flows associated with the project. The higher the IRR, the more desirable the investment is considered to be. Therefore, the correct answer is B, internal rate of return.

Question 17

You know that two mutually exclusive projects are of different sizes.The smaller project is known to have a positive NPV.Which one of these accurately describes a method of properly determining which one,if either,project should be accepted?

Accepted Answer

When faced with mutually exclusive projects that have different sizes, the best method to choose the project is to compare their incremental IRR with the discount rate. If the incremental IRR exceeds the discount rate, it means that the incremental cash flows generated by selecting the larger project are worthy of the additional investment. This is because the incremental IRR measures the additional return generated by choosing one project over the other. Therefore, the correct approach to choosing between mutually exclusive projects that have different sizes is to accept the larger project if the incremental IRR exceeds the discount rate.

Question 18

The internal rate of return

Accepted Answer

The internal rate of return (IRR) and net present value (NPV) methods will provide the same accept/reject decision for a project when the project's cash flows are conventional (i.e., an initial outlay followed by a series of positive cash inflows) and the projects under consideration are independent. This is because both methods are based on the same set of cash flows and aim to assess the profitability of a project, albeit through different mechanisms.

Question 19

The modified internal rate of return is designed primarily to analyze projects that

Accepted Answer

The modified internal rate of return (MIRR) is specifically designed to handle projects that have a mix of positive and negative cash flows. It addresses a drawback of the traditional IRR method, which assumes that all cash inflows are reinvested at the same rate as the initial investment. MIRR assumes that positive cash flows are reinvested at the firm's cost of capital, while negative cash flows are financed at the firm's borrowing rate. MIRR is useful not just for financing projects, but also for investing projects where cash flows do not follow a uniform pattern. It can be used for projects that are both independent and mutually exclusive, and can handle projects with different sizes and lifecycles. However, MIRR is particularly useful for projects that have positive cash flows at the outset, followed by negative cash flows later on.

Question 20

An independent,financing type project has an IRR of 11.4 percent and a required rate of return of 10.6 percent.Given this,you know the

Accepted Answer

The answer of An independent,financing type project has an IRR...

Quiz 7: Net Present Value AMCQ Other Investment Rules