Exam 10: Capital-Budgeting Techniques and Practice

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

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

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

What is the net present value's assumption about how cash flows are reinvested?

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?

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

One of the disadvantages of the payback method is that it ignores time value of money.

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

The profitability index provides an advantage over the net present value method by reporting the present value of benefits per dollar invested.

If a project's profitability index is less than one,then the project should be rejected.

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?

Consider the following two projects: Net Cash Flow Each Period a.Calculate the net present value of each of the above projects,assuming a 14 percent discount rate. b.What is the internal rate of return for each of the above projects? c.Compare and explain the conflicting rankings of the NPVs and IRRs obtained in parts a and b above. d.If 14 percent is the required rate of return,and these projects are independent,what decision should be made? e.If 14 percent is the required rate of return,and the projects are mutually exclusive,what decision should be made?

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 equivalent annual annuity?

The net present value method

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.

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 B,rounded to the nearest dollar,is

One drawback of the payback method is that some cash flows may be ignored.

If a project is acceptable using the NPV criteria,it will also be acceptable when using the profitability index and IRR criteria.

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.

When reviewing the net present profile for a project,