Q&A Hero

Q: Determine the five-year equivalent annual annuity of the following project if the appropriate discount rate is 16%. Initial Outflow = $150,000 Cash Flow Year 1 = $40,000 Cash Flow Year 2 = $90,000 Cash Flow Year 3 = $60,000 Cash Flow Year 4 = $0 Cash Flow Year 5 = $80,000 A) $7,058 B) $8,520 C) $9,454 D) $9,872

Q: Your firm is considering investing in one of two mutually exclusive projects. Project A requires an initial outlay of $3,500 with expected future cash flows of $2,000 per year for the next three years. Project B requires an initial outlay of $2,500 with expected future cash flows of $1,500 per year for the next two years. The appropriate discount rate for your firm is 12% and it is not subject to capital rationing. Assuming both projects can be replaced with a similar investment at the end of their respective lives, compute the NPV of the two chain cycle for Project A and three chain cycle for Project B. A) $2,232 and $85 B) $5,000 and $1,500 C) $2,865 and $94 D) $3,528 and $136

Q: Your company is considering an investment in one of two mutually exclusive projects. Project 1 involves a labor intensive production process. Initial outlay for Project 1 is $1,495 with expected after-tax cash flows of $500 per year in years 1-5. Project 2 involves a capital intensive process, requiring an initial outlay of $6,704. After-tax cash flows for Project 2 are expected to be $2,000 per year for years 1-5. Your firm's discount rate is 10%. If your company is not subject to capital rationing, which project(s) should you take on? A) Project 1 B) Project 2 C) Projects 1 and 2 D) Neither project is acceptable.

Q: Interstate Appliance Inc. is considering the following 3 mutually exclusive projects. Projected cash flows for these ventures are as follows:Plan APlan BPlan CInitialInitialInitialOutlay = $3,600,000Outlay = $6,000,000Outlay = $3,500,000Cash Flow:Cash Flow:Cash Flow:Yr 1 = $-0-Yr 1 = $4,000,000Yr 1 = $2,000,000Yr 2= -0-Yr 2 = 3,000,000Yr 2 = -0-Yr 3 = -0-Yr 3 = 2,000,000Yr 3 = 2,000,000Yr 4 = -0-Yr 4 = -0-Yr 4 = 2,000,000Yr 5 = $7,000,000Yr 5 = -0-Yr 5 = 2,000,000If Interstate Appliance has a 12% cost of capital, what decision should be made regarding the projects above?A) accept plan AB) accept plan BC) accept plan CD) accept Plans A, B and C

Q: Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The equivalent annual annuity amount for project A is A) $12,989. B) $13,357. C) $15,024. D) $18,532.

Q: If a project's IRR is equal to its required return, then the project's NPV is equal to zero and its PI is equal to one.

Q: Both the profitability index (PI) and net present value (NPV) are based on the present value of all future free cash flows, but the PI is a relative measure while the NPV is an absolute measure of a project's desirability.

Q: Finance theory suggests that the IRR criterion is the most favorable capital budgeting decision tool.

Q: Two projects are mutually exclusive if the accept/reject decision for one project has no impact on the accept/reject decision for the other project.

Q: An infinite-life replacement chain allows projects of different lengths to be compared.

Q: A project's equivalent annual annuity (EAA) is the annuity cash flow that yields the same present value as the project's NPV.

Q: The size disparity problem occurs when mutually exclusive projects of unequal size are being examined.

Q: The mutually exclusive project with the highest positive NPV will also have the highest IRR.

Q: IRR should not be used to choose between mutually exclusive projects.

Q: If two projects are mutually exclusive, then the IRR is more important than the NPV in deciding the project that should be chosen.

Q: How might capital rationing conflict with the goal of maximizing shareholders' wealth?

Q: I301 Motors has several investment projects under consideration, all with positive net present values. However, due to a shortage of trained personnel, a limit of $1,250,000 has been placed on the capital budget for this year. Which of the projects listed below should be included in this year's capital budget? Explain your answer.ProjectInitial OutlayNPVA$250,000$325,000B250,000350,000C100,000700,000D375,000112,500E375,00075,000

Q: Under what condition would you NOT accept a project that has a positive net present value? A) If the project has a profitability index less than zero. B) If two or more projects are mutually inclusive. C) If the firm is limited in the capital it has available (capital rationing). D) If a project has more than one sign reversal.

