Question 1

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?
A)Select the project with the higher internal rate of return
B)Accept the project with the shorter payback period
C)Accept the larger project if the incremental IRR exceeds the discount rate
D)Select the project with the higher profitability index
E)Accept the smaller project without any further analysis

Accepted Answer

The incremental internal rate of return (IRR) is the difference between the IRR of the larger project and the IRR of the smaller project. If the incremental IRR exceeds the discount rate, then it is more profitable to invest in the larger project. This approach takes into consideration both the size of the project and the time value of money. Therefore, option C is the best choice. The other options do not provide an appropriate method of selecting between two mutually exclusive projects of different sizes.

Question 2

Analysis using the profitability index
A)frequently conflicts with the accept and reject decisions generated by the application of the net present value rule.
B)is useful as a decision tool when investment funds are limited.
C)offers no real value when making capital structure decisions.
D)utilizes the same basic variables as those used in the average accounting return.
E)produces results that typically are difficult to comprehend or apply.

Accepted Answer

The profitability index is useful as a decision tool when investment funds are limited, as it helps in comparing different investments and determining their relative value based on their returns per investment dollar. It can help in prioritizing investments and allocating funds efficiently.

Question 3

The two most commonly used methods of capital budgeting analysis are the
A)internal rate of return and net present value methods.
B)net present value and payback methods.
C)profitability index and the internal rate of return methods.
D)net present value and discounted payback methods.
E)average accounting return and discounted payback methods.

Accepted Answer

The internal rate of return (IRR) and net present value (NPV) methods are considered to be the most commonly used methods of capital budgeting analysis. The IRR calculates the rate of return that would make the NPV of an investment equal to zero, whereas the NPV method calculates the difference between the present value of cash inflows and the present value of cash outflows. Both methods are widely used by businesses to evaluate potential investment opportunities and make informed decisions about capital expenditures.

Question 4

The internal rate of return
A)is more reliable as a decision making tool than net present value when considering mutually exclusive projects.
B)is the discount rate that makes the net present value of a project equal to one.
C)is easier to apply than net present value when cash flows are unconventional.
D)will provide the same accept/reject decision as NPV when cash flows are conventional and projects are independent.
E)is influenced by daily changes in the market rate of interest.

Accepted Answer

The internal rate of return (IRR) will provide the same accept/reject decision as net present value (NPV) when cash flows are conventional (i.e., normal cash flow patterns) and projects are independent.

Question 5

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?
A)Profitability index
B)Internal rate of return
C)Payback
D)Net present value
E)Accounting rate of return

Accepted Answer

The net present value (NPV) method is the most appropriate for comparing mutually exclusive projects, as it calculates the present value of all future cash flows (both inflows and outflows) of each project and compares them to determine which one generates the highest value. Therefore, management should rely most heavily on the analysis results from the NPV method to decide whether to build the book outlet or the restaurant.

Question 6

When two projects can share the same economic resource,the projects are generally considered to be
A)mutually exclusive.
B)independent.
C)underfunded.
D)inferior.
E)financially equivalent.

Accepted Answer

When two projects can share the same economic resource, they are considered independent. This means that the projects can coexist without affecting each other. In contrast, mutually exclusive projects cannot be pursued simultaneously because choosing one implies giving up the other. Underfunded and inferior are not fitting descriptors as they do not relate to the relationship between two projects. Financial equivalence pertains to comparing alternatives based on their present value or cost, but does not capture the concept of sharing resources. Therefore, the best choice is B.

Question 7

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?
A)Discounted payback
B)Modified internal rate of return
C)Average accounting rate of return
D)Incremental internal rate of return
E)Internal rate of return

Accepted Answer

The Incremental Internal Rate of Return (IRR) is best for comparing mutually exclusive projects, especially when they have different scales of investment.

Question 8

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
A)(Sum of all net income / 5)/ ($48,000 / 2)
B)(Sum of all net income / 2)/ ($48,000 / 2)
C)($48,000 / 5)/ (Sum of all net income / 5)
D)($48,000 / 2)/ (Sum of all net income / 2)
E)(Sum of all net income / 5)/ $48,000

Accepted Answer

The Average Accounting Return (AAR) is calculated by dividing the average net income over the project's life by the average book value of the investment. Since straight-line depreciation is used, the average book value is the initial cost divided by 2. Therefore, the formula for AAR is:

AAR = (Average net income / Number of years) / (Initial cost / 2)

Substituting the given values:

AAR = (Sum of all net income / 5) / ($48,000 / 2)

So, the correct choice is A.

Question 9

The discount rate that makes the net present value of an investment exactly equal to zero is called the
A)profitable rate of return.
B)internal rate of return.
C)average accounting return.
D)profitability index.
E)risk-free rate.

Accepted Answer

The description matches the definition of internal rate of return. This is the rate that makes the present value of cash inflows equal to the initial investment. The other options are incorrect or not a perfect match to the given description.

Question 10

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?
A)The lines representing the projects will be upward sloping.
B)If one project has equal cash flows for each year of its life,the line representing that project will be horizontal.
C)The lines representing the projects will be parallel over multiple discount rates.
D)The lines representing the projects must cross at a point where the NPV of each project is positive.
E)The project lines will reflect lower NPV values at higher discount rates.

