Q&A Hero

Q: Most firms use the payback period as a secondary capital-budgeting technique, which in a sense allows them to control for risk.

Q: Currently, most firms use NPV and IRR as their primary capital-budgeting technique.

Q: Many firms today continue to use the payback method but employ the NPV or IRR methods as secondary decision methods of control for risk.

Q: With respect to the capital budgeting practices of large U. S. corporations: A) the profitability index has been gaining in popularity. B) IRR and NPV have been gaining in popularity. C) payback and discounted payback have been gaining in popularity. D) IRR and NPV have declined in popularity.

Q: Which of the following best explains the continuing popularity of the payback method? A) Mathematical simplicity and some insight into the riskiness of cash flows. B) Uses all cash flows and takes into account the time value of money. C) Reliably selects the projects that add most value to the firm. D) It provides objective selection criteria and is taught as the primary method in most business schools.

Q: Recent surveys of the CFOs of large U.S. companies rank the popularity of major capital budgeting methods in which order? A) IRR, NPV, Payback, Discounted Payback, Profitability Index B) Payback, Discounted Payback, Profitability Index,IRR, NPV C) NPV, IRR, Profitability Index, Discounted Payback, Payback D) NPV, IRR, Payback, Discounted Payback, Profitability Index

Q: Tinker Tools, Inc. is considering a project with the following cash flows. Calculate the MIRR of the project assuming a reinvestment rate of 8%. Year Cash Flows 0 ($70,000) 1 ($55,000) 2 $40,000 3 $60,000 4 $100,000

Q: Black Friday Inc. has estimated the following cash flows for a project it is considering: Period Cash Flow 0 ($150,000) 1 $70,000 2 $80,000 3 ($100,0000) a. What is the payback period for this project? b. What is the obvious problem with using the payback method in this case?

Q: Project November requires an initial investment of $500,000. The present value of operating cash flows is $550,000. Project December requires an initial investment of $750,000. The present value of operating cash flows is $810,000. a. Compute the profitability index for each project. b. If the the projects are mutually exclusive, does the profitability index rank them correctly?

Q: Discuss the merits and shortcomings of using the payback period for capital budgeting decisions.

Q: Determine the IRR on the following projects: a. Initial outlay of $35,000 with an after-tax cash flow at the end of the year of $5,836 for seven years b. Initial outlay of $350,000 with an after-tax cash flow at the end of the year of $70,000 for seven years c. Initial outlay of $3,500 with an after-tax cash flow at the end of the year of $1,500 for three years

Q: The IRR is the discount rate that equates the present value of the project's future net cash flows with the project's initial outlay.

Q: According to the modified internal rate of return (MIRR) technique, when a project's MIRR is greater than its cost of capital, the project should be accepted.

Q: It is possible for a project to have more than one IRR if there is more than one sign change in the after-tax cash flows due to the project.

Q: If the NPV of a project is zero, then the profitability index should equal one.

Q: The IRR assumes that cash flows are reinvested at the cost of capital.

Q: The internal rate of return (IRR) will increase as the required rate of return of a project is increased.

Q: The profitability index provides the same decision result as the net present value (NPV) method.

Q: If the project's payback period is greater than or equal to zero, the project should always be accepted.

Q: When several sign reversals in the cash flow stream occur, the IRR equation can have more than one positive IRR.

Q: One of the disadvantages of the payback method is that it ignores cash flows beyond the payback period.

Q: One drawback of the payback method is that it focuses primarily on the length of time in which the cost of the investment is recovered in nominal terms versus measuring total value the project will add to the firm.

Q: What is the payback period for a $20,000 project that is expected to return $6,000 for the first two years and $3,000 for Years 3 through 5? A) 3 1/2 B) 4 1/2 C) 4 2/3 D) 5

Q: We compute the profitability index of a capital-budgeting proposal by: A) multiplying the IRR 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 cost of the project. D) multiplying the cash inflow by the IRR.

Q: Dizzyland Enterprises has been presented with an investment opportunity which will yield end-of-year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10%. What is the profitability index for this investment? A) 1.34 B) 0.87 C) 1.85 D) 0.21

Q: You have been asked to analyze a capital investment proposal. The project's cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project's MIRR? A) 12.62% B) 10.44% C) 16.73% D) 19.99%

Q: Which of the following is considered to be a deficiency of the IRR? A) It fails to properly rank capital projects. B) It could produce more than one rate of return. C) It fails to utilize the time value of money. D) It is not useful in accounting for risk in capital budgeting.

