Question 1

You can evaluate alternative projects with different lives by calculating and comparing their equivalent annual annuity.

Accepted Answer

Equivalent annual annuity is a method used to compare alternative projects with different lives by calculating the equal annual cash flows that each alternative will generate over their respective lives.

Question 2

When comparing two projects with different lives, why do you compute an annuity with an equivalent present value (PV) to the net present value (NPV)?

Accepted Answer

Computing an annuity with an equivalent PV to the NPV allows for comparison of projects on a per-year basis, making it easier to evaluate their cost or value created annually, despite having different lifespans.

Question 3

When different projects put different demands on a limited resource, then net present value (NPV) is always the best way to choose the best project.

Accepted Answer

Net present value (NPV) is just one of several methods that can be used to analyze and rank projects. Other methods, such as internal rate of return (IRR) and payback period, may be more appropriate depending on the specific situation and the preferences of the decision maker. Additionally, even if NPV is used, it cannot always determine the best project if the projects have different investment levels or time horizons.

Question 4

How do you apply the Net Present Value rule when multiple projects are available and you have the added constraint of accepting only one project?

Accepted Answer

The answer of How do you apply the Net Present...

Question 5

A company has four projects it wishes to undertake. Which of these investments should be the lowest priority, given a discount rate of 5%?

Accepted Answer

B)
 11ea84dc_f55d_5f1e_9a63_c331de4f92f1_TB1316_00_TB1316_00

Question 6

What can you comment about the shape of the net present value (NPV) profile of a multiple IRR project?

Accepted Answer

The answer of What can you comment about the shape...

Question 7

Is there a unique way for calculating the MIRR to resolve the multiple IRR situation?

Accepted Answer

The answer of Is there a unique way for calculating...

Question 8

A lawn maintenance company compares two ride-on mowers-the Excelsior, which has an expected working-life of six years, and the Grassassinator, which has a working life of four years. After examining the equivalent annual annuities of each mower, the company decides to purchase the Excelsior. Which of the following, if true, would be most likely to make them change that decision?

Accepted Answer

Since the Excelsior has an expected working-life of six years, it would not be the best choice if it is only expected to be needed for three years. In this case, the Grassassinator may be a more cost-effective choice as it has a shorter working life but a lower initial cost. The other options may affect the running costs or market conditions, but they do not directly impact the decision between the two mowers with different working lives.

Question 9

Jenkins Security has learned that a rival has offered to supply a parking garage with security for ten years for $45,000 up front and a further $15,000 per year. If Jenkins Security offers to provide security for eight years for an upfront cost of $60,000 and a separate yearly payment, by what maximum amount can this yearly payment be over $20,000, so that Jenkins' offer matches the equivalent annual annuity of their rival's offer? (Assume a cost of capital of 5%.)

Accepted Answer

D) Using a financial calculator,
spreading $45,000 over 10 years = $5827.70587; thus, 11ea84dc_f55c_74b6_9a63_3b612a996098_TB1316_11_TB1316_11 spreading $60,000 over 8 years = $9283.30882; thus, the 11ea84dc_f55c_74b7_9a63_a327e3c2f18f_TB1316_11_TB1316_11

Question 10

A small department store in a mall has the opportunity to rent an additional 20,000 square feet of space for five years. It can divide up this space between the above new departments. Each department will require a different amount of space, and each department is expected to make a yearly profit as shown, for each of the next five years. The discount rate is 10%. Based on this information, what departments should be added?

Accepted Answer

B)
 11ea84dc_f55d_10fc_9a63_a9fd82f6195f_TB1316_00_TB1316_00

Question 11

The profitability index can break down completely when dealing with multiple resource restraints.

Accepted Answer

A) Using a financial calculator, 11ea84dc_f55c_c2d8_9a63_ab33d3f95762_TB1316_11_TB1316_11 11ea84dc_f55c_c2d9_9a63_53d676505b0c_TB1316_11_TB1316_11

Question 12

A consultancy calculates that it can supply crude oil assaying services to a small oil producer for $115,000 per year for five years. There are some upfront costs the consultancy will require the oil producer to absorb. What is the maximum that these upfront costs could be, if the equivalent annual annuity to the oil company is to be under $160,000, given that the cost of capital is 9%?

Accepted Answer

B) Annual difference = $160,000 - $115,000 = $45,000;
PV over 5 years at 9% = $175,034

Question 13

A security company offers to provide CCTV coverage for a parking garage for ten years for an initial payment of $50,000 and additional payments of $30,000 per year. What is the equivalent annual annuity of this deal, given a cost of capital of 5%?

Accepted Answer

D) Using a financial calculator, 11ea84dc_f55b_ff84_9a63_cd8b5dc15ac3_TB1316_00_TB1316_00

Question 14

What are some potential problems in using internal rate of return (IRR) for mutually exclusive projects?

Accepted Answer

The answer of What are some potential problems in using...

Question 15

A company buys a color printer that will cost $16,000 to buy, and last 5 years. It is assumed that it will require servicing costing $500 each year. What is the equivalent annual annuity of this deal, given a cost of capital of 8%?

Accepted Answer

D) Using a financial calculator, 11ea84dc_f55c_2695_9a63_e38ae6dce222_TB1316_00_TB1316_00

Question 16

A garage is comparing the cost of buying two different car hoists. Hoist A will cost $20,000, will require servicing of $1000 every two years, and last ten years. Hoist B will cost $15,000, require servicing of $800 per year, and last eight years. If the cost of capital is 7%, which is the better option, given that the firm has an ongoing requirement for a hoist?

Accepted Answer

D) Using a financial calculator,
NPV(A) = -$23,393 equivalent annual annuity (A) = -$3,331
NPV(B) = -$19,777 equivalent annual annuity (B) = -$3,312

Question 17

When using equivalent annual annuities to compare the costs of projects with different lives, you should not consider any changes in the expected replacement cost of equipment.

Accepted Answer

When using equivalent annual annuities to compare the costs of projects with different lives, changes in the expected replacement cost of equipment should be considered to accurately evaluate the total cost of each project.

Question 18

What is a safe method to use when confronted with mutually exclusive projects?

Accepted Answer

The answer of What is a safe method to use...

Question 19

The owner of a number of gas stations is considering installing coffee machines in his gas stations. It will cost $260,000 to install the coffee machines, and they are expected to boost cash flows by $111,428 per year for their five-year working life. What must the cost of capital be if this investment has a profitability index of 1?

Accepted Answer

C)
 11ea84dc_f55c_e9ea_9a63_1390aa392b27_TB1316_00_TB1316_00

Question 20

A janitorial services firm is considering two brands of industrial vacuum cleaners to equip their staff. Option A will cost $1,500, require servicing of $200 per year, and it will last five years. Option B will cost $1,000, require servicing of $100 per year, and it will last three years. If the cost of capital is 8%, which is the better option, given that the firm has an ongoing requirement for vacuum cleaners?

Accepted Answer

D) Using a financial calculator,
NPV(A) = -$2,298.54 equivalent annual annuity (A) = -$575.68
NPV(B) = -$1257.71 equivalent annual annuity (B) = -$488.03

Quiz 8: Investment Decision Rules