Question 1

You have a choice between two projects,Project1 pays $12,000 back at the end of 1 period on an investment of $10,000.Project 2 pays back $6,500 at the end of 1 period on an investment of $5,000.Which project should be chosen and what is the problem that you must be concerned with in this choice?
A) Project 1; discount rate.
B) Project 2; discount rate.
C) Project 1; project scales.
D) Project 2; project scales.
E) Project 1, cash flow timings.

Accepted Answer

Project 1 has a return of $2,000 on a $10,000 investment (20% return), and Project 2 has a return of $1,500 on a $5,000 investment (30% return). The issue is with project scales, as comparing absolute returns ignores the scale of the investment.

Question 2

The elements that cause problems with the use of the IRR in projects that are mutually exclusive are:
A) the discount rate and scale problems.
B) timing and scale problems.
C) the discount rate and timing problems.
D) scale and reversing flow problems.
E) timing and reversing flow problems.

Accepted Answer

The answer of The elements that cause problems with the...

Question 3

The profitability index is the ratio of:
A) average net income to average investment.
B) internal rate of return to current market interest rate.
C) net present value of cash flows to internal rate of return.
D) net present value of cash flows to average accounting return.
E) present value of cash flows to initial investment cost.

Accepted Answer

The profitability index is calculated by taking the present value of cash flows and dividing it by the initial investment cost. Therefore, the correct answer is E - "present value of cash flows to initial investment cost."

Question 4

The internal rate of return for a project will increase if:
A) the initial cost of the project can be reduced.
B) the total amount of the cash inflows is reduced.
C) each cash inflow is moved such that it occurs one year later than originally projected.
D) the required rate of return is reduced.

Accepted Answer

Reducing the initial cost of the project will result in a higher internal rate of return as it reduces the denominator in the calculation of IRR, which is the initial investment. Therefore, a lower initial investment will lead to a higher IRR.

Question 5

The IRR decision rule can be reversed because:
A) the NPV rule is not the same as the IRR.
B) the IRR is based on a mutually exclusive investment.
C) instead of an investment project it is a financing project.
D) the IRR is greater than 100%.

Accepted Answer

The IRR decision rule can be reversed for financing projects because the IRR represents the cost of financing. In such cases, a lower IRR is preferable as it indicates a lower cost of borrowing, contrasting with investment projects where a higher IRR is sought after.

Question 6

A mutually exclusive project is a project whose:
A) acceptance or rejection has no effect on other projects.
B) NPV is always negative.
C) IRR is always negative.
D) acceptance or rejection effects other projects.

Accepted Answer

Mutually exclusive projects are those where the decision to invest in one project affects the decision on other projects, meaning if one project is chosen, the other cannot be chosen due to constraints like budget, resources, or project scope.

Question 7

Under capital rationing the profitability index is used to select investments because of limited capital by their:
A) excess profit to achieve the highest payoff.
B) reward per dollar cost to achieve the highest incremental NPV.
C) incremental IRR to maximize the total rate of return.
D) capital usage rate to stay within budget.

Accepted Answer

The profitability index (PI) is calculated by dividing the present value of future cash flows by the initial investment, and it measures the reward per dollar cost. When capital is restricted, the goal is to select investments that provide the highest incremental net present value (NPV). The profitability index is useful as it puts NPV in terms of ratios, which makes it easier to compare projects with different investment sizes. Therefore, the best choice is B, reward per dollar cost to achieve the highest incremental NPV.

Question 8

A project will have only one internal rate of return if:
A) all cash flows after the initial expense are positive.
B) average accounting return is positive.
C) net present value is negative.
D) net present value is positive.
E) net present value is zero.

Accepted Answer

The internal rate of return (IRR) is unique for a project if all future cash flows following the initial investment are positive. This is because the project's cash flow pattern does not change sign more than once, avoiding the possibility of multiple IRRs.

Question 9

The problem of multiple IRRs can occur when:
A) there is only one sign change in the cash flows.
B) the first cash flow is always positive.
C) the cash flows decline over the life of the project.
D) there is more than one sign change in the cash flows.