Accepted Answer

As the discount rate increases, the present value of future cash flows decreases, leading to lower NPV values for both projects.

Question 11

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
A)initial cash flow is negative.
B)net present value is positive.
C)cash flows are conventional.
D)accept/reject decision cannot be based on the IRR.
E)project should be rejected.

Accepted Answer

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

Question 12

The average accounting return method
A)ignores some project years.
B)ignores the timing of net income.
C)properly discounts all values.
D)is preferred by financial analysts over the alternative methods.
E)is never used in practice.

Accepted Answer

The average accounting return method only considers the average net income over the life of the project and ignores the timing of net income. It does not properly discount all values and is not preferred by financial analysts. Although it is not commonly used in practice, it is important to understand as a basic capital budgeting method.

Question 13

The modified internal rate of return is designed primarily to analyze projects that
A)are financing rather than investing projects.
B)are mutually exclusive.
C)have positive and then negative cash flows following the initial cash flow.
D)have significantly different sizes.
E)are both mutually exclusive and have significantly different lives.

Accepted Answer

The modified internal rate of return (MIRR) is used to analyze projects that involve positive and negative cash flows following the initial investment. This is because traditional IRR can sometimes overestimate the profitability of such projects. MIRR adjusts for this by assuming that positive cash flows are reinvested at a specified rate and negative cash flows are financed at a different rate. The other options listed do not align with the primary purpose of MIRR.

Question 14

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?
A)The discount rate used in computing the net present value was less than 12.6 percent.
B)The discounted payback period will have to be less than 2.87 years.
C)The project life must be 2.87 years.
D)This project should be accepted based on the internal rate of return.
E)The required rate of return must be greater than 12.6 percent.

Accepted Answer

Since the NPV is negative, the required rate of return must be greater than the IRR of 12.6 percent for the project to be viable. Therefore, E is the correct choice, and the other statement choices are all wrong.

Question 15

An investment is acceptable if the profitability index (PI)of the investment is
A)greater than one.
B)less than one.
C)greater than the internal rate of return (IRR).
D)less than the net present value (NPV).
E)greater than a prespecified rate of return.

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 16

Two key weaknesses of the internal rate of return rule are the
A)arbitrary determination of a discount rate and failure to consider initial expenditures.
B)failure to correctly analyze mutually exclusive projects and the multiple rate of return problem.
C)failure to consider all cash flows and the multiple rate of return problem.
D)failure to consider initial expenditures and failure to correctly analyze mutually exclusive projects.
E)failure to correctly analyze mutually exclusive projects and the lack of a clear-cut decision rule.

Accepted Answer

The internal rate of return rule has two key weaknesses: the failure to correctly analyze mutually exclusive projects and the multiple rate of return problem.

Question 17

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?
A)0
B)1
C)2
D)3
E)4

Accepted Answer

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

Question 18

Assume a project has normal cash flows.According to the accept/reject rules,the project should be accepted if the
A)PI is less than 1.
B)AAR is less than the required AAR.
C)IRR exceeds the required return.
D)payback period is less than the life of the project.
E)discounted payback period is less than the life of the project.

Accepted Answer

The accept/reject rules state that a project should be accepted if the IRR exceeds the required return. This means that the project is generating a rate of return that is higher than what is required by the investors or company. Therefore, the project is financially attractive and should be accepted. The other options provided do not align with the accept/reject rules.

Question 19

Assume a project has normal cash flows and a positive (non-zero)net present value.The project's
A)profitability index will be less than 1.
B)internal rate of return will exceed its required rate of return.
C)costs exceed its benefits.
D)discounted payback period will exceed the life of the project.
E)payback period must equal the life of the project.

Accepted Answer

A project with a positive net present value means that the present value of inflows is greater than the present value of outflows. This also implies that the project's internal rate of return is greater than the required rate of return. Choice A is incorrect because the profitability index will be greater than 1. Choice C is incorrect because costs are less than benefits. Choice D is incorrect because the discounted payback period will be less than the life of the project. Choice E is also incorrect as the payback period does not need to equal the life of the project.

Question 20

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
A)it makes no difference which project you accept as long as the discount rate does not exceed 11.34 percent.
B)Project A should always be preferred.
C)one project will be preferred at rates less than 11.34 percent and the other will be preferred at higher rates.
D)Project B must require a smaller investment than Project A at Time 0.
E)Project B should only be accepted if the discount rate is 11.34 percent.

Accepted Answer

Since both projects have positive NPVs at the same discount rate, the choice between them would depend on the investor's preferences. If the investor values larger cash flows in the first two years, they would prefer Project A. However, if they prioritize larger cash flows in the later years, they would prefer Project B. Therefore, the choice between the two projects would depend on the discount rate and the investor's preferences, and hence, option C is the correct answer.

Quiz 7: Net Present Value and Other Investment Rules

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?

Analysis using the profitability index

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

The internal rate of return

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

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?

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

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

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?

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

The average accounting return method

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

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?

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

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

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?

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

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

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