Question 1

Which one of the following statements is correct?
A) If the IRR exceeds the required return, the profitability index will be less than 1.0.
B) The profitability index will be greater than 1.0 when the net present value is negative.
C) When the internal rate of return is greater than the required return, the net present value is positive.
D) Projects with conventional cash flows have multiple internal rates of return.
E) If two projects are mutually exclusive, you should select the project with the shortest payback period.

Accepted Answer

When the internal rate of return is greater than the required return, it means that the project is generating more return than the investor's minimum required return. Therefore, the net present value of the project will be positive. Options A and B are incorrect statements. Option D is true for projects with nonnormal cash flows. Option E is an incorrect statement as the selection should be based on the project's overall profitability rather than just the payback period.

Question 2

The reinvestment approach to the modified internal rate of return:
A) individually discounts each separate cash flow back to the present.
B) reinvests all the cash flows, including the initial cash flow, to the end of the project.
C) discounts all negative cash flows to the present and compounds all positive cash flows to the end of the project.
D) discounts all negative cash flows back to the present and combines them with the initial cost.
E) compounds all of the cash flows, except for the initial cash flow, to the end of the project.

Accepted Answer

The answer of The reinvestment approach to the modified internal...

Question 3

The modified internal rate of return is specifically designed to address the problems associated with which one of the following?
A) Mutually exclusive projects
B) Unconventional cash flows
C) Long-term projects
D) Negative net present values
E) Crossover points

Accepted Answer

The modified internal rate of return (MIRR) is designed to address the problems associated with unconventional cash flows, which can occur when a project has non-normal cash flows such as multiple changes in cash flow direction or non-conventional timing of cash flows. MIRR solves this problem by assuming that all cash flows are reinvested at a specified reinvestment rate until the end of the project.

Question 4

Which one of the following methods of analysis ignores the time value of money?
A) Net present value
B) Internal rate of return
C) Discounted cash flow analysis
D) Payback
E) Profitability index

Accepted Answer

Payback method only considers the time required to recover the initial investment and does not account for the time value of money, making it the method that ignores the time value of money.

Question 5

Which one of the following is most closely related to the net present value profile?
A) Internal rate of return
B) Average accounting return
C) Profitability index
D) Payback
E) Discounted payback

Accepted Answer

The net present value (NPV) profile shows the relationship between the discount rate and the NPV of a project. The internal rate of return (IRR) is the discount rate that makes the NPV equal to zero, and it is closely related to the NPV profile. As the discount rate changes, the NPV changes and the IRR moves along the NPV profile. The other options (average accounting return, profitability index, payback, and discounted payback) are not as closely related to the NPV profile as the IRR.

Question 6

You are using a net present value profile to compare investments A and B, which are mutually exclusive. Which one of the following statements correctly applies to the crossover point between these two?
A) The internal rate of return for project A equals that of project B, but generally does not equal zero.
B) The internal rate of return of each project is equal to zero.
C) The net present value of each project is equal to zero.
D) The net present value of project A equals that of project B, but generally does not equal zero.
E) The net present value of each project is equal to the respective project's initial cost.

Accepted Answer

The crossover point is where the net present values of both projects are equal, indicating the discount rate at which both projects are equally preferable.

Question 7

The profitability index reflects the value created per dollar:
A) invested.
B) of sales.
C) of net income.
D) of taxable income.
E) of shareholders' equity.

Accepted Answer

The profitability index is calculated by dividing the present value of future cash flows by the initial investment. Therefore, it reflects the value created per dollar invested.

Question 8

Which one of the following will occur when the internal rate of return equals the required return?
A) The average accounting return will equal 1.0.
B) The profitability index will equal 1.0.
C) The profitability index will equal 0.
D) The net present value will equal the initial cash outflow.
E) The profitability index will equal the average accounting return.

Accepted Answer

The answer of Which one of the following will occur...

Question 9

Which one of the following is an indicator that an investment is acceptable?
A) Modified internal rate of return equal to zero
B) Profitability index of zero
C) Internal rate of return that exceeds the required return
D) Payback period that exceeds the required period
E) Negative average accounting return

Accepted Answer

An internal rate of return (IRR) that exceeds the required return is an indicator that an investment is acceptable. This means that the investment is expected to generate a return that is higher than the minimum required return, making it a profitable investment.

Question 10

Which one of the following analytical methods is based on net income?
A) Profitability index
B) Internal rate of return
C) Average accounting return
D) Modified internal rate of return
E) Payback

Accepted Answer

Average accounting return is based on net income as it calculates the average profitability of an investment over its life based on accounting income. The other methods listed are not based solely on net income.

Question 11

If a project with conventional cash flows has a profitability index of 1.0, the project will:
A) never pay back.
B) have a negative net present value.
C) have a negative internal rate of return.
D) produce more cash inflows than outflows in today's dollars.
E) have an internal rate of return that equals the required return.

Accepted Answer

The answer of If a project with conventional cash flows...

Question 12

The average accounting return:
A) measures profitability rather than cash flow.
B) discounts all values to today's dollars.
C) is expressed as a percentage of an investment's current market value.
D) will equal the required return when the net present value equals zero.
E) is used more often by CFOs than the internal rate of return.

Accepted Answer

The average accounting return measures profitability, not cash flow. It is calculated as the average net income from an investment divided by the average book value of the investment. It does not discount values to today's dollars, express as a percentage of current market value, or equal the required return when the net present value equals zero. While it may be used by CFOs, it is not necessarily used more often than the internal rate of return.