Q: You are in charge of one division of Yeti Surplus Inc. Your division is subject to capital rationing. Your division has 4 indivisible projects available, detailed as follows:ProjectInitial OutlayIRRNPV12 million18%2,500,00021 million15%950,00031 million10%600,00043 million9%2,000,000If you must select projects subject to a budget constraint of 5 million dollars, which set of projects should be accepted so as to maximize firm value?A) Projects 1, 2 and 3B) Project 1 onlyC) Projects 1 and 4D) Projects 2, 3 and 4

Q: Capital rationing may be imposed because of all of the following EXCEPT A) capital market conditions are poor. B) management has a fear of debt. C) stockholder control problems prevent issuance of additional stock. D) the company's stock price is at an historically high level.

Q: The net present value always provides the correct decision provided that A) cash flows are constant over the asset's life. B) the required rate of return is greater than the internal rate of return. C) capital rationing is not imposed. D) the internal rate of return is positive.

Q: When capital rationing exists, the divisibility of projects is ignored and projects are funded in order of their PI's or IRR's.

Q: Capital rationing generally leads to higher stock prices as management is doing the best job it can in selecting only the best capital budgeting projects.

Q: Positive NPV projects may be rejected when capital must be rationed.

Q: The profitability index can be helpful when a financial manager encounters a situation where capital rationing is required.

Q: The payback period may be more appropriate to use for companies experiencing capital rationing.

Q: What does a net present value profile tell you, and how is it constructed? How does the IRR enter into the net present value profile?

Q: What is the difference between the IRR and the MIRR?

Q: The Bolster Company is considering two mutually exclusive projects:YearInitial OutlayNPV0-$100,000-$100,000131,2500231,2500331,2500431,2500531,250200,000The required rate of return on these projects is 12 percent.a. What is each project's payback period?b. What is each project's discounted payback period?c. What is each project's net present value?d. What is each project's internal rate of return?e. Fully explain the results of your analysis. Which project do you prefer, and why?

Q: A project that requires an initial investment of $340,000 is expected to have an after-tax cash flow of $70,000 per year for the first two years, $90,000 per year for the next two years, and $150,000 for the fifth year? Assume the required return for this project is 10%. a. What is the NPV of the project%? b. What is the IRR of the project? c. What is the MIRR of the project? d. What is the PI of the project? e. What decision would you make regarding this project if the required rate of return is 10%? f. What is the equivalent annual annuity using a 10% required rate of return?

Q: Consider two mutually exclusive projects X and Y with identical initial outlays of $600,000 and useful lives of 5 years. Project X is expected to produce an after-tax cash flow of $180,000 each year. Project Y is expected to generate a single after-tax net cash flow of $1,015,000 in year 5. The discount rate is 14 percent. a. Calculate the net present value for each project. b. Calculate the IRR for each project. c. What decision should you make regarding these projects?

Q: D&B Contracting plans to purchase a new backhoe. The one under consideration costs $233,000, and has a useful life of 8 years. After-tax cash flows are expected to be $31,384 in each of the 8 years and nothing thereafter. Calculate the internal rate of return for the grader.

Q: Kingston Corp. is considering a new machine that requires an initial investment of $480,000 installed, and has a useful life of 8 years. The expected annual after-tax cash flows for the machine are $89,000 for each of the 8 years and nothing thereafter. a. Calculate the net present value of the machine if the required rate of return is 11 percent. b. Calculate the IRR of this project. c. Should Kingston accept the project (assume that it is independent and not subject to any capital rationing constraint)? Explain your answer.

Q: A project would be acceptable if A) the payback is greater than the discounted equivalent annual annuity. B) the equivalent annual annuity is greater than or equal to the firm's discount rate. C) the profitability index is greater than the net present value. D) the net present value is positive.

Q: If the NPV (Net Present Value) of a project with multiple sign reversals is positive, then the project's required rate of return ________ its calculated IRR (Internal Rate of Return). A) must be less than B) must be greater than C) could be greater or less than D) The required rate of return cannot be determined without actual cash flows.

Q: What is the internal rate of return's assumption about how cash flows are reinvested? A) They are reinvested at the firm's discount rate. B) They are reinvested at the required rate of return. C) They are reinvested at the project's internal rate of return. D) They are only reinvested at the end of the project.

Q: A one-sign-reversal project should be accepted if it A) generates an internal rate of return that is higher than the profitability index. B) produces an internal rate of return that is greater than the firm's discount rate. C) results in an internal rate of return that is above a project's equivalent annual annuity. D) results in a modified internal rate of return that is higher than the internal rate of return.

Q: A significant disadvantage of the internal rate of return is that it A) does not fully consider the time value of money. B) does not give proper weight to all cash flows. C) may have an unrealistic reinvestment assumption. D) is expressed as a percentage.

Q: A significant disadvantage of the internal rate of return is that it A) does not fully consider the time value of money. B) does not give proper weight to all cash flows. C) can result in multiple rates of return (more than one IRR). D) is expressed as a percentage.

