Questions in Chapter 9 concept.

qz 1) _____ quantifies in dollar terms how stockholder wealth will be affected by undertaking a project under consideration. [A] Discounted payback analysis [B] The average accounting return [C] The internal rate of return [D] Net present value [E] The profitability index [A] :This measures a project in terms of time, not in dollar terms. Review section 9.3. [B] :This measures a project as a ratio of net income to book value, not in dollar terms. Review section 9.4. [C] :This measures a project as a rate of return, not in dollar terms. Review section 9.5. [D] :You are correct! [E] :This measures a project as a benefit-to-cost ratio, not in dollar terms. Review section 9.6.

2) A project has a required return of 15 percent, conventional cash flows and a five-year life. Of the following values that have been computed, which value is inconsistent with the other four? [A] The discounted payback is exactly five years. [B] The profitability index is zero. [C] The net present value is zero. [D] The internal rate of return is 15 percent. [E] The present value of the future cash flows is equal to the initial outlay [A] :Since the discounted payback is exactly five years, what is the NPV? Review section 9.3. [B] :You are correct! The PI needs to equal 1 to be consistent with the other four. [C] :Since choices C and E say the same thing, neither one is the correct answer. Also, if the NPV is $0, this would be consistent with the IRR being equal to the required return, so D can't be correct. That only leaves two choices. Which one is not consistent with C, D, and E? Review sections 9.3 and 9.6. [D] :Since choices C and E say the same thing, neither one is the correct choice. Also, if the NPV is $0, this would be consistent with the IRR being equal to the required return, so D can't be correct. That only leaves two choices. Which one is not consistent with C, D, and E? Review sections 9.3 and 9.6. [E] :Since choices C and E say the same thing, neither one is the correct choice. Also, if the NPV is $0, this would be consistent with the IRR being equal to the required return, so D can't be correct. That only leaves two choices. Which one is not consistent with C, D, and E? Review sections 9.3 and 9.6.

3) A disadvantage of the payback rule and the average accounting return is that both ignore the time value of money. [A] True [B] False [A] :You are correct! [B] :Do you have to discount the cash flows to compute either of these two? Review sections 9.2 and 9.4.

4) Which one of the following excludes the time value of money principle? [A] discounted payback [B] profitability index [C] net present value [D] internal rate of return [E] average accounting return [A] :How do you compute the discounted cash flows? Review section 9.3. [B] :How do you compute the present value of the cash inflows? Review section 9.6. [C] :How do you compute net present value? Review section 9.1. [D] :How do you compute the internal rate of return? Review section 9.5. [E] :You are correct!

5) A project costs $475 and has cash flows of $100 for the first three years and $75 in each of the project's last five years. If the discount rate is 10 percent, what is the discounted payback period for the project? [A] The project never pays back on a discounted basis. [B] 6.29 years [C] 6.87 years [D] 7.03 years [E] 7.99 years [A] :You are correct! [B] :Did you find the present value of the first three cash flows to be $248.68 and the present value of the last five cash flows to be $213.61, meaning the project doesn't pay back on a discounted basis? Review section 9.3. [C] :Did you find the present value of the first three cash flows to be $248.68 and the present value of the last five cash flows to be $213.61, meaning the project doesn't pay back on a discounted basis? Review section 9.3. [D] :Did you find the present value of the first three cash flows to be $248.68 and the present value of the last five cash flows to be $213.61, meaning the project doesn't pay back on a discounted basis? Review section 9.3. [E] :Did you find the present value of the first three cash flows to be $248.68 and the present value of the last five cash flows to be $213.61, meaning the project doesn't pay back on a discounted basis? Review section 9.3.

6) To use the payback rule, the average accounting return or the profitability index you must first set an arbitrary cutoff. [A] True [B] False [A] :This is true for the first two, but not for the profitability index. Review section 9.6. [B] :You are correct!

7) Very few large U.S. firms use the payback rule when making capital budgeting decisions.

[A] True [B] False [A] :On the contrary, the payback rule is one of the most popular decision rules in practice despite its rather significant shortcomings. Review section 9.7. [B] :You are correct!

8) To find the _____ we begin by setting the net present value of a project equal to zero. I. payback II. discounted payback III. profitability index IV. internal rate of return [A] I only [B] II only [C] IV only [D] II and IV only [E] III and IV only [A] :This rule ignores the time value of money so it can't be related to the NPV. Review section 9.2. [B] :This rule does not require all project cash flows be considered but the NPV does. Review section 9.3. [C] :You are correct! [D] :At least one of these choices is incorrect. Review sections 9.3 and 9.5. [E] :At least one of these choices is incorrect. Review sections 9.5 and 9.6.

9) Both the internal rate of return and the profitability index decision rules may lead to incorrect decisions when comparing mutually exclusive investments. [A] True [B] False [A] :You are correct! [B] :This is a disadvantage of both of these rules. Review sections 9.5 and 9.6.

10) Complete the following decision rule: A project should be accepted if its ________ exceeds the firm's required rate of return. [A] internal rate of return [B] net present value [C] payback [D] discounted payback [E] average accounting return [A] :You are correct! [B] :This decision rule does not require comparisons with the required return. Review section 9.1. [C] :This decision rule does not require comparisons with the required return. Review section 9.2. [D] :This decision rule does not require comparisons with the required return. Review section 9.3.

[E] :This decision rule does not require comparisons with the required return. Review section 9.4.

11) For projects with conventional cash flows and positive discount rates, the payback period will be shorter than the discounted payback period. [A] True [B] False [A] :You are correct! [B] :With a positive discount rate the discounted cash flows will be lower than the undiscounted cash flows. Review sections 9.2 and 9.3.

12) Which of the following statements are correct? I. Net present value (NPV) is the difference between the present value of an asset or project and its cost. II. The financial manager acts in the shareholders' best interests by identifying and implementing positive NPV projects. III. NPVs can normally be directly observed in the market. IV. Investment criteria other than NPV provide additional information about whether or not a project truly has a positive NPV. [A] I and II only [B] II and III only [C] II, III, and IV only [D] I, II, and IV only [E] I, II, III, and IV [A] :Dont the other methods provide additional information that either confirms or conflicts with the NPV decision? Review section 9.8. [B] :Where do you find net present values of projects publicly listed? Review section 9.8. [C] :Where do you find net present values of projects publicly listed? Review section 9.8. [D] :You are correct! [E] :Where do you find net present values of projects publicly listed? Review section 9.8.

13) A net present value (NPV) of zero implies that an investment's: [A] cost exceeds the present value of its cash inflows. [B] cost is equal to the present value of its cash inflows. [C] internal rate of return (IRR) is greater than the firm's required rate of return. [D] present value of cash inflows is positive. [E] present value of cash inflows exceeds the investment's cost. [A] :This statement implies the NPV would be negative. Review section 9.1. [B] :You are correct! [C] :If the NPV is zero, shouldn't the IRR be the same as the required rate of return? Review section 9.5. [D] :This statement ignores the initial investment. Review section 9.1. [E] :This statement implies the NPV would be positive. Review section 9.1.

14) Which one of the following is an advantage of a capital budgeting rule? [A] The payback rule ignores the time value of money. [B] The discounted payback rule requires a cutoff hurdle time period be set. [C] The profitability index is closely related to the net present value. [D] The average accounting return is based on accounting data. [E] There may be multiple internal rates of return for a given project [A] :This is a disadvantage, not an advantage. Review section 9.2. [B] :This is a disadvantage, not an advantage. Review section 9.3. [C] :You are correct! [D] :This is a disadvantage, not an advantage. Review section 9.4. [E] :This is a disadvantage, not an advantage. Review section 9.5.

