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Q:
Project LMK requires an initial outlay of $500,000 and has a profitability index of 1.4. The project is expected to generate equal annual cash flows over the next ten years. The required return for this project is 16%. What is project LMK's internal rate of return?
A) 19.88%
B) 22.69%
C) 24.78%
D) 26.12%
Q:
Project LMK requires an initial outlay of $400,000 and has a profitability index of 1.5. The project is expected to generate equal annual cash flows over the next twelve years. The required return for this project is 20%. What is project LMK's net present value?
A) $600,000
B) $150,000
C) $120,000
D) $80,000
Q:
DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI's required rate of return is 8%. What is the modified internal rate of return of this project?
A) 10.87%
B) 11.57%
C) 13.68%
D) 15.13%
Q:
DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI's required rate of return is 8%. What is the internal rate of return of this project?
A) 10.87%
B) 11.57%
C) 13.68%
D) 15.13%
Q:
DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI's required rate of return is 8%. What is the net present value of this project?
A) $104,089
B) $100,328
C) $96,320
D) $87,417
Q:
DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI's required rate of return is 8%. What is the payback period of this project?
A) 4.00 years
B) 3.09 years
C) 2.91 years
D) 2.50 years
Q:
Which of the following statements is MOST correct?
A) If a project's internal rate of return (IRR) exceeds the required return, then the project's net present value (NPV) must be negative.
B) If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.
C) The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the IRR.
D) A project with a NPV = 0 is not acceptable.
Q:
Project Alpha has an internal rate of return (IRR) of 15 percent. Project Beta has an IRR of 14 percent. Both projects have a required return of 12 percent. Which of the following statements is MOST correct?
A) Both projects have a positive net present value (NPV).
B) Project Alpha must have a higher NPV than Project Beta.
C) If the required return were less than 12 percent, Project Beta would have a higher IRR than Project Alpha.
D) Project Beta has a higher profitability index than Project Alpha.
Q:
Project W requires a net investment of $1,000,000 and has a payback period of 5.6 years. You analyze Project W and decide that Year 1 free cash flow is $100,000 too low, and Year 3 free cash flow is $100,000 too high. After making the necessary adjustments,
A) the payback period for Project W will be longer than 5.6 years.
B) the payback period for Project W will be shorter than 5.6 years.
C) the IRR of Project W will increase.
D) the NPV of Project W will decrease.
Q:
The capital budgeting manager for XYZ Corporation, a very profitable high technology company, completed her analysis of Project A assuming 5-year depreciation. Her accountant reviews the analysis and changes the depreciation method to 3-year depreciation. This change will
A) increase the present value of the NCFs.
B) decrease the present value of the NCFs.
C) have no effect on the NCFs because depreciation is a non-cash expense.
D) only change the NCFs if the useful life of the depreciable asset is greater than 5 years.
Q:
If a project is acceptable using the IRR criterion, it will also be acceptable using the MIRR criterion.
Q:
If a project is acceptable using the NPV criterion, then it will also be acceptable using the discounted payback period since both methods use discounted cash flows to make the accept/reject decision.
Q:
Calculating the modified internal rate of return on an Excel spreadsheet involves the use of the IRR function multiple times, once using the financing rate, and once using the reinvestment rate.
Q:
Because the MIRR assumes reinvestment at the cost of capital while IRR assumes reinvestment at the project's IRR, the MIRR will always be less than the IRR.
Q:
A project that is very sensitive to the selection of a discount rate will have a steep net present value profile.
Q:
The internal rate of return is the discount rate that equates the present value of the project's free cash flows with the project's initial cash outlay.
Q:
NPV may be calculated on an Excel spreadsheet simply by entering the project's free cash flows into Excel's NPV function.
Q:
A project with a NPV of zero should be rejected since even the returns on U.S. Treasury bills are greater than zero.
Q:
A major disadvantage of the discounted payback period is the arbitrariness of the process used to select the maximum desired payback period.
Q:
Any project deemed acceptable using the discounted payback period will also be acceptable if using the traditional payback period.
Q:
The discounted payback period takes the time value of money into account in that it uses discounted free cash flows rather than actual undiscounted free cash flows in calculating the payback period.
Q:
Many financial managers believe the payback period is of limited usefulness because it ignores the time value of money; hence, it is referred to as the discounted payback period.
Q:
The payback period ignores the time value of money and therefore should not be used as a screening device for the selection of capital budgeting projects.
Q:
If a project has multiple internal rates of return, the lowest rate should be used for decision-making purposes.
Q:
A project's net present value profile shows how sensitive the project is to the choice of a discount rate.
Q:
NPV assumes reinvestment of intermediate free cash flows at the cost of capital, while IRR assumes reinvestment of intermediate free cash flows at the IRR.
Q:
A project's IRR is analogous to the concept of the yield to maturity for bonds.
Q:
Because the NPV and PI methods both yield the same accept/reject decision, a company attempting to rank capital budgeting projects for funding consideration can use either method and get the same results.
Q:
Marketing is crucial to capital budgeting success because the goal of a good capital budgeting project is to maximize the company's sales.
Q:
The profitability index is the ratio of the present value of the future free cash flows to the initial investment.
Q:
The main disadvantage of the NPV method is the need for detailed, long-term forecasts of free cash flows generated by prospective projects.
Q:
One positive feature of the payback period is it emphasizes the earliest forecasted free cash flows, which are less uncertain than later cash flows and provide for the liquidity needs of the firm.
Q:
For any individual project, if the project is acceptable based on its internal rate of return, then the project will also be acceptable based on its modified internal rate of return.
Q:
If a firm imposes a capital constraint on investment projects, the appropriate decision criterion is to select the set of projects that has the highest positive net present value subject to the capital constraint.
Q:
If a project is acceptable using the NPV criteria, it will also be acceptable when using the profitability index and IRR criteria.
Q:
If a project's profitability index is less than one, then the project should be rejected.
Q:
The internal rate of return is the discount rate that equates the present value of the project's future free cash flows with the project's initial outlay.
Q:
For a project with multiple sign reversals in its cash flows, the net present value can be the same for two entirely different discount rates.
Q:
Mutually exclusive projects have more than one IRR.
Q:
The internal rate of return will equal the discount rate when the net present value equals zero.
Q:
If the net present value of a project is zero, then the profitability index will equal one.
Q:
NPV is the most theoretically correct capital budgeting decision tool examined in the text.
Q:
Many firms today continue to use the payback method but also employ the NPV or IRR methods, especially when large projects are being analyzed.
Q:
When several sign reversals in the cash flow stream occur, a project can have more than one IRR.
Q:
The capital budgeting decision-making process involves measuring the incremental cash flows of an investment proposal and evaluating the attractiveness of these cash flows relative to the project's cost.
Q:
One of the disadvantages of the payback method is that it ignores time value of money.
Q:
Whenever the internal rate of return on a project equals that project's required rate of return, the net present value equals zero.
Q:
The net present value of a project will increase as the required rate of return is decreased (assume only one sign reversal).
Q:
The profitability index provides an advantage over the net present value method by reporting the present value of benefits per dollar invested.
Q:
The required rate of return reflects the costs of funds needed to finance a project.
Q:
One drawback of the payback method is that some cash flows may be ignored.
Q:
The modified internal rate of return represents the project's internal rate of return assuming that intermediate cash flows from the project can be reinvested at the project's required return.
Q:
The net present value profile clearly demonstrates that the NPV of a project increases as the discount rate increases.
Q:
If a project's internal rate of return is greater than the project's required return, then the project's profitability index will be greater than one.
Q:
An acceptable project should have a net present value greater than or equal to zero and a profitability index greater than or equal to one.
Q:
If a project is acceptable using the net present value criteria, then it will also be acceptable under the less stringent criteria of the payback period.