Q: Which of the following statements about the internal rate of return (IRR) is true? A) It has the most conservative and realistic reinvestment assumption. B) It never gives conflicting answers. C) It fully considers the time value of money. D) It is greater than the modified internal rate of return if the discount rate is higher than the IRR.

Q: Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment's internal rate of return? A) 27.28% B) 21.26% C) 20.53% D) 15.98%

Q: Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment's profitability index? A) 1.21 B) 1.26 C) 1.43 D) 1.69

Q: Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment's net present value? A) $540,000 B) $378,458 C) $192,369 D) $112,583

Q: An independent project should be accepted if it A) produces a net present value that is greater than or equal to zero. B) produces a net present value that is greater than the equivalent IRR. C) has only one sign reversal. D) produces a profitability index greater than or equal to zero.

Q: A significant advantage of the internal rate of return is that it A) provides a means to choose between mutually exclusive projects. B) provides the most realistic reinvestment assumption. C) avoids the size disparity problem. D) considers all of a project's cash flows and their timing.

Q: Your firm is considering an investment that will cost $750,000 today. The investment will produce cash flows of $250,000 in year 1, $300,000 in years 2 through 4, and $100,000 in year 5. What is the investment's discounted payback period if the required rate of return is 10%? A) 3.33 years B) 3.16 years C) 2.67 years D) 2.33 years

Q: A significant disadvantage of the payback period is that it A) is complicated to explain. B) increases firm risk. C) does not properly consider the time value of money. D) provides a measure of liquidity.

Q: A significant advantage of the payback period is that it A) places emphasis on time value of money. B) allows for the proper ranking of projects. C) tends to reduce firm risk because it favors projects that generate early, less uncertain returns. D) gives proper weighting to all cash flows.

Q: You are considering investing in a project with the following year-end after-tax cash flows: Year 1: $57,000 Year 2: $72,000 Year 3: $78,000 If the initial outlay for the project is $185,000, compute the project's internal rate of return. A) 3.98% B) 5.54% C) 11.89% D) 14.74%

Q: If the NPV (Net Present Value) of a project with one sign reversal is positive, then the project's IRR (Internal Rate of Return) ________ the required rate of return. A) must be less than B) must be greater than C) could be greater or less than D) The project's IRR cannot be determined without actual cash flows.

Q: Consider a project with the following information:YearAfter-tax Accounting Profits fromAfter-tax Cash Flow Operations1$799$75021501,00032001,200Initial outlay = $1,500Compute the profitability index if the company's discount rate is 10%.A) 15.8B) 1.61C) 1.81D) 0.62

Q: Compute the discounted payback period for a project with the following cash flows received uniformly within each year and with a required return of 8%.Initial Outlay = $100Cash Flows:Year 1 = $40Year 2 = $50Year 3 = $60A) 2.10 yearsB) 2.21 yearsC) 2.33 yearsD) 3.00 years

Q: For the net present value (NPV) criteria, a project is acceptable if NPV is ________, while for the profitability index a project is acceptable if PI is ________. A) greater than zero; greater than the required return B) greater than or equal to zero; greater than zero C) greater than one; greater than or equal to one D) greater than or equal to zero; greater than or equal to one

Q: Your company is considering a project with the following cash flows: Initial Outlay = $3,000,000 Cash Flows Year 1-8 = $547,000 Compute the internal rate of return on the project. A) 6.38% B) 8.95% C) 9.25% D) 12.34%

Q: Design Quilters is considering a project with the following cash flows:Initial Outlay = $126,000Cash Flows:Year 1 = $44,000Year 2 = $59,000Year 3 = $64,000If the appropriate discount rate is 11.5%, compute the NPV of this project.A) -$14,947B) $2,892C) $7,089D) $41,000

Q: Southeast Compositions, Inc. is considering a project with the following cash flows:Initial Outlay = $126,000Cash Flows:Year 1 = $44,000Year 2 = $59,000Year 3 = $64,000Compute the net present value of this project if the company's discount rate is 14%.A) $1,193B) $561C) $209D) $715

Q: All of the following are criticisms of the payback period criterion EXCEPT A) time value of money is not accounted for. B) cash flows occurring after the payback are ignored. C) it deals with accounting profits as opposed to cash flows. D) None of the above; they are all criticisms of the payback period criteria.

Q: The internal rate of return is A) the discount rate that makes the NPV positive. B) the discount rate that equates the present value of the cash inflows with the present value of the cash outflows. C) the discount rate that makes NPV negative and the PI greater than one. D) the rate of return that makes the NPV positive.

Q: The disadvantage of the IRR method is that A) the IRR deals with cash flows. B) the IRR gives equal regard to all returns within a project's life. C) the IRR will always give the same project accept/reject decision as the NPV. D) the IRR requires long, detailed cash flow forecasts.

