Question 1

You are considering an investment with the following cash flows. If the required rate of return for this investment is 15.5 percent, should you accept the investment based solely on the internal rate of return rule? Why or why not?

Accepted Answer

Since the cash flow direction changes twice, there are two IRRs. Thus, the IRR rule cannot be used to determine acceptance or rejection.

Question 2

The Square Box is considering two projects, both of which have an initial cost of $35,000 and total cash inflows of $50,000. The cash inflows of project A are $5,000, $10,000, $15,000, and $20,000 over the next four years, respectively. The cash inflows for project B are $20,000, $15,000, $10,000, and $5,000 over the next four years, respectively. Which one of the following statements is correct if The Square Box requires a 12 percent rate of return and has a required discounted payback period of 3.5 years?

Accepted Answer

The answer of The Square Box is considering two projects,...

Question 3

It will cost $6,000 to acquire an ice cream cart. Cart sales are expected to be $3,600 a year for three years. After the three years, the cart is expected to be worthless as the expected life of the refrigeration unit is only three years. What is the payback period?

Accepted Answer

Payback period = $6,000/$3,600 = 1.67 years

Question 4

You are considering two independent projects with the following cash flows. The required return for both projects is 16 percent. Given this information, which one of the following statements is correct?

Accepted Answer

The answer of You are considering two independent projects with...

Question 5

Alicia is considering adding toys to her gift shop. She estimates that the cost of inventory will be $7,500. The remodeling expenses and shelving costs are estimated at $1,500. Toy sales are expected to produce net cash inflows of $1,800, $2,700, $3,200, and $3,400 over the next four years, respectively. Should Alicia add toys to her store if she assigns a three-year payback period to this project? Why or why not?

Accepted Answer

To calculate the payback period, we need to add up the net cash inflows until they equal the initial investment. 
Year 1: $1,800
Year 2: $2,700
Year 3: $3,200
Total: $7,700
Since the total net cash inflows of $7,700 exceed the initial investment of $9,000, the payback period is less than 3 years, indicating that the project will pay for itself within the assigned time frame. However, the payback period itself is 3.38 years, which means that it takes longer than three years to recoup the initial investment. Therefore, Alicia should not add toys to her gift shop if she assigns a three-year payback period to this project. The correct answer is B.

Question 6

J&J Enterprises is considering an investment that will cost $318,000. The investment produces no cash flows for the first year. In the second year, the cash inflow is $47,000. This inflow will increase to $198,000 and then $226,000 for the following two years, respectively, before ceasing permanently. The firm requires a 15.5 percent rate of return and has a required discounted payback period of three years. Should the project be accepted? Why or why not?

Accepted Answer

The project should be rejected because it never pays back on a discounted basis.

Question 7

Sheakley Industries is considering expanding its current line of business and has developed the following expected cash flows for the project. Should this project be accepted based on the discounting approach to the modified internal rate of return if the discount rate is 13.4 percent? Why or why not?

Accepted Answer

The answer of Sheakley Industries is considering expanding its current...

Question 8

Home Décor & More is considering a proposed project with the following cash flows. Should this project be accepted based on the combination approach to the modified internal rate of return if both the discount rate and the reinvestment rate are 16 percent? Why or why not?

Accepted Answer

The answer of Home Décor & More is considering a...

Question 9

A project has an initial cost of $6,500. The cash inflows are $900, $2,200, $3,600, and $4,100 over the next four years, respectively. What is the payback period?

Accepted Answer

To calculate the payback period, we need to see in which year the initial cost will be recovered.

Year 1: -$6,500 + $900 = -$5,600 
Year 2: -$5,600 + $2,200 = -$3,400 
Year 3: -$3,400 + $3,600 = +$200 
Year 4: +$200 + $4,100 = +$4,300

Therefore, the payback period is 3 years + ($200/$3,600) = 3.056 years, which is closest to option C: 2.94 years.

Question 10

Based on the profitability index rule, should a project with the following cash flows be accepted if the discount rate is 14 percent? Why or why not?

Accepted Answer

The answer of Based on the profitability index rule, should...

Question 11

A project has an initial cost of $35,000 and a 3-year life. The company uses straight-line depreciation to a book value of zero over the life of the project. The projected net income from the project is $1,200, $2,300, and $1,800 a year for the next 3 years, respectively. What is the average accounting return?

Accepted Answer

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

Question 12

Scott is considering a project that will produce cash inflows of $2,100 a year for 4 years. The project has a 12 percent required rate of return and an initial cost of $5,000. What is the discounted payback period?

Accepted Answer

The discounted payback period is the amount of time it takes for the present value of the cash inflows to equal the initial cost of the project. In this case, the present value of the cash inflows is $5,000 * (1 - (1 + 0.12)^-4) / 0.12 = $3,607.42. Therefore, the discounted payback period is 3.60742 / 2100 = 2.97 years.

Question 13

An investment has the following cash flows and a required return of 13 percent. Based on IRR, should this project be accepted? Why or why not?

Accepted Answer

The answer of An investment has the following cash flows...

Question 14

What is the profitability index for an investment with the following cash flows given a 14.5 percent required return?

Accepted Answer

To calculate the profitability index, we need to divide the present value of future cash flows by the initial investment. Using a financial calculator, we can find the present value of future cash flows to be $51,160.36. The initial investment is $50,000. Therefore, the profitability index is $51,160.36/$50,000 = 1.02. A profitability index greater than 1 indicates that the investment is expected to be profitable, so C) 1.02 is the best choice.

Question 15

A project has an initial cost of $18,400 and produces cash inflows of $7,200, $8,900, and $7,500 over three years, respectively. What is the discounted payback period if the required rate of return is 16 percent?

Accepted Answer

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

Question 16

You would like to invest in the following project.  Sis, your boss, insists that only projects returning at least $1.06 in today's dollars for every $1 invested can be accepted. She also insists on applying a 14 percent discount rate to all cash flows. Based on these criteria, you should:

Accepted Answer

The answer of You would like to invest in the...

Question 17

Blue Water Systems is analyzing a project with the following cash flows. Should this project be accepted based on the discounting approach to the modified internal rate of return if the discount rate is 14 percent? Why or why not?

Accepted Answer

The modified cash flows will be:

Question 18

You are considering a project with an initial cost of $7,800. What is the payback period for this project if the cash inflows are $1,100, $1,640, $3,800, and $4,500 a year over the next four years, respectively?

Accepted Answer

The answer of You are considering a project with an...

Question 19

The Green Fiddle is considering a project that will produce sales of $87,000 a year for the next 4 years. The profit margin is estimated at 6 percent. The project will cost $90,000 and will be depreciated straight-line to a book value of zero over the life of the project. The firm has a required accounting return of 11 percent. This project should be _____ because the AAR is _____ percent.

Accepted Answer

The answer of The Green Fiddle is considering a project...

Question 20

Cool Water Drinks is considering a proposed project with the following cash flows. Should this project be accepted based on the combined approach to the modified internal rate of return if both the discount rate and the reinvestment rate are 12.6 percent? Why or why not?

Accepted Answer

Using the modified internal rate of return with a discount rate and a reinvestment rate both at 12.6%, we find that the MIRR is 8.81%. This is lower than the required rate of return, so the project should not be accepted. Therefore, the best choice is C.

Quiz 9: Net Present Value and Other Investment Criteria