Q: Aroma Candles, Inc. is evaluating a project with the following cash flows. The project involves a new product that will not affect the sales of any other project. Which two methods would always lead to the same accept/reject decision for this project, regardless of the discount rate. Year Cash Flows 0 ($120,000) 1 $30,000 2 $70,000 3 $90,000 A) Payback and Discounted Payback B) NPV and Payback C) NPV and IRR D) Discounted Payback and IRR

Q: Aroma Candles, Inc. is evaluating a project with the following cash flows. Calculate the IRR of the project. (Round to the nearest whole percentage.) Year Cash Flows 0 ($120,000) 1 $30,000 2 $70,000 3 $90,000 A) 18% B) 23% C) 28% D) 33%

Q: Whenever the IRR on a project equals that project's required rate of return, A) the NPV equals 0. B) The NPV equals the initial investment. C) The profitability index equals 0. D) The NPV equals 1.

Q: The owner of a small construction business has asked you to evaluate the purchase of a new front end loader. You have determined that this investment has a large, positive, NPV, but are afraid that your client will not understand the method. A good alternative method in this circumstance might be A) the payback method B) the profitability index C) the internal rate of return D) the modified internal rate of return

Q: The director of capital budgeting of South Park Development Corporation is evaluating a project that will cost $200,000; it is expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year. If the firm's cost of capital is 14% and its tax rate is 40%, what is the project's IRR? A) 8% B) 14% C) 18% D) -5%

Q: The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10%. Assume cash flows occur evenly during the year, 1/365th each day. What is the discounted payback period for this investment? A) 5.23 years B) 4.86 years C) 4.35 years D) 3.72 years

Q: Kannan Enterprise has a project with an initial outlay of $40,000, followed by three years of annual incremental cash flows of $35,000. The terminal cash flow of the project is $10,000. Assuming a discount rate of 10%, which of the following is the correct equation to solve for the IRR of the project? A) $40,000 = $35,000(1.12)1 + $35,000(1.12)2 + $45,000(1.12)3 B) $40,000 = $35,000(1 + IRR)1 + $35,000(1+IRR)2 + $45,000(1+IRR)3 C) $40,000 = $35,000/(1.12)IRR + $35,000/(1.12)IRR + $45,000/(1.12)IRR D) $40,000 = $35,000(1+IRR)-1 + $35,000(1.IRR)-2 + $45,000(1+IRR)-3

Q: Frazier Fudge has a project with an initial outlay of $40,000, followed by three years of annual incremental cash flows of $35,000. The terminal cash flow of the project is $10,000. Assuming a cost of capital of 10%, calculate the MIRR of the project. A) 46.5% B) 51.3% C) 62.9% D) 74.7%

Q: We-Know-Widgets, Inc. is analyzing a project that requires an initial investment of $10,000, followed by cash inflows of $1,000 in Year 1, $4,000 in Year 2, and $15,000 in Year 3. The cost of capital is 10%. What is the profitability index of the project? A) 1.04 B) 1.55 C) 1.78 D) 1.97

Q: Use the following information to answer the following question(s). Below are the expected after-tax cash flows for Projects Y and Z. Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%. Project Y Project Z Year 1 $12,000 $10,000 Year 2 $8,000 $10,000 Year 3 $6,000 0 Year 4 $2,000 0 Year 5 $2,000 0 You are considering investing in a project with the following year-end after-tax cash flows: Year 1: $5,000 Year 2: $3,200 Year 3: $7,800 If the initial outlay for the project is $12,113, compute the project's IRR. A) 14% B) 10% C) 32% D) 24%

Q: Use the following information to answer the following question(s). Below are the expected after-tax cash flows for Projects Y and Z. Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%. Project Y Project Z Year 1 $12,000 $10,000 Year 2 $8,000 $10,000 Year 3 $6,000 0 Year 4 $2,000 0 Year 5 $2,000 0 Discounted payback for Project Y is: A) three years. B) 3.14 years. C) four years. D) two years.

Q: Analysis of a machine indicates that it has a cost of $5,375,000. The machine is expected to produce cash inflows of $1,825,000 in Year 1; $1,775,000 in Year 2; $1,630,000 in Year 3; $1,585,000 in Year 4; and $1,650,000 in Year 5. What is the machine's IRR? A) 12.16% B) 17.81% C) 23.00% D) 11.11%

Q: MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000. The project will generate after-tax cash flows of $33,100 in Year 1, $31,500 in Year 2, and $31,200 in Year 3. Assume that the appropriate discount rate is 10% and that the firm's tax rate is 40%. What is the project's discounted payback period? A) 2.81 years B) 2.33 years C) 1.22 years D) The project never reaches payback.

