Question 1

The NPV of a project with an initial investment of $1,000 that provides after-tax operating cash flows of $300 per year for four years where the firm's cost of capital is 15 percent is $856.49.

Accepted Answer

The NPV (Net Present Value) of a project is calculated by discounting the future cash flows back to their present value and then subtracting the initial investment. Using the given information and a discount rate of 15%, the NPV calculation does not result in $856.49.

Question 2

What is the NPV for a project if its cost of capital is 0 percent and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1,$1,900,000 in year 2,$1,700,000 in year 3,and $1,300,000 in year 4?

Accepted Answer

When the cost of capital is 0 percent, the NPV is simply the sum of the cash inflows minus the initial investment. Summing the inflows gives $1,800,000 + $1,900,000 + $1,700,000 + $1,300,000 = $6,700,000. Subtracting the initial investment of $5,000,000 from this sum gives an NPV of $1,700,000.

Question 3

For a project that has an initial cash outflow followed by cash inflows,the profitability index (PI)is equal to the present value of cash inflows divided by the cost of capital.

Accepted Answer

The profitability index (PI) is calculated as the present value of future cash inflows divided by the initial investment (or initial cash outflow), not divided by the cost of capital.

Question 4

If the NPV is greater than $0,a project should be accepted.

Accepted Answer

A positive NPV indicates that the project is expected to generate more cash inflows than outflows, thus increasing the overall value of the company. Therefore, it is beneficial to accept the project.

Question 5

The net present value is found by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to the project's internal rate of return.

Accepted Answer

The net present value (NPV) is found by subtracting a project's initial investment from the present value of its cash inflows discounted at the project's cost of capital or discount rate, not necessarily the internal rate of return (IRR).

Question 6

The NPV of a project with an initial investment of $2,500 that provides after-tax operating cash flows of $500 per year for four years where the firm's cost of capital is 15 percent is $427.49.

Accepted Answer

The NPV (Net Present Value) calculation involves discounting future cash flows back to their present value using the cost of capital and then subtracting the initial investment. Given the data, the correct NPV calculation would not precisely result in $427.49 due to the specifics of the cash flows and the discount rate provided.

Question 7

If the NPV is less than the initial investment,a project should be rejected.

Accepted Answer

The decision to accept or reject a project based on NPV (Net Present Value) does not directly compare NPV to the initial investment. Instead, if the NPV is positive, it means the project's returns exceed its costs (including the initial investment), and the project should be accepted. If the NPV is negative, it means the project's costs exceed its returns, and it should be rejected.

Question 8

Which of the following is an advantage of NPV?

Accepted Answer

NPV takes into account the time value of investors' money, which means that it considers the opportunity cost of money invested today versus the potential returns in the future. This is an important advantage because it helps decision-makers to choose between alternative investment opportunities by considering the present value of future cash flows. Option A is incorrect because NPV does not measure risk exposure, although it can incorporate risk in the discount rate used. Option C is incorrect because NPV is not highly sensitive to discount rates since they are an input in the calculation. Option D is incorrect because NPV does not measure how quickly a firm can breakeven, but rather the present value of cash flows over the entire life of a project.

Question 9

The return that must be earned on a project in order to leave the firm's value unchanged is ________.

Accepted Answer

The return required to leave the firm's value unchanged is equivalent to the cost of capital. This is because the cost of capital represents the minimum return that investors require in order to invest in the project, and if the project only earns the cost of capital, the firm's value will not increase. The internal rate of return (A) is the return at which the project's net present value is zero, which represents an increase in firm value. The interest rate (B) is the cost of borrowing, and is not necessarily the same as the cost of capital. The compound rate (D) is not a commonly used financial term.

Question 10

A capital budgeting technique that can be computed by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to a firm's cost of capital is called profitability index.

Accepted Answer

The described technique is actually the Net Present Value (NPV), not the Profitability Index. The Profitability Index is calculated by dividing the present value of future cash inflows by the initial investment.

Question 11

If the net present value of a project is greater than zero,the firm will earn a return greater than its cost of capital.The acceptance of such a project would enhance the wealth of the firm's owners.

Accepted Answer

A positive net present value indicates that the project's expected cash inflows are greater than its initial investment, which means that the firm will earn a return greater than its cost of capital. Therefore, the acceptance of such a project would enhance the wealth of the firm's owners.

Question 12

The discount rate is the return that an investment project must meet or exceed to maintain or increase the firm's value.

Accepted Answer

The discount rate is the minimum rate of return that a project must generate in order to exceed the cost of capital and create value for the firm. By setting a discount rate, a company can evaluate investment decisions based on whether they will generate returns that exceed this rate. Therefore, the statement is true.

Question 13

The NPV of a project is the difference between an investment's net operating profit after taxes and the cost of funds used to finance the investment,which is found by multiplying the dollar amount of the funds used to finance the investment by the firm's weighted average cost of capital.

Accepted Answer

The NPV (Net Present Value) of a project is calculated by discounting the future cash flows from the investment back to their present value using the firm's weighted average cost of capital (WACC) and then subtracting the initial investment cost. It does not directly involve the net operating profit after taxes or a simple multiplication of the funds used by the WACC.

Question 14

A firm can accept a project with a net present value of zero because ________.

Accepted Answer

A project with a net present value of zero means that the project will generate exactly enough cash flows to cover the initial investment and required rate of return. Therefore, the firm's owners' wealth will be maintained, but not necessarily enhanced.

Question 15

Economic value added is the difference between an investment's net operating profit after taxes and the accounting profit.

Accepted Answer

Economic Value Added (EVA) is the difference between a company's net operating profit after taxes and its cost of capital (including both equity and debt), not the accounting profit.

Question 16

A firm is evaluating an investment proposal which has an initial investment of $5,000 and cash flows presently valued at $4,000.The net present value of the investment is ________.

Accepted Answer

The net present value (NPV) is calculated by subtracting the initial investment from the present value of cash flows. Here, NPV = $4,000 - $5,000 = -$1,000.

Question 17

Thinking in terms of the goal of wealth maximization,a project breaks even for shareholders,meaning that it neither creates nor destroys value,if ________.

Accepted Answer

The NPV (Net Present Value) of a project is the difference between its expected cash inflows and outflows, discounted to their present values. If the NPV is zero, then the project is neither adding nor subtracting value for the shareholders, making it break even. Options B, C, and D do not necessarily indicate break-even as they do not take into account the time value of money or the cost of capital.

Question 18

A capital budgeting technique that can be computed by subtracting a project's initial investment from the present value of its cash inflows discounted at a rate equal to a firm's cost of capital is called net present value.

Accepted Answer

This is the definition of net present value.

Question 19

If the NPV is greater than the initial investment,a project should be rejected.

Accepted Answer

If the NPV is greater than the initial investment, it means that the project is expected to generate positive cash flows and create value for the company. Therefore, a project with a positive NPV should be accepted, not rejected.

Question 20

What is the NPV for a project whose cost of capital is 15 percent and initial after-tax cost is $5,000,000 and is expected to provide after-tax operating cash inflows of $1,800,000 in year 1,$1,900,000 in year 2,$1,700,000 in year 3,and $1,300,000 in year 4?

Accepted Answer

The answer of What is the NPV for a project...

Quiz 10: Capital Budgeting Techniques