15) Consider a project with an initial investment and positive future cash flows. As the discount rate is increased the internal rate of return ________ while the net present value ____ [A] remains constant; increases. [B] decreases; remains constant. [C] remains constant; decreases. [D] increases; remains constant. [E] decreases; decreases. [A] :You are partially correct. What happens to present values as the discount rate is increased? Review section 9.1. [B] :Why would the IRR change in this case? What happens to present values as the discount rate is increased? Review sections 9.1 and 9.5. [C] :You are correct! [D] :Why would the IRR change in this case? What happens to present values as the discount rate is increased?. Review sections 9.1 and 9.5. [E] :Why would the IRR change in this case? Review section 9.5.

16) From a financial point of view, which one of the following is a correct statement? [A] The internal rate of return is considered to be the best project analysis technique. [B] The average accounting return is preferable to the profitability index method. [C] Discounted payback analysis requires the use of a discount rate. [D] Internal rate of return is the preferred method for comparing mutually exclusive investments. [E] Regular payback analysis is preferable to discounted payback analysis. [A] :Is it the IRR that all of the other decision rules are compared to? Review sections 9.1 and 9.5. [B] :If the PI is closely related to NPV and if the NPV is considered best in principle, why is the AAR better than the PI? Review sections 9.4 and 9.6. [C] :You are correct! [D] :The IRR should not be used for mutually exclusive investment decisions. Review section 9.5. [E] :Since discounted payback incorporates the time value of money and regular payback does not, discounted payback is preferable. Review sections 9.2 and 9.3.

17) Which one of the following decision rules is best for evaluating projects when distant cash flows and the time value of money are to be ignored? [A] payback [B] net present value [C] average accounting return [D] profitability index [E] internal rate of return [A] :You are correct! [B] :NPV considers all cash flows in its calculation and considers the time value of money. Review section 9.1. [C] :This ignores the time value of money and is based on net income earned over the entire life of a project. Review section 9.4. [D] :The profitability index considers all cash flows in its calculation and considers the time value of money. Review section 9.6. [E] :The IRR considers all cash flows in its calculation and considers the time value of money. Review section 9.5.

18) Which one of the following statements is true concerning discounted payback analysis for projects which have conventional cash flows and for which the discount rate is positive? [A] Discounted payback is better than simple payback because in simple payback analysis the cutoff payback period is arbitrarily set by management. [B] Any project that never pays back on a discounted basis must have a positive net present value. [C] When comparing two projects, the one with the shorter payback period on a discounted basis will have the larger net present value. [D] Discounted payback is much simpler to calculate than regular payback. [E] The discounted payback period will be longer than the regular payback period. [A] :An arbitrary cutoff point must be set for both discounted and simple payback. Review sections 9.2 and 9.3. [B] :This type of project would have to have a negative NPV. Review section 9.3. [C] :Since the cash flows beyond the cutoff point are ignored by payback, you cannot draw any conclusions regarding the relative NPVs. Review section 9.3. [D] :The regular payback is easier to calculate since it doesn't require any discounting of cash flows. Review section 9.2. [E] :You are correct!

19) You are considering the following two projects: Project : Year 0 : Year 1 : Year 2 : Year 3 A : -$200 : $100 : $100 : $100 B : -$300 : $175 : $125 : $125 Which of the following statements concerning these projects and the payback method of analysis are correct? I. With a payback cutoff of 1.5 years, both projects are unacceptable. II. With a payback cutoff of 3 years, both projects are acceptable. III. Since both projects pay back, the NPV of both must be positive. IV. Based on the payback criteria, you would be indifferent between the two. [A] I and II only

[B] III and IV only [C] I and IV only [D] I, III, and IV only [E] I, II, and IV only [A] :Correct, but there is at least one more correct option. Review section 9.2. [B] :At least one of these is incorrect. Review section 9.2. [C] :Correct, but there is at least one more correct option. Review section 9.2. [D] :At least one of these is incorrect. Review section 9.2. [E] :You are correct!

20) An investment should be accepted if the net present value is positive. [A] True [B] False [A] :You are correct! [B] :This is the correct statement of the net present value decision rule. Review section 9.1.

21) Which of the following questions are addressed in the capital budgeting process? I. What products or services will we offer or sell? II. In what markets will we compete? III. What new products will we introduce? [A] I only [B] III only [C] I and II only [D] I and III only [E] I, II, and III [A] :Correct, but there is at least one more correct option. Review the introduction to chapter 9. [B] :Correct, but there is at least one more correct option. Review the introduction to chapter 9. [C] :Correct, but why isn't choice III correct as well? Review the introduction to chapter 9. [D] :Correct, but why isn't choice II correct as well? Review the introduction to chapter 9. [E] :You are correct!

22) Which of the following are problems associated with the internal rate of return? I. omission of time value of money considerations II. bias against long-term projects III. inability to rank mutually exclusive or different sized projects IV. multiple results if some future cash flows are negative [A] I and II only [B] I and III only [C] III and IV only [D] II and III only [E] II and IV only [A] :At least one of these is incorrect. Review section 9.5. [B] :At least one of these is incorrect. Review section 9.5.

[C] :You are correct! [D] :At least one of these is incorrect. Review section 9.5. [E] :At least one of these is incorrect. Review section 9.5.

23) Which capital investment evaluation technique is described by the attributes below? 1. easy to understand and communicate 2. may result in multiple answers 3. may lead to incorrect decisions when applied to mutually exclusive investments [A] net present value [B] internal rate of return [C] average accounting return [D] payback [E] discounted payback [A] :None of these apply to the NPV rule. Review section 9.1. [B] :You are correct! [C] :None of these apply to the AAR rule. Review section 9.4. [D] :The payback rule neither results in multiple answers nor leads to incorrect decisions in comparing mutually exclusive investments. Review section 9.2. [E] :The discounted payback rule neither results in multiple answers nor leads to incorrect decisions in comparing mutually exclusive investments. Review section 9.3.

24) If a project has conventional cash flows, it may also have more than one IRR. [A] True [B] False [A] :Projects with conventional cash flows have at most one IRR. Review section 9.5. [B] :You are correct!

25) Which of the following consider the time value of money in their computation? I. payback II. average accounting return III. profitability index [A] I only [B] II only [C] III only [D] I and III only [E] II and III only [A] :This does not consider the time value of money. Review the disadvantages of this rule in section 9.2. [B] :This does not consider the time value of money. Review the disadvantages of this rule in section 9.4. [C] :You are correct! [D] :At least one of these choices is incorrect. Review sections 9.2 and 9.6. [E] :At least one of these choices is incorrect. Review sections 9.4 and 9.6.

26) The essence of _____ is determining whether a proposed investment or project will generate positive wealth for the owners of the firm once it is in place. [A] strategic asset allocation [B] capital structure analysis [C] cash flow analysis [D] payback analysis [E] working capital analysis [A] :You are correct! [B] :This choice deals with how a firm is financed not the evaluation of investment opportunities. Review the introduction to chapter 9. [C] :This term is too general to fit the definition stated in the question. Review the introduction to chapter 9. [D] :Payback analysis does not investigate additions to stockholder wealth. Review the introduction to chapter 9. [E] :This choice deals with how a firm manages its short-term resources, not the evaluation of investment opportunities. Review the introduction to chapter 9.