Q: The advantages of NPV are all of the following EXCEPT A) it can be used as a rough screening device to eliminate those projects whose returns do not materialize until later years. B) it provides the amount by which positive NPV projects will increase the value of the firm. C) it allows the comparison of benefits and costs in a logical manner through the use of time value of money principles. D) it recognizes the timing of the benefits resulting from the project.

Q: What is the payback period for a project with an initial investment of $180,000 that provides an annual cash inflow of $40,000 for the first three years and $25,000 per year for years four and five, and $50,000 per year for years six through eight? A) 5.80 years B) 5.20 years C) 5.40 years D) 5.59 years

Q: We compute the profitability index of a capital budgeting proposal by A) multiplying the internal rate of return by the cost of capital. B) dividing the present value of the annual after-tax cash flows by the cost of capital. C) dividing the present value of the annual after-tax cash flows by the cash investment in the project. D) multiplying the cash inflow by the internal rate of return.

Q: Initial OutlayCash Flow in Period 1Cash Flow in Period 2Cash Flow in Period 3Cash Flow in Period 4$4,000,000$1,546,170$1,546,170$1,546,170$1,546,170The Internal Rate of Return (to nearest whole percent) isA) 10%.B) 18%.C) 20%.D) 24%.

Q: A machine that costs $1,500,000 has a 3-year life. It will generate after-tax annual cash flows of $700,000 at the end of each year. It will be salvaged for $200,000 at the end of year 3. If your required rate of return for the project is 13%, what is the NPV of this investment? A) $291,417 B) $400,000 C) $600,000 D) $338,395

Q: Given the following annual net cash flows, determine the internal rate of return to the nearest whole percent of a project with an initial outlay of $750,000.YearNet Cash Flow1$500,0002$150,0003$250,000A) 9%B) 11%C) 13%D) 15%

Q: Raindrip Corp. can purchase a new machine for $1,875,000 that will provide an annual net cash flow of $650,000 per year for five years. The machine will be sold for $120,000 after taxes at the end of year five. What is the net present value of the machine if the required rate of return is 13.5%. A) $558,378 B) $513,859 C) $473,498 D) $447,292

Q: A project requires an initial investment of $389,600. The project generates free cash flow of $540,000 at the end of year 4. What is the internal rate of return for the project? A) 138.6% B) 38.6% C) 8.5% D) 6.9%

Q: When reviewing the net present profile for a project, A) the higher the discount rate, the higher the NPV. B) the higher the discount rate, the higher the IRR. C) the IRR will always be a point on the horizontal axis line where NPV = 0. D) the IRR will always be a point on the horizontal axis equal to the required return.

Q: All of the following are sufficient indications to accept a project EXCEPT (assume that there is no capital rationing constraint, and no consideration is given to payback as a decision tool) A) the net present value of an independent project is positive. B) the profitability index of an independent project exceeds one. C) the IRR of a mutually exclusive project exceeds the required rate of return. D) the NPV of a mutually exclusive project is positive and exceeds that of all other projects.

Q: Arguments against using the net present value and internal rate of return methods include that A) they fail to use accounting profits. B) they require detailed long-term forecasts of the incremental benefits and costs. C) they fail to consider how the investment project is to be financed. D) they fail to use the cash flow of the project.

Q: The net present value method A) is consistent with the goal of shareholder wealth maximization. B) recognizes the time value of money. C) uses all of a project's cash flows. D) all of the above

Q: Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The modified internal rate of return for Project B is A) 17.84%. B) 18.52%. C) 19.75%. D) 22.80%.

Q: Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%.The modified internal rate of return for Project A is A) 19.19%. B) 24.18%. C) 26.89%. D) 29.63%.

Q: Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The internal rate of return for Project B is A) 29.74%. B) 30.79%. C) 35.27%. D) 36.77%.

Q: Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The internal rate of return for Project A is A) 31.43%. B) 29.42%. C) 25.88%. D) 19.45%.

Q: Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The profitability index for Project B is A) 1.55. B) 1.48. C) 1.39. D) 1.33.

Q: Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The profitability index for Project A is A) 1.27. B) 1.22. C) 1.17. D) 1.12.

Q: Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.'s required rate of return for these projects is 10%. The net present value for Project B is A) $58,097. B) $66,363. C) $74,538. D) $112,000.

Q: Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. The firm's required rate of return for these projects is 10%. The net present value for Project A is A) $12,358. B) $16,947. C) $19,458. D) $26,074.

Q: A capital budgeting project has a net present value of $30,000 and a modified internal rate of return of 15%. The project's required rate of return is 13%. The internal rate of return is A) greater than $30,000. B) less than 13%. C) between 13% and 15%. D) greater than 15%