Q: MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000. The project will generate after-tax cash flows of $33,100 in Year 1, $31,500 in Year 2, and $31,200 in Year 3. Assume that the firm's proper rate of discount is 10% and that the firm's tax rate is 40%. What is the project's payback? A) 0.33 years B) 1.22 years C) 2.33 years D) Three years

Q: Use the following information to answer the following question(s). Below are the expected after-tax cash flows for Projects Y and Z. Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%. Project Y Project Z Year 1 $12,000 $10,000 Year 2 $8,000 $10,000 Year 3 $6,000 0 Year 4 $2,000 0 Year 5 $2,000 0 What is payback for Project Z? A) Two years B) One year C) Zero years D) Project Z does not payback the original investment.

Q: Use the following information to answer the following question(s). Below are the expected after-tax cash flows for Projects Y and Z. Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%. Project Y Project Z Year 1 $12,000 $10,000 Year 2 $8,000 $10,000 Year 3 $6,000 0 Year 4 $2,000 0 Year 5 $2,000 0 Payback for Project Y is: A) two years. B) one year. C) three years. D) four years.

Q: Which of the following series of cash flows could have more than one IRR? (Negative cash flows are in parentheses.) A) $(XX,XXX), $X,XXX , $X,XXX, $X,XXX B) $(XX,XXX), $X,XXX , $X,XXX, $X,XXX, $(XX,XXX) C) $X,XXX, $X,XXX , $X,XXX, $X,XXX, $(XX,XXX) D) $XX,XXX, $X,XXX , $X,XXX, $X,XXX

Q: Project Ell requires an initial investment of $50,000 and the produces annual cash flows of $30,000, $25,000, and $15,000. Project Ess requires an initial investment of $60,000 and then produces annual cash flows of $25,000 per year for the next ten years. The company ranks projects by their payback periods. A) Projects with unequal lives cannot be ranked using the payback method. B) Ess will be ranked higher than Ell. C) Ell and Ess will be ranked equally. D) Ell will be ranked higher than Ess.

Q: A new forklift under consideration by Home Warehouse requires an initial investment of $100,000 and produces annual cash flows of $50,000, $40,000, and $30,000. Which of the following will not change if the required rate of return is increased from 10% to 12%. A) The net present value. B) The internal rate of return. C) The profitability index. D) The modified internal rate of return.

Q: Project H requires an initial investment of $100,000 and produces annual cash flows of $50,000, $40,000, and $30,000. Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000, $40,000, and $50,000. The projects are mutually exclusive. The company accepts projects with payback periods of 3 years or less. A) Project H will be accepted. B) Project T will be accepted. C) H and T will both be accepted. D) Neither projected will be accepted.

Q: Manheim Candles is considering a project with the following incremental cash flows. Assume a discount rate of 10%. Year Cash Flow 0 ($20,000) 1 0 2 $30,000 3 $30,000 Calculate the project's MIRR. (Round to the nearest whole percentage.) A) 31% B) 47% C) 53% D) 61%

Q: Consider a project with the following cash flows: After-Tax After-Tax Accounting Cash Flow Year Profits from Operations 1 $799 $750 2 $150 $1,000 3 $200 $1,200 Initial outlay = $1,500 Terminal cash flow = 0 Compute the profitability index if the company's discount rate is 10%. A) 15.8 B) 1.61 C) 1.81 D) 0.62

Q: Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). The company accepts all projects with a payback period of 2 years or less. A) The payback rule would reject this project because of its risks are too high. B) The payback rule would reject this project because all negative cash flows are added together. C) If strictly applied, the payback rule would reject this project. D) If strictly applied, the payback rule would accept this project.

Q: Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). A) All possible IRR's for this project are negative. B) It is not possible to compute an IRR for this project. C) This project might have more than one IRR, but only one MIRR. D) The project is unacceptable at any required rate of return. This project might have more than one IRR.

Q: Compute the payback period for a project with the following cash flows, if the company's discount rate is 12%. Initial outlay = $450 Cash flows: Year 1 = $325 Year 2 = $65 Year 3 = $100 A) 3.43 years B) 3.17 years C) 2.88 years D) 2.6 years

Q: Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). A) All possible IRR's for this project are negative. B) It is not possible to compute an IRR for this project. C) The project is unacceptable at any required rate of return. D) This project might have more than one IRR.

