Question 1

Which one of the following statements is correct concerning the average accounting return (AAR)?

Accepted Answer

A)  The average book value used in the AAR formula will always equal one-half of the initial investment as long as straight-line depreciation over the life of the project is used. 
B)  The average net income is the same as the total cash flows from the project minus the initial cash outflow to start the project. 
C)  The AAR is similar to the profitability index in that both are based on accounting values rather than financial cash flows. 
D)  Under the AAR rule, a project should be accepted if the targeted AAR is greater than the project's AAR. 
E)  The AAR is a true financial rate of return, which is relatively easy to compute. 
A)  The average book value used in the AAR formula will always equal one-half of the initial investment as long as straight-line depreciation over the life of the project is used. 
B)  The average net income is the same as the total cash flows from the project minus the initial cash outflow to start the project. 
C)  The AAR is similar to the profitability index in that both are based on accounting values rather than financial cash flows. 
D)  Under the AAR rule, a project should be accepted if the targeted AAR is greater than the project's AAR. 
E)  The AAR is a true financial rate of return, which is relatively easy to compute.

Question 2

The internal rate of return method of analysis should not be used to analyze projects with conventional cash flows.

Accepted Answer

A) True 
 B)False

Question 3

A 50- year project has a cost of $500,000 and has annual cash flows of $100,000 in years 1-25, and $200,000 in years 26-50. The company's required rate is 8%. Given this information, calculate the discounted payback of the project.

Accepted Answer

A)  9.95years 
B)  8.85years 
C)  7.75years 
D)  6.65years 
E)  5.55years 
A)  9.95years 
B)  8.85years 
C)  7.75years 
D)  6.65years 
E)  5.55years

Question 4

The use of the profitability index could lead to incorrect decisions in comparing mutually exclusive investments.

Accepted Answer

A) True 
 B)False

Question 5

When comparing the payback and discounted payback, both methods are biased towards liquidity.

Accepted Answer

A) True 
 B)False

Question 6

Which of the following does NOT incorporate discounted cash flow (DCF) valuation in its calculation?

Accepted Answer

A)  Discounted payback 
B)  Profitability index 
C)  Net present value 
D)  Internal rate of return 
E)  Average accounting return 
A)  Discounted payback 
B)  Profitability index 
C)  Net present value 
D)  Internal rate of return 
E)  Average accounting return

Question 7

Which of the following ranks decision rules from worst to best in terms of their overall usefulness in capital budgeting analysis.

Accepted Answer

A)  Payback, IRR, NPV. 
B)  Payback, NPV, IRR. 
C)  IRR, NPV, Payback. 
D)  NPV, IRR, Payback. 
E)  IRR, Payback, NPV. 
A)  Payback, IRR, NPV. 
B)  Payback, NPV, IRR. 
C)  IRR, NPV, Payback. 
D)  NPV, IRR, Payback. 
E)  IRR, Payback, NPV.

Question 8

Floyd Clymer is the CFO of Bonavista Mustang, a manufacturer of parts for classic automobiles. Floyd is considering the purchase of a two-ton press which will allow the firm to stamp out auto fenders. The equipment costs $250,000. The project is expected to produce after-tax cash flows of $60,000 the first year, and increase by $10,000 annually; the after-tax cash flow in year 5 will reach $100,000. Liquidation of the equipment will net the firm $10,000 in cash at the end of five years, making the total cash flow in year five $110,000. What is the payback period for the proposed investment?

Accepted Answer

A)  2.0 years 
B)  2.4 years 
C)  3.0 years 
D)  3.4 years 
E)  The investment doesn't pay back 
A)  2.0 years 
B)  2.4 years 
C)  3.0 years 
D)  3.4 years 
E)  The investment doesn't pay back

Question 9

You are considering a project with an initial cost of $6,400. What is the payback period for this project if the cash inflows are $900, $1,350, $2,800, and $1,500 a year over the next four years, respectively?

Accepted Answer

A)  3.21 years 
B)  3.48 years 
C)  3.90 years 
D)  4.21 years 
E)  4.90 years 
A)  3.21 years 
B)  3.48 years 
C)  3.90 years 
D)  4.21 years 
E)  4.90 years

Question 10

A 50- year project has a cost of $500,000 and has annual cash flows of $100,000 in years 1-25, and $200,000 in years 26-50. The company's required rate is 8%. Given this information, calculate the NPV of the project.

Accepted Answer

A)  $879,219 
B)  $779,219 
C)  $679,219 
D)  $579,219 
E)  $479,219 
A)  $879,219 
B)  $779,219 
C)  $679,219 
D)  $579,219 
E)  $479,219

Question 11

You are considering an investment with the following cash flows. Your required return is 10%, you require a payback of three years and a discounted payback of four years. If your objective is to maximize your wealth, should you take this investment?

Accepted Answer

A)  Yes, because the payback is 2.5 years. 
B)  Yes, because the discounted payback is four years. 
C)  Yes, because both the payback and the discounted payback are less than two years. 
D)  No, because the NPV is negative. 
E)  No, because the project has a large negative cash flow at the end of its life. 
A)  Yes, because the payback is 2.5 years. 
B)  Yes, because the discounted payback is four years. 
C)  Yes, because both the payback and the discounted payback are less than two years. 
D)  No, because the NPV is negative. 
E)  No, because the project has a large negative cash flow at the end of its life.

Question 12

The initial cost of an investment is not an element in computing the internal rate of return method.

Accepted Answer

A) True 
 B)False

Question 13

Ginny Trueblood is considering an investment which will cost her $120,000. The investment produces no cash flows for the first year. In the second year the cash inflow is $35,000. This inflow will increase to $55,000 and then $75,000 for the following two years before ceasing permanently. Ginny requires a 10 % rate of return and has a required discounted payback period of three years. Ginny should _____ this project because the discounted payback period is _____

Accepted Answer

A)  Accept; 2.03 years. 
B)  Accept; 2.97 years. 
C)  Accept; 3.97 years. 
D)  Reject; 3.03 years. 
E)  Reject; 3.97 years. 
A)  Accept; 2.03 years. 
B)  Accept; 2.97 years. 
C)  Accept; 3.97 years. 
D)  Reject; 3.03 years. 
E)  Reject; 3.97 years.

Question 14

The primary reason that company projects with positive net present values are considered acceptable is that:

Accepted Answer

A)  They create value for the owners of the firm. 
B)  The project's rate of return exceeds the rate of inflation. 
C)  They return the initial cash outlay within three years or less. 
D)  The required cash inflows exceed the actual cash inflows. 
E)  The investment's cost exceeds the present value of the cash inflows. 
A)  They create value for the owners of the firm. 
B)  The project's rate of return exceeds the rate of inflation. 
C)  They return the initial cash outlay within three years or less. 
D)  The required cash inflows exceed the actual cash inflows. 
E)  The investment's cost exceeds the present value of the cash inflows.

Question 15

Would you accept a project which is expected to pay $10,000 a year for seven years if the initial investment is $40,000 and your required return is 15%?

Accepted Answer

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)  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

Question 16

An element of the IRR concept is the rate designated as the minimum acceptable rate for a project to be accepted

Accepted Answer

A) True 
 B)False

Question 17

Tim is considering two projects, both of which have an initial cost of $12,000 and total cash inflows of $15,000. The cash inflows of project A are $1,000, $2,000, $4,000, and $8,000 over the next four years, respectively. The cash inflows for project B are $8,000, $4,000, $2,000 and $1,000 over the next four years, respectively. Which one of the following statements is correct if Tim requires a 10 % rate of return and has a required discounted payback period of 3 years? Given this information, Tim should accept project A because it has a payback period of 2.65 years.

Accepted Answer

A) True 
 B)False

Question 18

Based on the profitability index (PI) rule, should a project with the following cash flows be accepted if the discount rate is 8 %? Why or why not?

Accepted Answer

A)  Yes; because the PI is 1.008 
B)  Yes; because the PI is.992 
C)  Yes; because the PI is.999 
D)  No; because the PI is 1.008 
E)  No; because the PI is.992 
A)  Yes; because the PI is 1.008 
B)  Yes; because the PI is.992 
C)  Yes; because the PI is.999 
D)  No; because the PI is 1.008 
E)  No; because the PI is.992

Question 19

The crossover point is defined as the discount rate that:

Accepted Answer

A)  Causes the net present value of a project to equal zero. 
B)  Causes the IRR of one project to exceed the IRR of a second project. 
C)  Indicates the point where the IRR equals zero as IRR moves in a downward direction. 
D)  Makes the net present values of two projects equal. 
E)  Causes a project to move from a positive net present value to a negative net present value. 
A)  Causes the net present value of a project to equal zero. 
B)  Causes the IRR of one project to exceed the IRR of a second project. 
C)  Indicates the point where the IRR equals zero as IRR moves in a downward direction. 
D)  Makes the net present values of two projects equal. 
E)  Causes a project to move from a positive net present value to a negative net present value.

Question 20

The internal rate of return method of analysis should not be used for comparing two mutually exclusive projects of similar size.

Accepted Answer

A) True 
 B)False

Exam 9: Net Present Value and Other Investment Criteria

Which one of the following statements is correct concerning the average accounting return (AAR)?

The internal rate of return method of analysis should not be used to analyze projects with conventional cash flows.

A 50- year project has a cost of $500,000 and has annual cash flows of $100,000 in years 1-25, and $200,000 in years 26-50. The company's required rate is 8%. Given this information, calculate the discounted payback of the project.

The use of the profitability index could lead to incorrect decisions in comparing mutually exclusive investments.

When comparing the payback and discounted payback, both methods are biased towards liquidity.

Which of the following does NOT incorporate discounted cash flow (DCF) valuation in its calculation?

Which of the following ranks decision rules from worst to best in terms of their overall usefulness in capital budgeting analysis.

You are considering a project with an initial cost of $6,400. What is the payback period for this project if the cash inflows are $900, $1,350, $2,800, and $1,500 a year over the next four years, respectively?

A 50- year project has a cost of $500,000 and has annual cash flows of $100,000 in years 1-25, and $200,000 in years 26-50. The company's required rate is 8%. Given this information, calculate the NPV of the project.

You are considering an investment with the following cash flows. Your required return is 10%, you require a payback of three years and a discounted payback of four years. If your objective is to maximize your wealth, should you take this investment?

The initial cost of an investment is not an element in computing the internal rate of return method.

The primary reason that company projects with positive net present values are considered acceptable is that:

Would you accept a project which is expected to pay $10,000 a year for seven years if the initial investment is $40,000 and your required return is 15%?

An element of the IRR concept is the rate designated as the minimum acceptable rate for a project to be accepted

Based on the profitability index (PI) rule, should a project with the following cash flows be accepted if the discount rate is 8 %? Why or why not?

The crossover point is defined as the discount rate that:

The internal rate of return method of analysis should not be used for comparing two mutually exclusive projects of similar size.

Introduction to Corporate Finance

Financial Statements, Cash Flow, and Taxes

Working With Financial Statements

Long-Term Financial Planning and Corporate Growth

Introduction to Valuation: the Time Value of Money

Discounted Cash Flow Valuation

Interest Rates and Bond Valuation

Stock Valuation

Making Capital Investment Decisions

Project Analysis and Evaluation

Lessons From Capital Market History

Return, Risk, and the Security Market Line

Cost of Capital

Raising Capital

Financial Leverage and Capital Structure Policy

Dividends and Dividend Policy

Short-Term Finance and Planning

Cash and Liquidity Management

Credit and Inventory Management

International Corporate Finance

Leasing

Mergers and Acquisitions

Enterprise Risk Management

Options and Corporate Securities

Behavioural Finance: Implications for Financial Management

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