27) An investment's average net income divided by its average book value is called its: [A] payback. [B] discounted payback. [C] net present value. [D] internal rate of return. [E] average accounting return. [A] :This rule does not relate net income to book value. Review section 9.2. [B] :This rule does not relate net income to book value. Review section 9.3. [C] :This rule does not relate net income to book value. Review section 9.1. [D] :This rule does not relate net income to book value. Review section 9.5. [E] :You are correct!

28) Suppose you are evaluating two mutually exclusive projects, A and B. Project A costs $350 and has cash flows of $250 and $250 in the next 2 years, respectively. B costs $300 and generates cash flows of $300 and $100. What is the crossover rate for these projects? [A] 26.38 percent [B] 27.47 percent [C] 30.28 percent [D] 61.80 percent [E] 83.48 percent [A] :You need to review this calculation in section 9.5. [B] :You need to review this calculation in section 9.5. [C] :You are correct! [D] :You need to review this calculation in section 9.5. [E] :You need to review this calculation in section 9.5.

29) Ranking conflicts can arise between the internal rate of return (IRR) and the net present value (NPV) when: [A] the first cash flow of a project is negative and the remaining cash flows are positive. [B] projects are independent of one another. [C] a project has more than one NPV. [D] projects are mutually exclusive. [E] the profitability index is greater than one. [A] :These cash flows are considered to be conventional. Doesnt the conflict occur when cash flows are not conventional? Review section 9.5. [B] :If projects are dependent, not independent, then ranking problems may occur. Review section 9.5. [C] :A project cannot have more than one NPV if there is only one required rate of return. Review section 9.1. [D] :You are correct! [E] :This will not create a ranking problem between the IRR and the NPV. Review section 9.6.

30) Which one of the following capital investment evaluation techniques uses readily available information in an easy to compute manner? [A] net present value [B] internal rate of return [C] average accounting return [D] payback period [E] discounted payback period [A] :The NPV is not easy to calculate and the required information normally has to be calculated. Review section 9.1. [B] :The IRR is not easy to calculate and the required information normally has to be calculated. Review section 9.5. [C] :You are correct! [D] :While the payback computation is easy, the information required normally has to be calculated. Review section 9.2. [E] :The discounted payback is not easy to calculate and the required information normally has to be calculated. Review section 9.3.

31) You undertake a project with an initial investment of $10,000. You expect to receive $3,500 a year for the next 4 years. If the required return is 15 percent, what is the NPV? [A] -$435.26 [B] -$32.48 [C] -$7.58 [D] $4.63 [E] $5.49 [A] :You need to review this calculation in section 9.1. [B] :You need to review this calculation in section 9.1. [C] :You are correct! [D] :You need to review this calculation in section 9.1. [E] :You need to review this calculation in section 9.1.

32) The use of which of the following could lead to incorrect decisions in comparing mutually exclusive investments? I. internal rate of return II. profitability index III. average accounting return [A] I only [B] II only [C] III only [D] I and II only [E] I and III only [A] :Correct, but there is another correct option also. Review sections 9.4 and 9.6. [B] :Correct, but there is another correct option also. Review sections 9.5 and 9.6. [C] :The inability to compare mutually exclusive investments is not a disadvantage of this decision rule. Review section 9.4. [D] :You are correct! [E] :At least one of these is incorrect. Review sections 9.4 and 9.5.

33) A project that requires an initial cash outlay after which all remaining cash flows are inflows is said to be: [A] independent. [B] conventional. [C] mutually exclusive. [D] value-creating. [E] short term. [A] :This sentence does not describe an independent project. Review section 9.5. [B] :You are correct! [C] :This sentence does not describe a mutually exclusive project. Review section 9.5. [D] :This sentence does not describe a value-creating project. Review section 9.5. [E] :This sentence does not describe a short-term project. Review section 9.5.

34) According to the 1999 capital budgeting survey cited in the text, most chief financial officers of U.S. firms: [A] prefer to rely exclusively on payback analysis to evaluate projects. [B] use the average accounting return as their primary method of evaluating capital budgeting projects. [C] who use payback analysis appear to use it only in conjunction with some other type of analysis. [D] prefer to use the profitability index to analyze their investment projects. [E] make use of payback analysis more heavily than discounted cash flow methods. [A] :There are other methods that are used more heavily than payback. Review section 9.7. [B] :The AAR is used as a primary method of evaluating projects by relatively few of these companies. Review section 9.7. [C] :You are correct!

[D] :The PI is the least used of the methods listed. Review section 9.7. [E] :Both IRR and NPV, which are discounted cash flow methods, are preferred over payback. Review section 9.7.

35) Which capital investment evaluation technique is described by the attributes below? 1. closely related to net present value 2. easy to understand and communicate 3. may lead to incorrect decisions in comparing mutually exclusive investments 4. may be useful when the available investment funds are limited [A] discounted payback [B] internal rate of return [C] average accounting return [D] payback period [E] profitability index [A] :The discounted payback is useful for comparing mutually exclusive investments. Review section 9.3. [B] :The IRR does not have the advantage of being useful when investment funds are limited. Review section 9.5. [C] :The AAR does not fit these attributes. Review section 9.4. [D] :The payback period does not fit these attributes. Review section 9.2. [E] :You are correct!

36) The following is a list of the primary disadvantages of which one of the following evaluation methods as compared to the net present value method? 1. ignores cash flows beyond the cutoff date 2. requires an arbitrary cutoff point 3. biased against long-term projects 4. may reject positive NPV projects [A] profitability index [B] internal rate of return [C] average accounting return [D] payback period [E] discounted payback period [A] :None of these are considered to be disadvantages of the PI rule. Review section 9.6. [B] :None of these are considered to be disadvantages of the IRR rule. Review section 9.5. [C] :The only item in this list that is a disadvantage of the AAR is the requirement of an arbitrary cutoff point. Review section 9.4. [D] :One of the primary disadvantages of this rule is that it ignores the time value of money, which is absent from this list. There is a better answer. Review section 9.2. [E] :You are correct!

37) An advantage of the payback rule is that it is easy to understand. [A] True [B] False

[A] :You are correct! [B] :Payback is a measure of how long it takes to recover the initial investment. Isn't that easy to understand? Review section 9.2.

38) A project costs $475 and has cash flows of $100 for the first three years and $75 in each of the project's last five years. What is the payback period of the project? [A] The project never pays back. [B] 4.75 years [C] 5.00 years [D] 5.33 years [E] 6.37 years [A] :Since the cash inflows over the life of the project total $675, it will pay back at some point. Review section 9.2. [B] :After 4.75 years, you have only recovered a total of $431.25. Review section 9.2. [C] :After five years, you have only recovered a total of $450. Review section 9.2. [D] :You are correct! [E] :At the end of six years, the cash inflows total $525, so the project must pay back sometime prior to the end of the sixth year. Review section 9.2.

39) The management of a firm wishes to accept projects with a high degree of liquidity, avoid the higher forecasting error associated with distant cash flows, and avoid projects that require a large amount of research and development. The firm would be justified in using the ________ rule to evaluate its projects. [A] internal rate of return [B] net present value [C] average accounting return [D] payback [E] profitability index [A] :The IRR does not possess these attributes as advantages. Review section 9.5. [B] :The NPV does not possess these attributes as advantages. Review section 9.1. [C] :The AAR does not possess these attributes as advantages. Review section 9.4. [D] :You are correct! [E] :The PI does not possess these attributes as advantages. Review section 9.6.

40) A manager will prefer the internal rate of return rule over the net present value rule if the manager: [A] prefers to talk in terms of rates of return. [B] can accurately forecast future cash flows. [C] dislikes discounting cash flows. [D] is considering different sized projects. [E] is considering mutually exclusive projects. [A] :You are correct! [B] :This does not make the IRR preferable to the NPV. Review sections 9.1 and 9.5.