Accepted Answer

Multiple IRRs occur when there are more than one sign change in the cash flows, meaning that there are multiple internal rates of return that could potentially match the initial investment with the discounted cash flows. This occurs when the cash flows switch between positive and negative multiple times over the life of the project, leading to multiple possible solutions for the IRR equation.

Question 10

Which of the following correctly orders the investment rules of average accounting return (AAR),internal rate of return (IRR),and net present value (NPV)from the most desirable to the least desirable?
A) AAR, IRR, NPV.
B) AAR, NPV, IRR.
C) IRR, AAR, NPV.
D) NPV, AAR, IRR.
E) NPV, IRR, AAR.

Accepted Answer

NPV is generally considered the most reliable method because it accounts for the time value of money and provides a direct estimate of the added value from an investment. IRR is next, as it also considers the time value of money but can be misleading for non-conventional cash flows or multiple IRRs. AAR is the least desirable because it does not account for the time value of money and is based on accounting profits rather than cash flows.

Question 11

If there is a conflict between mutually exclusive projects due to the IRR,one should:
A) drop the two projects immediately.
B) spend more money on gathering information.
C) depend on the NPV as it will always provide the most value.
D) depend on the AAR because it does not suffer from these same problems.

Accepted Answer

Depending on the Net Present Value (NPV) is the most reliable method in this scenario because NPV directly measures the increase in value brought by the projects, taking into account the time value of money, which is a more comprehensive approach than the Internal Rate of Return (IRR) in cases of mutually exclusive projects.

Question 12

The Carnation Chemical Company is investing in an incinerator to dispose of PCB waste.The incinerator costs $1.5 million and will generate end of year cash of $1 million for the next 3 years.At the end of 3 years the incinerator will be worthless and must be disposed of at the cost of $500,000.The internal rate of return for this project is:
A) between 10% and 20%.
B) between 20% and 30%.
C) between 30% and 40%.
D) more than 40%.

Accepted Answer

The answer of The Carnation Chemical Company is investing in...

Question 13

The Balistan Rug Company is considering investing in a new loom that will cost $12,000.The new loom will create positive end of year cash flow of $5,000 for the next 3 years.The internal rate of return for this project is:
A) between 10% and 15%.
B) between 15% and 20%.
C) between 20% and 25%.
D) between 25% and 30%.
E) less than 10%.

Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. In this case, the cash flows are $5,000 for each of the next 3 years, and the initial investment is $12,000. Without calculating the exact IRR, we can estimate it by recognizing that the total cash inflow ($15,000 over 3 years) is more than the initial investment ($12,000), but not by a huge margin. The IRR must be positive but not extremely high, placing it in the range of between 10% and 15%.

Question 14

Using the internal rate of return rule,a conventional project should be accepted if the internal rate of return is:
A) only equal to the current weighted average cost of capital.
B) greater than the current weighted average cost of capital.
C) less than the current weighted average cost of capital.
D) negative.
E) positive.

Accepted Answer

According to the internal rate of return rule, a project should be accepted if the IRR is greater than the current weighted average cost of capital. This is because the IRR represents the rate at which the project generates cash flows, and if it is higher than the cost of capital, it is considered profitable and therefore acceptable.

Question 15

You are considering a project with the following data: Internal rate of return 8.7%
Profitability ratio .98
Net present value -$393
Payback period 2.44 years
Required return 9.5%
Which one of the following is correct given this information?
A) The discount rate used in computing the net present value must have been less than 8.7%.
B) The discounted payback period will have to be less than 2.44 years.
C) The discount rate used to compute the profitability ratio was equal to the internal rate of return.
D) This project should be accepted based on the profitability ratio.
E) This project should be rejected based on the internal rate of return.

Accepted Answer

The internal rate of return (8.7%) is less than the required return (9.5%), indicating that the project's return is not sufficient to meet the required minimum rate of return. Therefore, the project should be rejected based on the internal rate of return. The negative net present value (-$393) also supports this decision. The profitability ratio (.98) is irrelevant in this case as it is less than 1, indicating a negative return on investment. The discounted payback period is also not applicable as it depends on the discounted cash flows, which are not provided in the data. Lastly, the discount rate used for the net present value calculation can be higher or lower than the internal rate of return, making option A incorrect.