Question 13

Which one of the following methods of analysis is most appropriate to use when two investments are mutually exclusive?
A) Internal rate of return
B) Profitability index
C) Net present value
D) Modified internal rate of return
E) Average accounting return

Accepted Answer

Net present value (NPV) is the most appropriate method of analysis when two investments are mutually exclusive. This is because NPV compares the present value of the expected cash inflows of each investment to the present value of the expected cash outflows. The investment with the higher NPV is typically considered the better choice. Other methods of analysis, such as internal rate of return, profitability index, and modified internal rate of return, can also be used, but may not provide as clear of a comparison between two mutually exclusive investments. Average accounting return is not a method of analysis used to compare mutually exclusive investments.

Question 14

Which one of the following is true if the managers of a firm only accept projects that have a profitability index greater than 1.5?
A) The firm should increase in value each time the firm accepts a new project.
B) The firm is most likely steadily losing value.
C) The price of the firm's stock should remain constant.
D) The net present value of each new project is zero.
E) The internal rate of return on each new project is zero.

Accepted Answer

A profitability index greater than 1.5 means that the project's present value of cash inflows is 1.5 times higher than the project's initial investment. This indicates that the project is expected to generate a substantial return for the firm, and accepting such projects should lead to an increase in the firm's overall value.

Question 15

Which one of the following methods of analysis has the greatest bias towards short-term projects?
A) Net present value
B) Internal rate of return
C) Average accounting return
D) Profitability index
E) Payback

Accepted Answer

Payback method focuses solely on the time it takes to recoup the initial investment and does not take into account cash flows beyond that point, resulting in a bias towards short-term projects. The other methods consider cash flows over the entire life of the project and are less biased towards short-term projects.

Question 16

Which one of the following methods of analysis is most similar to computing the return on assets (ROA)?
A) Internal rate of return
B) Profitability index
C) Average accounting return
D) Net present value
E) Payback

Accepted Answer

The return on assets (ROA) is a profitability ratio that measures a company's ability to generate profit from its assets. The average accounting return is also a profitability ratio that measures how much profit a company generates relative to its average book value of assets. Both ratios use accounting data and are focused on profitability. Therefore, the most similar method is C - Average accounting return.

Question 17

Which one of the following is specifically designed to compute the rate of return on a project that has unconventional cash flows?
A) Average accounting return
B) Profitability index
C) Internal rate of return
D) Indexed rate of return
E) Modified internal rate of return

Accepted Answer

The Modified Internal Rate of Return (MIRR) is specifically designed to handle unconventional cash flows, which contain multiple changes in the cash flow direction (inflow to outflow or vice versa). Unlike the traditional IRR which assumes reinvestment at the project's IRR rate, the MIRR assumes reinvestment at the firm's cost of capital. This makes the MIRR a more accurate measure of profitability for projects with unconventional cash flows. Therefore, option E is the best choice.

Question 18

The internal rate of return is unreliable as an indicator of whether or not an investment should be accepted given which one of the following?
A) One of the time periods within the investment period has a cash flow equal to zero
B) The initial cash flow is negative
C) The investment has cash inflows that occur after the required payback period
D) The investment is mutually exclusive with another investment under consideration
E) The cash flows are conventional

Accepted Answer

The internal rate of return (IRR) can be unreliable in making investment decisions when comparing mutually exclusive investments. This is because IRR assumes that the cash flows from the investment can be reinvested at the same rate, which may not be the case when choosing between multiple investments with different cash flow patterns. In these situations, other methods such as net present value (NPV) or profitability index (PI) should be used to evaluate the investments. Choices A, B, C, and E are not necessarily factors that make IRR unreliable as an indicator of whether or not an investment should be accepted.

Question 19

Which one of the following methods of analysis ignores cash flows?
A) Profitability index
B) Net present value
C) Average accounting return
D) Modified internal rate of return
E) Internal rate of return

Accepted Answer

The average accounting return is a method that only considers accounting profits and does not take into account cash flows. The other options, such as net present value, internal rate of return, modified internal rate of return, and profitability index, all include cash flows in their analysis.

Question 20

An investment has conventional cash flows and a profitability index of 1.0. Given this, which one of the following must be true?
A) The internal rate of return exceeds the required rate of return.
B) The investment never pays back.
C) The net present value is equal to zero.
D) The average accounting return is 1.0.
E) The net present value is greater than 1.0.

Accepted Answer

A profitability index of 1.0 indicates that the present value of the expected cash inflows equals the initial cost of the investment. This means that the net present value is equal to zero.

Quiz 8: Net Present Value and Other Investment Criteria

Which one of the following statements is correct?

The reinvestment approach to the modified internal rate of return:

The modified internal rate of return is specifically designed to address the problems associated with which one of the following?

Which one of the following methods of analysis ignores the time value of money?

Which one of the following is most closely related to the net present value profile?

You are using a net present value profile to compare investments A and B, which are mutually exclusive. Which one of the following statements correctly applies to the crossover point between these two?

The profitability index reflects the value created per dollar:

Which one of the following will occur when the internal rate of return equals the required return?

Which one of the following is an indicator that an investment is acceptable?

Which one of the following analytical methods is based on net income?

If a project with conventional cash flows has a profitability index of 1.0, the project will:

The average accounting return:

Which one of the following methods of analysis is most appropriate to use when two investments are mutually exclusive?

Which one of the following is true if the managers of a firm only accept projects that have a profitability index greater than 1.5?

Which one of the following methods of analysis has the greatest bias towards short-term projects?

Which one of the following methods of analysis is most similar to computing the return on assets (ROA) ?

Which one of the following is specifically designed to compute the rate of return on a project that has unconventional cash flows?

The internal rate of return is unreliable as an indicator of whether or not an investment should be accepted given which one of the following?

Which one of the following methods of analysis ignores cash flows?

An investment has conventional cash flows and a profitability index of 1.0. Given this, which one of the following must be true?