[C] :This does not impact upon the choice of the IRR versus the NPV. Review sections 9.1 and 9.5. [D] :Would you prefer earning $10 which is a 100 percent return on project A or earning $100 which is a 10 percent return on project B? Review sections 9.1 and 9.5. [E] :The NPV is preferred over the IRR when considering mutually exclusive investments. Review section 9.5.

41) According to the net present value (NPV) rule, a firm should accept a project if: [A] the estimated NPV is positive. [B] the estimated NPV exceeds the average accounting net income. [C] the estimated NPV exceeds a project's cost. [D] the NPV exceeds the firm's target accounting rate of return. [E] the NPV is negative. [A] :You are correct! [B] :The NPV rule does not relate project cost to net income. Review section 9.1. [C] :You should review the computation of net present value. Review section 9.1. [D] :The NPV rule is not related in any way to the AAR. Review section 9.1. [E] :According to this choice the project should be rejected, not accepted. Review section 9.1.

42) Which one of the following factors can cause a project to have multiple IRRs? [A] a large initial cash outlay [B] an initial cash investment followed by positive cash flows for three years and a negative cash flow in the final year [C] negative cash flows in the first three years of a project but positive cash flows thereafter [D] conventional cash flows [E] mutually exclusive investments [A] :This will not lead to multiple IRRs. Review section 9.5. [B] :You are correct! [C] :This will not lead to multiple IRRs since the sign on the cash flows changes only once. Review section 9.5. [D] :This will not cause multiple IRRs. Review section 9.5. [E] :This will not cause multiple IRRs. Review section 9.5.

43) Two projects that are mutually exclusive are said to be independent. [A] True [B] False [A] :Mutually exclusive choices are not independent from one another. Review section 9.5. [B] :You are correct!

44) Which of the following are problems associated with payback analysis? I. omission of time value of money considerations II. bias against long-term projects

III. inability to rank mutually exclusive projects IV. multiple results when some future cash flows are negative [A] I and II only [B] II and III only [C] I, II, and IV only [D] I, II, and III only [E] I, II, III, and IV [A] :You are correct! [B] :At least one of these is incorrect. Review section 9.2. [C] :At least one of these is incorrect. Review section 9.2. [D] :At least one of these is incorrect. Review section 9.2. [E] :At least one of these is incorrect. Review section 9.2.

45) You need to borrow $2,000 quickly and Morry, the neighborhood loan shark, will give it to you if you promise to repay him $200.92 a month for the next year. From your viewpoint, what is the percentage cost of this transaction? [A] 1.0 percent per month [B] 1.7 percent per month [C] 2.0 percent per month [D] 2.5 percent per month [E] 3.0 percent per month [A] :From your viewpoint, the initial investment is -$2,000 for a project that generates cash outflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5. [B] :From your viewpoint, the initial investment is -$2,000 for a project that generates cash outflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5. [C] :From your viewpoint, the initial investment is -$2,000 for a project that generates cash outflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5. [D] :From your viewpoint, the initial investment is -$2,000 for a project that generates cash outflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5. [E] :You are correct!

46) Which of the following methods can be used when choosing between mutually exclusive projects? I. AAR II. PI III. IRR IV. NPV [A] I only [B] II and III only [C] II and IV only [D] I and IV only [E] I and III only [A] :Correct, but there is at least one more correct option. Review sections 9.1, 9.5 and 9.6. [B] :Neither of these can be used for mutually exclusive investment decisions. Review sections 9.5 and 9.6.

[C] :At least one of these should not be used for mutually exclusive investment decisions. Review sections 9.1 and 9.6. [D] :You are correct! [E] :At least one of these should not be used for mutually exclusive investment decisions. Review section 9.1.

47) The _____ is equal to the present value of an investment's future cash flows divided by its initial cost. [A] payback [B] profitability index [C] net present value [D] internal rate of return [E] average accounting return [A] :This rule ignores time value of money and therefore, does not relate the present value of the projects cash flows to the initial costs. Review section 9.2. [B] :You are correct! [C] :A NPV is reported in dollars, not as a ratio of benefits to cost. Review section 9.1. [D] :An IRR is reported as a rate of return, not as a ratio of benefits to cost. Review section 9.5. [E] :This rule does not relate project cash flows to the initial cost. Review section 9.4.

48) Which of the following are problems associated with the profitability index? I. omission of time value of money considerations VI. bias against long-term projects III. inability to rank mutually exclusive projects IV. multiple results if some future cash flows are negative [A] I only [B] II only [C] III only [D] IV only [E] III and IV only [A] :This is not a problem associated with the profitability index. Review section 9.6. [B] :This is not a problem associated with the profitability index. Review section 9.6. [C] :You are correct! [D] :This is not a problem associated with the profitability index. Review section 9.6. [E] :At least one of these is incorrect. Review section 9.6.

49) You need to borrow $2,000 quickly and Morry, the neighborhood loan shark, will give it to you if you promise to repay him $200.92 a month for the next year. Suppose that Morry has more customers than funds. Which capital budgeting technique would allow him to rank his potential customers in order to maximize his current wealth? [A] average accounting return [B] payback period [C] profitability index [D] net present value [E] discounted payback

[A] :This is not the best technique for ranking projects when funds are limited. Review section 9.4. [B] :This is not the best technique for ranking projects when funds are limited. Review section 9.2. [C] :You are correct! [D] :This is not the best technique for ranking projects when funds are limited. Review section 9.1. [E] :This is not the best technique for ranking projects when funds are limited. Review section 9.3.

50) A financial manager who consistently underestimates the ________ will tend to incorrectly reject projects that would actually create wealth for the stockholders. [A] marginal income tax rate [B] initial cost of projects [C] future cash outlays associated with projects [D] required return on projects [E] future cash inflows associated with projects [A] :Underestimating this would actually lead managers to accept, not reject more projects. Review section 9.1. [B] :Underestimating this would actually lead managers to accept, not reject more projects. Review section 9.1. [C] :Underestimating this would actually lead managers to accept, not reject more projects. Review section 9.1. [D] :Underestimating this would actually lead managers to accept, not reject more projects. Review section 9.1. [E] :You are correct!

51) Your firm needs to generate income from some unused equipment which the company owns. The president presents you with two options. First, you can sell the equipment or second, you can rent out the equipment. This is an example of a decision involving: [A] independent projects. [B] working capital projects. [C] positive NPV projects. [D] tax shields. [E] mutually exclusive projects. [A] :Can you simultaneously both rent and sell the equipment? Review section 9.5. [B] :This decision relates to fixed assets, not net working capital. Review section 9.5. [C] :The projects may have positive NPVs, but that is not the issue here. There is a better answer. Review section 9.5. [D] :Taxes are not the primary issue in this question. There is a better answer. Review section 9.5. [E] :You are correct!

52) Which one of the following is computed using only accounting numbers?

[A] payback period [B] profitability index [C] net present value [D] internal rate of return [E] average accounting return [A] :This requires the use of cash flows, not accounting numbers. Review section 9.2. [B] :This requires the use of cash flows, not accounting numbers. Review section 9.6. [C] :This requires the use of cash flows, not accounting numbers. Review section 9.1. [D] :This requires the use of cash flows, not accounting numbers. Review section 9.5. [E] :You are correct!

53) The _____ is the length of time required for an investment's discounted cash flows to equal its initial cost. [A] payback [B] discounted payback [C] net present value [D] internal rate of return [E] average accounting return [A] :This rule ignores the time value of money. Review section 9.2. [B] :You are correct! [C] :The NPV rule considers all project cash flows, not just the ones it takes to recover the initial investment in discounted terms. Review section 9.1. [D] :This is reported as a return in percentage points, not as a length of time. Review section 9.5. [E] :This rule does not relate cash flows to project cost. Review section 9.4.

54) Which one of the following decision rules has the advantage that the information needed for the computation is usually readily available? [A] net present value [B] internal rate of return [C] average accounting return [D] payback [E] discounted payback [A] :In this case the cash flows must be computed. Review section 9.1. [B] :In this case the cash flows must be computed. Review section 9.5. [C] :You are correct! [D] :In this case the cash flows must be computed. Review section 9.2. [E] :In this case the cash flows must be computed. Review section 9.3.

55) An investment is acceptable if the internal rate of return (IRR) exceeds the required return. [A] True [B] False [A] :You are correct! [B] :This is a correct statement of the IRR decision rule. Review section 9.5.

56) The net present value decision rule is considered a better overall method of project analysis than either the internal rate of return (IRR) or the profitability index (PI). [A] True [B] False [A] :You are correct! [B] :Can you apply the IRR and PI rules to all projects? Review sections 9.1, 9.5 and 9.6.

57) One of the risks a firm takes when it uses the ________ as the investment criterion for proposed projects is that it may reject some profitable projects because of the timing of their cash flows. [A] average accounting return [B] net present value [C] internal rate of return [D] profitability index [E] payback rule [A] :This rule is not based on cash flows. Review section 9.4. [B] :This rule requires all of a project's cash flows be considered. Review section 9.1. [C] :This rule requires all of a project's cash flows be considered. Review section 9.5. [D] :This rule requires all of a project's cash flows be considered. Review section 9.6. [E] :You are correct!

58) A project with a net present value equal to zero: [A] should be rejected. [B] has a profitability index that is greater than one. [C] is expected to yield a return equal to the firm's required return. [D] has a discounted payback period that is shorter than the life of the project. [E] has an internal rate of return that exceeds the required rate. [A] :If the NPV is zero, you are indifferent about the project and should accept it absent other more desirable investment opportunities. Review section 9.1. [B] :Remember, the PI is the present value of the cash flows divided by the initial investment. If the NPV is zero, what must be true about the PI ratio? Review section 9.6. [C] :You are correct! [D] :If the NPV is zero, the discounted payback is equal to the life of the project. Review section 9.3. [E] :What is the net present value when the IRR equals the required return? Review section 9.5.

59) If a project with conventional cash flows has a profitability index (PI) that is less than one, then the: [A] internal rate of return is greater than the required return. [B] discounted payback period is greater than the project's life.

[C] average accounting return is greater than the required return. [D] payback period is less than the maximum acceptable period. [E] net present value is positive. [A] :If the IRR exceeds the required return, isn't the PI greater than 1? Review sections 9.5 and 9.6. [B] :You are correct! [C] :The AAR is not related to the PI and the required return. Review section 9.4. [D] :The payback period is not related to the profitability index. Review section 9.2. [E] :You need to review how to interpret the profitability index in section 9.6.

60) If the net present value (NPV) is greater than zero for a project with conventional cash flows, then the: [A] internal rate of return (IRR) is equal to the firm's required rate of return. [B] profitability index is greater than 1. [C] payback period is shorter than required by the firm. [D] average accounting return exceeds the internal rate of return. [E] the project does not pay back on a discounted basis. [A] :What is the NPV when the IRR is equal to the required return? Review section 9.5. [B] :You are correct! [C] :The payback period does not relate directly to the NPV. Review section 9.2. [D] :The AAR does not relate directly to the IRR. Review sections 9.4 and 9.5. [E] :If a projects NPV is greater than zero, the project must pay back on a discounted basis at some point during its life. Review section 9.3.

61) A steep net present value (NPV) profile indicates that a project's NPV is very sensitive to changes in the cost of capital. [A] True [B] False [A] :You are correct! [B] :This response implies that a large change in the required return will change this project's NPV very little. Is that what a steep NPV profile suggests? Review section 9.5.

62) The length of time required for an investment's undiscounted cash flows to equal its initial cost is called the: [A] payback. [B] discounted payback. [C] average accounting return. [D] profitability index. [E] net present value. [A] :You are correct! [B] :This rule requires the use of discounted cash flows, not undiscounted cash flows as specified in the question. Review section 9.3. [C] :AAR compares net income and book values. Review section 9.4.

[D] :PI is not expressed in units of time. Review section 9.6. [E] :NPV is not expressed in units of time. Review section 9.1.

63) When multiple IRR's exist, a project must have a negative NPV at the highest IRR. [A] True [B] False [A] :By definition, what is the NPV at the IRR? Review section 9.5. [B] :You are correct!

64) If the required return is zero and a project has conventional cash flows, then: [A] the payback period exceeds the discounted payback period. [B] the net present value equals the difference between the undiscounted future cash flows and the initial cash outlay. [C] if the net present value is negative, the internal rate of return will be greater than zero. [D] the profitability index will be less than one. [E] the project will be acceptable according to the average accounting return criteria. [A] :The two payback periods would be identical in this case. Review sections 9.2 and 9.3. [B] :You are correct! [C] :If the NPV is negative at a required return of zero, then the NPV cannot be zero at any discount rate greater than zero. Review section 9.1. [D] :Even though the discount rate is zero, you can't draw any conclusions regarding the PI. Review section 9.6. [E] :The AAR does not relate to the cash flows and required return of a project. Review section 9.4.

65) Rank the following decision rules from worst to best in terms of their overall usefulness in capital budgeting analysis. I. NPV II. Payback III. IRR [A] II, III, I [B] II, I, III [C] III, I, II [D] I, III, II [E] III, II, I [A] :You are correct! [B] :This ranking is irrational if only because the NPV is considered best in principle. Thus, it should be ranked last when ordering from worst to best. Review section 9.1. [C] :This ranking is irrational if only because the NPV is considered best in principle. Thus, it should be ranked last when ordering from worst to best. Review section 9.1. [D] :This ranking is irrational if only because the NPV is considered best in principle. Thus, it should be ranked last when ordering from worst to best. Review section 9.1. [E] :Review the disadvantages of the payback rule as compared to those of the IRR. Review sections 9.2 and 9.5.

66) Your boss presents you with two capital budgeting proposals. The first one involves buying a new delivery truck and the second one involves building additional warehouse space. Provided there are sufficient funds for both, this is an example: [A] of mutually exclusive projects. [B] of crossover analysis. [C] where the internal rate of return should not be used as an analytical tool. [D] of two independent projects. [E] where the net present value is unreliable as a decision making tool. [A] :How does acquiring a truck preclude you from acquiring more warehouse space? Review section 9.5. [B] :This response is not descriptive of this type of investment choice. Review section 9.5. [C] :Are these mutually exclusive projects? Review section 9.5. [D] :You are correct! [E] :Why can you not apply the net present value rule to this situation? Review section 9.1.

67) Which one of the following is based on net income rather than on cash flows? [A] profitability index [B] discounted payback [C] payback [D] average accounting return [E] internal rate of return [A] :PI uses cash flows. Review section 9.6. [B] :Discounted payback uses cash flows. Review section 9.3. [C] :Payback uses cash flows. Review section 9.2. [D] :You are correct! [E] :IRR uses cash flows. Review section 9.5.

68) What is the maximum number of internal rates of return (IRRs) that may exist for the following project? Yr0 = -$50,000; Yr1 = -$5,000; Yr2 = $50,000; Yr3 = $50,000; and Yr4 = -$25,000? [A] 0 [B] 1 [C] 2 [D] 3 [E] 4 [A] :Since the signs on the cash flows change twice, negative to positive then positive back to negative, there can be at most 2 IRRs. Review section 9.5. [B] :Since the signs on the cash flows change twice, negative to positive then positive back to negative, there can be at most 2 IRRs. Review section 9.5. [C] :You are correct! [D] :Since the signs on the cash flows change twice, negative to positive then positive back to negative, there can be at most 2 IRRs. Review section 9.5. [E] :Since the signs on the cash flows change twice, negative to positive then positive back to negative, there can be at most 2 IRRs. Review section 9.5.

69) If financial managers invest only in projects that have a profitability index greater than one then ________ should increase. I. the value of the firm II. shareholder wealth III. share price [A] I only [B] II only [C] III only [D] I and III only [E] I, II, and III [A] :Correct, but there is at least one other correct option also. Review section 9.6. [B] :Correct, but there is at least one other correct option also. Review section 9.6. [C] :Correct, but there is at least one other correct option also. Review section 9.6. [D] :If the share price increases, why doesnt shareholder wealth also increase? Review section 9.6. [E] :You are correct!

70) Suppose a firm invests $600 in a project. The initial cost is depreciated straight-line to zero over 3 years. Net income from the project is $100, $125, and $140 in each of the three years of the project's life. What is the average accounting return? [A] 18.25 percent [B] 20.28 percent [C] 35.49 percent [D] 40.56 percent [E] 60.83 percent [A] :To answer this, you must find the average net income and the average book value. Did you find the average book value to be $300? Review section 9.4. [B] :To answer this, you must find the average net income and the average book value. Did you find the average book value to be $300? Review section 9.4. [C] :To answer this, you must find the average net income and the average book value. Did you find the average book value to be $300? Review section 9.4. [D] :You are correct! [E] :To answer this, you must find the average net income and the average book value. Did you find the average book value to be $300? Review section 9.4.

71) Suppose you are considering a project that costs $300 and has expected cash flows of $110, $121 and $133.10 over the next three years, respectively. If the appropriate discount rate is 10 percent, what is the net present value of this project? [A] -$19.79 [B] $0.00 [C] $0.71 [D] $19.79 [E] $64.10

[A] :You need to review this calculation in section 9.1. [B] :You are correct! [C] :You need to review this calculation in section 9.1. [D] :You need to review this calculation in section 9.1. [E] :You need to review this calculation in section 9.1.

72) The _____ is the difference between an investment's present value and its cost. [A] payback [B] profitability index [C] net present value [D] internal rate of return [E] average accounting return [A] :Payback measures time not differences in dollar values. Review section 9.2. [B] :The profitability index is reported as a benefit to cost ratio, not as a dollar amount. Review section 9.6. [C] :You are correct! [D] :The IRR is reported as a rate of return, not as a dollar value. Review section 9.5. [E] :This rule does not compare market values and costs. Review section 9.4.

73) Which of the following is (are) biased in favor of liquid investments? I. payback period II. average accounting return III. discounted payback [A] I only [B] III only [C] I and II only [D] I and III only [E] I, II, and III [A] :Correct, but there is at least one more correct option. Review sections 9.3 and 9.4. [B] :Correct, but there is at least one more correct option. Review sections 9.2 and 9.4. [C] :At least one of these choices is incorrect. Review sections 9.2 and 9.4. [D] :You are correct! [E] :At least one of these choices is incorrect. Review sections 9.2, 9.3 and 9.4.

74) You are comparing two projects using a net present value profile. At the point where the net present values (NPV) of the two projects are equal, the: [A] internal rate of return (IRR) of each project is equal to zero. [B] IRR of each project is equal to the cost of capital. [C] interest rate that makes the net present values equal is called the crossover rate. [D] projects will both have net present values equal to zero. [E] average accounting return (AAR) exceeds the cost of capital. [A] :Note that the problem states the NPVs will be equal, not necessarily zero. Review section 9.5.

[B] :Note that the problem states the NPVs will be equal, not necessarily zero. Review section 9.5. [C] :You are correct! [D] :The NPVs can be equal and still be greater than or less than zero. Review section 9.5. [E] :The AAR is not related to the NPV. Review section 9.4.

75) The profitability index is computed using accounting income and accounting book values. [A] True [B] False [A] :This describes the average accounting return, not the profitability index. Review sections 9.4 and 9.6. [B] :You are correct!

76) What is the internal rate of return (IRR) decision rule? [A] accept a project when the IRR is greater than zero [B] accept a project if at the IRR the NPV is positive [C] reject any project if the IRR is below 10 percent [D] accept a project if the IRR exceeds the firm's bank borrowing rate [E] accept a project if the IRR exceeds the firm's required rate of return [A] :How does this relate to the required rate of return? Review section 9.5. [B] :By definition, the NPV is zero at the IRR. Review section 9.5. [C] :How does this relate to the required rate of return? Review section 9.5. [D] :The IRR decision rule does not depend on a firm's bank borrowing rate. Review section 9.5. [E] :You are correct!

77) You run a small bagel shop and are considering replacing your four sales clerks with automated machines that allow customers to buy their bagels without any human interaction. Of the following, the most difficult task you face in computing the net present value of this project is estimating the: [A] proposed reduction in wages. [B] tax shield of the new project. [C] cost of the new equipment that will be required. [D] cost of installing the new equipment. [E] total change in sales. [A] :This would be relatively easy since you already know what you are paying the four employees you would replace. Review section 9.1. [B] :This would be relatively easy to identify once you determine the cost of the new machines. Review section 9.1. [C] :You could get this information simply by calling an equipment dealer. Review section 9.1. [D] :You could get this information simply by getting a price quote from a contractor. Review section 9.1. [E] :You are correct!

78) You are going to choose one of two mutually exclusive investments. Investment A pays $35,000 a year for 4 years and has an initial cost of $80,000. Investment B pays $60,000 a year for 5 years and has an initial cost of $170,000. If your required return is 13 percent, which investment should you choose and why? [A] A; because it costs less initially [B] A; because its IRR exceeds 13 percent [C] A; because it has a higher IRR [D] B; because its IRR exceeds 13 percent [E] B; because it has a higher NPV [A] :Project A does cost less, but what about the NPVs? Review section 9.1. [B] :In fact, both projects have IRRs that exceed 13 percent. Can you use the IRR rule to rank mutually exclusive investments? Review section 9.5. [C] :Can you use the IRR rule to rank mutually exclusive investments? Review section 9.5. [D] :In fact, both projects have IRRs that exceed 13 percent. Can you use the IRR rule to rank mutually exclusive investments? Review section 9.5. [E] :You are correct!

79) You need to borrow $2,000 quickly and Morry, the neighborhood loan shark, will give it to you if you promise to repay him $200.92 a month for the next year. Suppose that Morry's cost of funds is 1 percent per month. From Morrys point of view, what is the net present value of this deal? [A] $44.11 [B] $111.01 [C] $226.17 [D] $261.37 [E] $292.01 [A] :Did you compute the net present value at a discount rate of 1 percent? Review section 9.5. [B] :Did you compute the net present value at a discount rate of 1 percent? Review section 9.5. [C] :Did you compute the net present value at a discount rate of 1 percent? Review section 9.5. [D] :You are correct! [E] :Did you compute the net present value at a discount rate of 1 percent? Review section 9.5.

80) As a financial manager, rank the following decision rules in order of preference from best to worst in terms of usefulness in making capital budgeting decisions. I. NPV II. discounted payback III. payback [A] I, II, III [B] I, III, II [C] II, I, III [D] II, III, I [E] III, I, II [A] :You are correct! [B] :Since the payback rule ignores the time value of money, the discounted payback rule is superior in at least this one important way. Review sections 9.2 and 9.3.

[C] :This choice is irrational if only because the NPV rule is considered to be the best in principle and should, therefore, be ranked the best of the three choices given. Review section 9.1. [D] :This choice is irrational if only because the NPV rule is considered to be the best in principle and should, therefore, be ranked the best of the three choices given. Review section 9.1. [E] :This choice is irrational if only because the NPV rule is considered to be the best in principle and should, therefore, be ranked the best of the three choices given. Review section 9.1.

81) If an investment has a ________ of 1.2 it can be said the investment generates $1.20 in present value benefits for each dollar invested. [A] profitability index [B] net present value [C] internal rate of return [D] payback [E] average accounting return [A] :You are correct! [B] :The net present value is not a benefit to cost ratio as described by this statement. Review sections 9.1 and 9.6. [C] :The internal rate of return is not a benefit to cost ratio as described by this statement. Review sections 9.5 and 9.6. [D] :The payback period is not a benefit to cost ratio as described by this statement. Review sections 9.2 and 9.6. [E] :The average accounting return is not a benefit to cost ratio as described by this statement. Review sections 9.4 and 9.6.

82) The profitability index, net present value, and internal rate of return are all closely related to one another. [A] True [B] False [A] :You are correct! [B] :If a project has conventional cash flows, all three will give the same decision. Review section 9.1, 9.5 and 9.6.

83) For all projects, the AAR will be less than the IRR. [A] True [B] False [A] :There is no prescribed relationship between the AAR and the IRR. Review sections 9.4 and 9.5. [B] :You are correct!

84) The ________ decision rule is considered the "best" in principle. [A] internal rate of return

[B] payback [C] average accounting return [D] net present value [E] profitability index [A] :You should review the disadvantages of this rule in section 9.5. [B] :You should review the disadvantages of this rule in section 9.2. [C] :You should review the disadvantages of this rule in section 9.4. [D] :You are correct! [E] :You should review the disadvantages of this rule in section 9.6.

85) If investment funds are limited and the projects under consideration are independent from one another, then the accounting rate of return should be used to rank projects to determine which ones should be accepted. [A] True [B] False [A] :Since these are independent investments, the profitability index should be used to rank the projects. Review section 9.6. [B] :You are correct!

86) In which of the following cases is it possible that the NPV and IRR rules will lead to different decisions? I. project cash flows are conventional II. the IRR is negative III. an investment decision involves mutually exclusive choices [A] I only [B] III only [C] I and II only [D] I and III only [E] II and III only [A] :If project cash flows are conventional there will only be one IRR and both the NPV and IRR will lead to the same decision. Review section 9.5. [B] :You are correct! [C] :If project cash flows are conventional there will only be one IRR and both the NPV and IRR will lead to the same decision. The fact that the IRR is negative will not lead to differing decisions. Review section 9.5. [D] :At least one of these choices is incorrect. Review section 9.5. [E] :At least one of these choices is incorrect. Review section 9.5.

87) Would you accept a project which is expected to pay $10,000 a year for 7 years if the initial investment is $40,000 and your required return is 15 percent? [A] yes; the NPV is $1,604 [B] yes; the NPV is $1,446 [C] yes; the NPV is $4,238 [D] no; the NPV is -$1,369

[E] no; the NPV is -$2,783 [A] :You are correct! [B] :You need to review the computation of NPV in section 9.1. [C] :You need to review the computation of NPV in section 9.1. [D] :You need to review the computation of NPV in section 9.1. [E] :You need to review the computation of NPV in section 9.1.

88) A project that has a discounted payback period longer than its life also has a positive NPV. [A] True [B] False [A] :If the project doesn't ever pay back on a discounted basis, how can it have a positive NPV? Review section 9.3. [B] :You are correct!

89) What is the IRR, to the nearest whole percent, of an investment that costs $77,000 and pays $27,500 a year for 4 years? [A] 16 percent [B] 18 percent [C] 20 percent [D] 22 percent [E] 24 percent [A] :You are correct! [B] :You need to review the calculation of IRRs in section 9.5. [C] :You need to review the calculation of IRRs in section 9.5. [D] :You need to review the calculation of IRRs in section 9.5. [E] :You need to review the calculation of IRRs in section 9.5.

90) Which of the following are correct statements concerning capital budgeting decision rules? I. If a project has a profitability index greater than one, the project should be accepted. II. If a firm's target average accounting return is lower than that computed for a given project, the project should be accepted. III. If the cost of capital is greater than the internal rate of return, the project should be accepted. IV. If a project has a payback period that is less than what the company requires, the project should be accepted. [A] I and II only [B] I and IV only [C] I, III and IV only [D] I, II and IV only [E] II, III and IV only [A] :Correct, but there is at least one more correct option. Review section 9.2. [B] :This decision rule is stated correctly. Review section 9.4. [C] :At least one of these options is incorrect. Review sections 9.2, 9.5 and 9.6. [D] :You are correct!

[E] :At least one of these options is incorrect. Review sections 9.2, 9.4 and 9.5.

91) Compute the NPV, to the nearest whole dollar, for a project with an initial investment of $40,000 and cash inflows of $11,000 a year for 5 years given a required return of 11.649 percent. [A] -$1,205 [B] -$1,103 [C] $0 [D] $567 [E] $1,218 [A] :You need to review calculation of NPVs in section 9.1. [B] :You need to review calculation of NPVs in section 9.1. [C] :You are correct! [D] :You need to review calculation of NPVs in section 9.1. [E] :You need to review calculation of NPVs in section 9.1.

92) Suppose a project costs $300 and produces cash flows of $100 over each of the following six years. What is the IRR of the project? [A] 0 percent [B] 10.0 percent [C] 24.3 percent [D] 34.9 percent [E] 38.1 percent [A] :This choice is irrational since the total cash inflows for the project are $600, making the NPV $300 at a discount rate of 0 percent. Review section 9.5. [B] :If you check, you should find the NPV is positive, not zero, at this rate of interest. Review section 9.5. [C] :You are correct! [D] :If you check, you should find the NPV is negative, not zero, at this rate of interest. Review section 9.5. [E] :If you check, you should find the NPV is negative, not zero, at this rate of interest. Review section 9.5.

93) What is the net present value, rounded to the nearest whole dollar, of the following set of cash flows if the required return is 14 percent? Yr0 = -$50,000; Yr1 = -$5,000; Yr2 = $50,000; Yr3 = $50,000; and Yr4 = -$25,000? [A] -$500 [B] $3,034 [C] $9,525 [D] $10,376 [E] $41,410 [A] :You need to review this calculation in section 9.1. [B] :You are correct! [C] :You need to review this calculation in section 9.1. [D] :You need to review this calculation in section 9.1.

[E] :You need to review this calculation in section 9.1.

94) Which capital investment evaluation technique is described by the attributes below? 1. easy to understand 2. biased towards liquidity 3. requires an arbitrary cutoff point 4. ignores the time value of money [A] net present value [B] internal rate of return [C] profitability index [D] payback [E] discounted payback [A] :None of these apply to the NPV rule. Review section 9.1. [B] :Except for the first statement, none of the rest apply to the IRR rule. Review section 9.5. [C] :Except for the first statement, none of the rest apply to the PI rule. Review section 9.6. [D] :You are correct! [E] :The first three statements do apply to the discounted payback, but this rule does not ignore the time value of money. Review section 9.3.

95) You need to borrow $2,000 quickly, and Morry, the neighborhood loan shark, will give it to you if you promise to repay him $200.92 a month for the next year. From Morry's viewpoint, what is the IRR of this transaction? [A] 1.0 percent per month [B] 1.7 percent per month [C] 2.0 percent per month [D] 2.5 percent per month [E] 3.0 percent per month [A] :From Morry's viewpoint, the initial investment is $2,000 for a project that generates cash inflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5. [B] :From Morry's viewpoint, the initial investment is $2,000 for a project that generates cash inflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5. [C] :From Morry's viewpoint, the initial investment is $2,000 for a project that generates cash inflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5. [D] :From Morry's viewpoint, the initial investment is $2,000 for a project that generates cash inflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5. [E] :You are correct!

96) Which of the following are problems associated with net present value? I. omission of time value of money considerations II. bias against long-term projects III. inability to rank mutually exclusive projects IV. multiple results if some future cash flows are negative [A] I only [B] II only [C] III only

[D] IV only [E] None of these are problems that apply to NPV. [A] :This is not a problem associated with NPV. Review section 9.1. [B] :This is not a problem associated with NPV. Review section 9.1. [C] :This is not a problem associated with NPV. Review section 9.1. [D] :This is not a problem associated with NPV. Review section 9.1. [E] :You are correct!

97) You are considering the following independent projects but you have limited funds to invest and can't take them all. Using the profitability index, rank the projects in the order in which you would accept them. That is, rank them from best to worst. I. Project I requires an initial investment of $100,000 and has a NPV of $30,000. II. Project II requires an initial investment of $80,000 and has a NPV of $25,000. III. Project III requires an initial investment of $40,000 and has a NPV of $17,000. [A] I, II, III [B] II, III, I [C] III, I, II [D] III, II, I [E] I, III, II [A] :Did you get a PI of 1.3 for project I? That is computed as ($100,000 + $30,000) / $100,000 = 1.3. Review section 9.6. [B] :If you didn't get a profitability index of 1.3, 1.3125, and 1.425 for I, II and III, respectively, you have done something wrong. If you did get these numbers, you have not ranked them correctly. Review section 9.6. [C] :If you didn't get a profitability index of 1.3, 1.3125, and 1.425 for I, II and III, respectively, you have done something wrong. If you did get these numbers, you have not ranked them correctly. Review section 9.6. [D] :You are correct! [E] :If you didn't get a profitability index of 1.3, 1.3125, and 1.425 for I, II and III, respectively, you have done something wrong. If you did get these numbers, you have not ranked them correctly. Review section 9.6.

98) Which one of the following is considered to be an advantage of the average accounting return method of analysis? [A] incorporation of time value of money [B] estimation of the appropriate cutoff rate [C] reliance on net income and book values [D] reliance on book values and not market values [E] ease of computation [A] :The time value of money is ignored in this computation. Review the disadvantages of this rule in section 9.4. [B] :The cutoff must be arbitrarily determined for this rule. Review the disadvantages of this rule in section 9.4. [C] :This is considered to be a disadvantage, not an advantage of this rule. Review the disadvantages of this rule in section 9.4. [D] :This is considered to be a disadvantage, not an advantage of this rule. Review the disadvantages of this rule in section 9.4.

[E] :You are correct!

99) What is the payback period of a $40,000 investment with the following cash flows? Yr1 = 20,000; Yr2 = 25,000; Yr3 = 10,000; Yr4 = 10,000; Yr5 = 5,000. [A] 1.00 year [B] 1.80 years [C] 2.00 years [D] 2.25 years [E] 3.50 years [A] :At the end of one year you have only recovered half of the initial investment. Review section 9.2. [B] :You are correct! [C] :At the end of two years you have recovered more than the initial investment, meaning the payback must be something less than two years. Review section 9.2. [D] :At the end of two years you have recovered more than the initial investment, meaning the payback must be something less than two years. Review section 9.2. [E] :At the end of two years you have recovered more than the initial investment, meaning the payback must be something less than two years. Review section 9.2.

100) A firm that only accepts projects for which the IRR is equal to the firm's required return will, on average, neither create nor destroy wealth for its shareholders. [A] True [B] False [A] :You are correct! [B] :What is the NPV of a project for which the IRR is the same as the required rate of return? Review section 9.5.

101) Net present value (NPV): [A] is equal to the initial investment in a project. [B] compares project cost to the present value of the project benefits. [C] is equal to zero when the discount rate used is less than the internal rate of return (IRR). [D] is simplified by the fact that future cash flows are easy to estimate. [E] requires a firm to set an arbitrary cutoff point for determining whether or not a project should be accepted. [A] :If only the initial investments are considered, all NPVs would be negative. Review section 9.1. [B] :You are correct! [C] :If the IRR exceeds the discount rate, would the project really have a NPV of zero? Review section 9.5. [D] :Cash flows are not easy to estimate. Review section 9.1. [E] :The NPV rule does not require an arbitrary cutoff. What is the decision rule? Review section 9.1.

102) Compute the NPV of the following project using a discount rate of 12 percent: Yr0 -$500; Yr1 -$50; Yr2 $50; Yr3 $200; Yr4 $400; Yr5 $400. [A] $0.00 [B] $61.22 [C] $118.75 [D] $208.00 [E] $269.21 [A] :You need to review this calculation in section 9.1. [B] :You need to review this calculation in section 9.1. [C] :You are correct! [D] :You need to review this calculation in section 9.1. [E] :You need to review this calculation in section 9.1.

103) The average accounting return (AAR) decision rule states that a project should be accepted whenever the AAR: [A] is positive. [B] exceeds the internal rate of return (IRR). [C] indicates that a project has more than recaptured its initial cost in terms of net income. [D] exceeds the target AAR. [E] is less than the IRR. [A] :With the AAR, you need to somehow establish a hurdle rate. This cutoff will almost always be set at something greater than zero. Review section 9.4. [B] :While a hurdle rate must be set for the AAR rule, it is not likely to be set relative to the IRR. Review section 9.4. [C] :The AAR does not relate net income to the initial cost. Review section 9.4. [D] :You are correct! [E] :While a hurdle rate must be set for the AAR rule, it is not likely to be set relative to the IRR. Review section 9.4.

104) You are considering the following two projects: Project : Year 0 : Year 1 : Year 2 : Year 3 A : -$200 : $100 : $100 : $100 B : -$300 : $175 : $125 : $125 Which one of the following statements concerning the profitability index (PI) is correct if the applicable discount rate is 14 percent? [A] The PI of project A is less than 1.0. [B] The PI of project B is less than 1.0. [C] Based on the PI, project A is preferable. [D] Both projects would be rejected based on the PI criterion. [E] The project with the smaller initial investment always has the higher PI. [A] :The NPV of project A is positive so the PI must exceed one. Review section 9.6. [B] :The NPV of project B is positive so the PI must exceed one. Review section 9.6. [C] :You are correct! [D] :The NPV of project A and project B are both positive so the PI's must exceed one. Review section 9.6.

[E] :This statement is not always true. Review section 9.6.

105) An advantage of the average accounting return is that the information needed to compute it will usually be available. [A] True [B] False [A] :You are correct! [B] :Dont you normally estimate the initial cost, income, and expenses for a project? Review section 9.4.