Q: Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). If the company 's required rate of return is 12%, the project should be: A) rejected because the IRR is less than 12%. B) accepted because the NPV is positive at 16%. C) the project is unacceptable at any discount rate. D) rejected because there may be more than one IRR.

Q: Your company is considering a project with the following cash flows: Initial outlay = $1,748.80 Cash flows Years 1-6 = $500 Compute the IRR on the project. A) 9% B) 11% C) 18% D) 24%

Q: Initial Outlay Cash Flow in Period 1 2 3 4 -$4,000 $1,546.17 $1,546.17 $1,546.17 $1,546.17 The IRR (to the nearest whole percent) is: A) 10%. B) 18%. C) 20%. D) 16%.

Q: Given the following annual net cash flows, determine the IRR to the nearest whole percent of a project with an initial outlay of $1,520. Year Net Cash Flow 1 $1,000 2 $1,500 3 $500 A) 48% B) 40% C) 32% D) 28%

Q: A project has an initial outlay of $4,000. It has a single payoff at the end of Year 4 of $6,996.46. What is the IRR for the project (round to the nearest percent)? A) 16% B) 13% C) 21% D) 15%

Q: If a project has a profitability index greater than 1, A) the npv will also be positive. B) the irr will be higher than the required rate of return. C) the present value of future cash flows will exceed the amount invested in the project. D) all of the above.

Q: Webley Corp. is considering two expansion options, but does not have enough capital to undertake both, Project W requires an investment of $100,000 and has an NPV of $10,000. Project D requires an investment of $80,000 and has an NPV of $8,200. If Webley use the profitability index to decide, it should: A) choose D because it has a higher profitability index. B) choose W because it has a higher profitability index. C) choose D because it has a lower profitability index. D) choose W because it has a higher profitability index.

Q: What is the NPV of a $45,000 project that is expected to have an after-tax cash flow of $14,000 for the first two years, $10,000 for the next two years, and $8,000 for the fifth year? Use a discount rate of 8%. Would you accept or reject the investment?

Q: Dudster Manufacturing has 2 options for installing legally required safety equipment. Option Ex has an initial cost of $25,000 and annual operating costs over 3 years of $5,000, $5,250, $5,600. Option WYE has an initial cost of $40,000 and annual operating costs of $4,000, $4,200, $4,450, $4,750, $5,100. Whether Dudster chooses Ex or Wye, the equipment is always needed and must be replaced at the end of its useful life. Which choice is least expensive over the long run? Use a discount rate of 9%.

Q: Two projects are under consideration by the same company at the same time. Project Alpha has a NPV of $20 million and an estimated useful life of 10 years. Project Beta has a NPV of $12 million and also an estimated useful life of 10 years. What should the company's decision be a) if the project's involve unrelated expansion decisions or b) if the project's are mutually exclusive because they would have to occupy the same space?

Q: Dieyard Battery Recyclers is considering a project with the following cash flows: Initial outlay = $13,000 Cash flows: Year 1 = $5,000 Year 2 = $3,000 Year 3 = $9,000 If the appropriate discount rate is 15%, compute the NPV of this project.

Q: What is the NPV of a $45,000 project that is expected to have an after-tax cash flow of $14,000 for the first two years, $10,000 for the next two years, and $8,000 for the fifth year? Use a 10% discount rate. Would you accept the project?

Q: The higher the discount rate, the greater the importance of the early cash flows.

Q: The required rate of return represents the cost of capital for a project.

Q: The equivalent annual cost method is most appropriate in which of the following situations? In each case, assume that several mutually exclusive options are available. A) Introducing a new product line B) Adding another store to a chain of retail stores C) Installation of federally mandated safety equipment D) Equipment to reduce production costs

Q: WSU Inc. has various options for replacing a piece of manufacturing equipment. The present value of costs for option Ell is $84,000. Option Ell has a useful life of 5 years; annual operating costs were discounted at 9%. What is the equivalent annual cost? A) $16,800 B) $21,595.77 C) $14,035.77 D) $18,312

Q: Which of the following is the correct equation to solve for the net present value of a project. A) NPV = CF0 + CF1/(1 + k)1 + CF2/(1 + k)2+...CFn/(1 + k)n B) NPV = CF0 + CF1(1 + k)1 + CF2(1 + k)2+...CFn(1 + k)n C) NPV = CF0 - CF1/(1 + k)1 - CF2/(1 + k)2-...CFn/(1 + k)n D) NPV = CF1/(1 + k)1 + CF2/(1 + k)2 +...CFn/(1 + k)n

Q: Project Full Moon has an initial outlay of $30,000, followed by positive cash flows of $10,000 in year 1, $15,000 in year 2, and $15,000 in year 3. The project should be accepted if the required rate of return is: A) greater than 0. B) less than 14.6%. C) less than 16.25%. D) greater than 12%.