Question 16

Suppose that a project has a cash flow pattern (-$2,000,$25,000,-$25000)Its IRR is given by:
A) 12.20%
B) 9.61% or 1040.39%
C) 25.25% or 250.52%
D) 4100.11%

Accepted Answer

To calculate IRR, we need to find the interest rate at which the sum of the present values of the cash inflows equals the sum of the present values of the cash outflows.

Using a financial calculator or Excel, we can find that the IRR of the given cash flow pattern is approximately 9.61%. However, be aware that there may be multiple IRRs for this pattern, as it has both positive and negative cash flows. It's also possible that the negative cash flows occur before the positive cash flows, leading to a situation where there is no real IRR.

Therefore, choice B is the best answer because it accounts for the potential range of IRRs for this type of cash flow pattern.

Question 17

A project will have more than one IRR if:
A) the IRR is positive.
B) the IRR is negative.
C) the NPV is zero.
D) the cash flow pattern exhibits more than one sign change.
E) the cash flow pattern exhibits exactly one sign change.

Accepted Answer

A project will have more than one IRR if the cash flow pattern exhibits more than one sign change. This occurs when there are both positive and negative cash flows at different points in time, leading to multiple discount rates that produce a net present value of zero.

Question 18

The internal rate of return tends to be:
A) easier for managers to comprehend than the net present value.
B) extremely accurate even when cash flow estimates are faulty.
C) ignored by most financial analysts.
D) used primarily to differentiate between mutually exclusive projects.

Accepted Answer

The internal rate of return is often preferred by managers because it is easier to understand and communicate than net present value. However, it is not necessarily more accurate than net present value and can be affected by faulty cash flow estimates. It is also used to compare mutually exclusive projects.

Question 19

The internal rate of return may be defined as:
A) the discount rate that makes the NPV cash flows equal to zero.
B) the difference between the market rate of interest and the NPV.
C) the market rate of interest less the risk-free rate.
D) the project acceptance rate set by management.

Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of a project's expected cash flows equal to zero. It is a commonly used metric for evaluating the profitability of investment opportunities.

Question 20

The two fatal flaws of the internal rate of return rule are:
A) arbitrary determination of a discount rate and failure to consider initial expenditures.
B) arbitrary determination of a discount rate and failure to correctly analyze mutually exclusive investment projects.
C) arbitrary determination of a discount rate and the multiple rate of return problem.
D) failure to consider initial expenditures and failure to correctly analyze mutually exclusive investment projects.
E) failure to correctly analyze mutually exclusive investment projects and the multiple rate of return problem.

Accepted Answer

The answer of The two fatal flaws of the internal...

Quiz 7: Net Present Value and Other Investment Rules

You have a choice between two projects,Project1 pays $12,000 back at the end of 1 period on an investment of $10,000.Project 2 pays back $6,500 at the end of 1 period on an investment of $5,000.Which project should be chosen and what is the problem that you must be concerned with in this choice?

The elements that cause problems with the use of the IRR in projects that are mutually exclusive are:

The profitability index is the ratio of:

The internal rate of return for a project will increase if:

The IRR decision rule can be reversed because:

A mutually exclusive project is a project whose:

Under capital rationing the profitability index is used to select investments because of limited capital by their:

A project will have only one internal rate of return if:

The problem of multiple IRRs can occur when:

Which of the following correctly orders the investment rules of average accounting return (AAR) ,internal rate of return (IRR) ,and net present value (NPV) from the most desirable to the least desirable?

If there is a conflict between mutually exclusive projects due to the IRR,one should:

The Balistan Rug Company is considering investing in a new loom that will cost $12,000.The new loom will create positive end of year cash flow of $5,000 for the next 3 years.The internal rate of return for this project is:

Using the internal rate of return rule,a conventional project should be accepted if the internal rate of return is:

You are considering a project with the following data: Internal rate of return 8.7% Profitability ratio .98 Net present value -$393 Payback period 2.44 years Required return 9.5% Which one of the following is correct given this information?

Suppose that a project has a cash flow pattern (-$2,000,$25,000,-$25000) Its IRR is given by:

A project will have more than one IRR if:

The internal rate of return tends to be:

The internal rate of return may be defined as:

The two fatal flaws of the internal rate of return rule are: