Question 1

Which one of the following statements is correct concerning the payback period?

Accepted Answer

The payback period is the time it takes for an investment to repay its initial cost. The acceptable payback period varies depending on the company's policies, the type of investment, and the industry norms. Therefore, option A is the correct statement indicating that an investment is acceptable if its calculated payback period is less than some pre-specified period of time. Option B, C, and D are incorrect as they do not take into account the pre-specified payback period, and option E refers to a discounted payback period, which is a different concept than the regular payback period.

Question 2

Which one of the following statements concerning net present value (NPV) is correct?

Accepted Answer

NPV represents the present value of an investment's cash inflows minus the present value of its cash outflows. An investment should be accepted if the NPV is positive and rejected if it is negative, as this indicates that the investment will generate more cash inflows than outflows and therefore increase the value of the firm. Accepting an investment with an NPV of zero would mean that the investment is expected to generate just enough cash inflows to cover its outflows, but not generate any additional value for the firm. Therefore, choice C is the correct statement. Choices A, B, D, and E are incorrect.

Question 3

The length of time required for a project's discounted cash flows to equal the initial cost of the project is called the:

Accepted Answer

The discounted payback period is the time it takes for the present value of cash inflows to cover the initial investment, considering the time value of money.

Question 4

Net present value:

Accepted Answer

Net present value is a more useful tool for comparing different sized projects as it considers the time value of money and provides a dollar value for the expected profitability of a project. The internal rate of return, on the other hand, provides a percentage rate of return and may not give a clear indication of which project is more profitable.

Question 5

The primary reason that company projects with positive net present values are considered acceptable is that:

Accepted Answer

The primary reason that projects with positive net present values are considered acceptable is that they create value for the owners of the firm. In other words, they increase the wealth of shareholders by generating future cash flows that are greater than the required initial investment. This is the fundamental objective of any investment decision, and projects that achieve this objective are typically considered acceptable. The other options are not necessarily true or relevant to the acceptability of an investment project.

Question 6

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

Accepted Answer

An investment is acceptable if the profitability index (PI) of the investment is greater than one, as a PI greater than one indicates that the project generates more cash flows than the amount invested.

Question 7

The present value of an investment's future cash flows divided by the initial cost of the investment is called the:

Accepted Answer

The formula for profitability index is the present value of future cash flows divided by the initial cost of the investment, making choice D the correct answer. The other choices refer to different financial metrics.

Question 8

All else constant,the net present value of a typical investment project increases when:

Accepted Answer

The net present value (NPV) of an investment project increases when the rate of return decreases because a lower discount rate increases the present value of future cash inflows, thereby increasing the NPV.

Question 9

The length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment is called the:

Accepted Answer

The payback period is the length of time required for the cash inflows from an investment to equal the initial investment cost. Therefore, option C is the correct answer. Option A (net present value) and option B (internal rate of return) are metrics used to evaluate the feasibility of an investment, but they are not directly related to the payback period. Option D (profitability index) is a ratio of the present value of expected cash inflows to the initial investment cost, while option E (discounted cash period) is not a commonly used financial term.

Question 10

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. It is the most accurate measure of a project's profitability and represents the actual rate of return earned by the investment. All other factors being equal, a higher internal rate of return is preferred as it indicates a more profitable investment.

Question 11

The difference between the present value of an investment and its cost is the:

Accepted Answer

The difference between the present value of an investment and its cost is referred to as the net present value (NPV). It is a financial measure that indicates whether the investment is profitable or not. NPV calculates the current value of future cash flows discounted to the present at a required rate of return. If the NPV is positive, it means the investment is expected to generate more cash than it costs, and if the NPV is negative, it means the investment is expected to generate less cash than it costs. Thus, option A is the correct answer.

Question 12

All else equal,the payback period for a project will decrease whenever the:

Accepted Answer

The payback period for a project will decrease whenever the cash inflows are moved earlier in time. This means that the project will be able to recoup its initial investment sooner, making it a more attractive investment.

Question 13

If a project has a net present value equal to zero,then: I. the present value of the cash inflows exceeds the initial cost of the project.
II) the project produces a rate of return that just equals the rate required to accept the project.
III) the project is expected to produce only the minimally required cash inflows.
IV) any delay in receiving the projected cash inflows will cause the project to have a negative net present value.

Accepted Answer

The answer of If a project has a net present...

Question 14

The discounted payback period of a project will decrease whenever the:

Accepted Answer

The discounted payback period measures the time it takes for the project to recoup its initial investment in present value terms. It takes into account the time value of money by discounting the cash inflows to their present value. Therefore, if the amount of each project cash inflow is increased, the project will generate more cash flows in the same period of time, which will reduce the discounted payback period. None of the other factors (increase in discount rate, initial cash outlay, time period of the project, or costs of fixed assets) will have a positive impact on the discounted payback period.

Question 15

A situation in which accepting one investment prevents the acceptance of another investment is called the:

Accepted Answer

A mutually exclusive investment decision is one in which accepting one investment precludes the acceptance of another investment. This could occur when two potential investments use the same resources or have incompatible goals. Therefore, the best choice is C.

Question 16

The advantages of the payback method of project analysis include the: I. application of a discount rate to each separate cash flow.
II) bias towards liquidity.
III) ease of use.
IV) arbitrary cutoff point.

Accepted Answer

The payback method is advantageous because it is easy to use (III) and has a bias towards liquidity (II), as it focuses on how quickly the initial investment can be recovered. However, it does not apply a discount rate to cash flows (I) and the cutoff point is considered a disadvantage, not an advantage.

Question 17

An investment is acceptable if its IRR:

Accepted Answer

The Internal Rate of Return (IRR) is the discount rate at which the net present value (NPV) of an investment equals zero. An investment is acceptable if its IRR is greater than the required return, as this means the investment is generating a return that exceeds the cost of capital.

Question 18

Payback is frequently used to analyze independent projects because:

Accepted Answer

Payback is easy and quick to calculate, which makes it suitable for analyzing independent projects. However, it does not consider the time value of money or all relevant cash flows, which are important factors in making investment decisions. Therefore, while payback is useful for a quick analysis, it should not be the only factor considered when evaluating a project.

Question 19

The discounted payback rule states that you should accept projects:

Accepted Answer

The discounted payback rule suggests that we should accept projects if their discounted payback period is less than a pre-specified period of time. This means that the cost of the project will be fully recovered within a reasonable and specified timeframe. The other options are incorrect because they either specify a period that is too short (C and E) or do not provide a clear guideline for determining which projects to accept (A and B).

Question 20

The possibility that more than one discount rate will make the NPV of an investment equal to zero is called the _______ problem.

Accepted Answer

The possibility that more than one discount rate will make the NPV of an investment equal to zero is referred to as the multiple rates of return problem. This is typically seen when there are non-conventional cash flows, such as initial cash outflows followed by inflows, or inconsistent cash flows. It makes decision-making complex since it is challenging to choose a discount rate when the problem presents multiple rates of return.

Quiz 5: Net Present Value and Other Investment Rules