Q: Which of the following is the correct equation to solve for the NPV of the project that has an initial outlay of $30,000, followed by three years of $20,000 in incremental cash inflow? Assume a discount rate of 10%. A) NPV = -30,000 + (3 20,000)/(1.10)3 B) NPV = -$30,000 + $20,000/(1.10)1 + $20,000/(1.10)2 + $20,000/(1.10)3 C) NPV = -$30,000 + $20,000/(1.01).10 + $20,000/(1.02).10 + $20,000/(1.03).10 D) NPV = -$30,000 + $20,000/(1.1).10 + $20,000(1.2).10 + $20,000(1.3).10

Q: A machine has a cost of $5,575,000. It will produce cash inflows of $1,825,000 (Year 1); $1,775,000 (Year 2); $1,630,000 (Year 3); $1,585,000 (Year 4); and $1,650,000 (Year 5). At a discount rate of 16.25%, the project should be: A) accepted. B) rejected. C) discounted at a lower rate. D) abandoned after the first year.

Q: A machine has a cost of $5,375,000. It will produce cash inflows of $1,825,000 (Year 1); $1,775,000 (Year 2); $1,630,000 (Year 3); $1,585,000 (Year 4); and $1,650,000 (Year 5). At a discount rate of 16.25%, what is the NPV? A) $81,724 B) $257,106 C) $416,912 D) $190,939

Q: Project Eh! requires an initial investment of $50,000, and has a net present value of $12,000. Project B requires an initial investment of $100,000, and has a net present value of $13,000. The projects are proposals for increasing revenue and are not mutually exclusive. The firm should accept: A) project Eh!. B) project B. C) both projects. D) neither project.

Q: Project EH! requires an initial investment of $50,000, and has a net present value of $12,000. Project BE requires an initial investment of $100,000, and has a net present value of $13,000. The projects are mutually exclusive. The firm should accept: A) project EH!. B) project BE. C) both projects. D) neither project.

Q: Which of the following is a correct equation to solve for the NPV of the project that has an initial outlay of $30,000, followed by incremental cash inflows in the next 3 years of $15,000, $20,000, and $30,000? Assume a discount rate of 10%. A) NPV = - $30,000 + $15,000(1.10)1 + $20,000(1.10)2 + $30,000(1.10)3 B) NPV = - $30,000 + $15,000/(1.10)1 + $20,000/(1.10)2 + $30,000/(1.10)3 C) NPV = - $30,000 + $15,000/(1.01).10 + $20,000/(1.02).10 + $30,000/(1.03).10 D) NPV = - $30,000 + $15,000/(1.1).10 + $20,000(1.2).10 + $30,000(1.3).10

Q: Use the following to answer the following question(s). The information below describes a project with an initial cash outlay of $10,000 and a required return of 12%. After-tax cash inflow Year 1 $6,000 Year 2 $2,000 Year 3 $2,000 Year 4 $2,000 You have been asked to analyze a capital investment proposal. The project's cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project's NPV? A) $101,247 B) $285,106 C) $473,904 D) $582,380

Q: Use the following to answer the following question(s). The information below describes a project with an initial cash outlay of $10,000 and a required return of 12%. After-tax cash inflow Year 1 $6,000 Year 2 $2,000 Year 3 $2,000 Year 4 $2,000 Which of the following statements is correct? A) The project should be accepted since its NPV is $353.87. B) The project should be rejected since its NPV is -$353.87. C) The project should be accepted since it has a payback of less than four years. D) The project should be rejected since its NPV is -$23.91.

Q: Artie's Soccer Ball Company is considering a project with the following cash flows: Initial outlay = $750,000 Incremental after-tax cash flows from operations Years 1-4 = $250,000 per year Compute the NPV of this project if the company's discount rate is 12%. A) $9,337 B) $7,758 C) $4,337 D) $2,534