Q:
The profitability index is the ratio of the company's net income (or profits) to the initial outlay or cost of a capital budgeting project.
Q:
Two projects that have the same cost and the same expected cash flows will have the same net present value.
Q:
A project with a payback period of four years is acceptable as long as the company's target payback period is greater than or equal to four years.
Q:
If project A generates $10 million of free cash flow over its five year useful life and project B generates $8 million of free cash flow over its five year useful life, then Project A will have a shorter payback period than Project B, assuming both projects require the same initial investment.
Q:
Advantages of the payback period include that it is easy to calculate, easy to understand, and that it is based on cash flows rather than on accounting profits.
Q:
The most critical aspect in determining the acceptability of a capital budgeting project is the impact the project will have on the company's net income over the projects entire useful life.
Q:
Why is the search for new profitable projects so important?
Q:
Free cash flows represent the benefits generated from accepting a capital-budgeting proposal.
Q:
GHJ Inc. is investing in a major capital budgeting project that will require the expenditure of $16 million. The money will be raised by issuing $2 million of bonds, $4 million of preferred stock, and $10 million of new common stock. The company estimates is after-tax cost of debt to be 7%, its cost of preferred stock to be 9%, the cost of retained earnings to be 14%, and the cost of new common stock to be 17%. What is the weighted average cost of capital for this project?
A) 12.20%
B) 13.12%
C) 13.75%
D) 14.23%
Q:
Baxter Inc. has a target capital structure of 30% debt, 15% preferred stock, and 55% common equity. The company's after-tax cost of debt is 7%, its cost of preferred stock is 11%, its cost of retained earnings is 15%, and its cost of new common stock is 16%. The company stock has a beta of 1.5 and the company's marginal tax rate is 35%. What is the company's weighted average cost of capital if retained earnings are used to fund the common equity portion?
A) 11.20%
B) 12.00%
C) 13.80%
D) 14.45%
Q:
Cost of capital is commonly used interchangeably with all of the following terms EXCEPT
A) the firm's required rate of return.
B) the hurdle rate for new investments.
C) the internal rate of return for new investments.
D) the firm's opportunity cost of funds.
Q:
A firm's weighted average cost of capital is determined using all of the following inputs EXCEPT
A) the firm's capital structure.
B) the amount of capital necessary to make the investment.
C) the firm's after-tax cost of debt.
D) the probability distribution of expected returns.
Q:
The firm's best financial structure is determined by finding the capital structure that minimizes the firm's cost of capital.
Q:
A company's capital structure mix is based on the proportion of fixed versus variable costs in its optimal production process.
Q:
A firm's weighted average cost of capital is a function of (1) the individual costs of capital, (2) the capital structure mix, and (3) the level of financing necessary to make the investment.
Q:
The market value weights are preferred when calculating a firm's weighted average cost of capital.
Q:
Using the weighted cost of capital as a cutoff rate assumes that future investments will be financed so as to maintain the firm's target degree of financial leverage.
Q:
Using the weighted cost of capital as a cutoff rate assumes that the riskiness of the project being evaluated is similar to the riskiness of the company's existing assets.
Q:
The mixture of financing sources used by a firm will vary from year to year, so many firms use target capital structure proportions when calculating the firm's weighted average cost of capital.
Q:
Once the weighted average cost of capital (WACC) is determined, then all projects of average risk will be compared to the original WACC regardless of the size of the capital budget.
Q:
The average cost of capital is the appropriate rate to use when evaluating new investments, even though the new investments may be in a higher risk class.
Q:
If a firm's tax rate increases, then its weighted average cost of capital increases also.
Q:
The best financial structure is determined by finding the debt and equity mix that maximizes the firm's cost of capital.
Q:
A corporation may lower its cost of capital by shifting a portion of its total financing from a higher cost source of capital, such as common equity, to a lower cost source of capital, such as debt.