Question 1

Firms that make investment decisions based on the payback rule may be biased toward rejecting projects:

Accepted Answer

A)  with short lives. 
B)  with long lives. 
C)  with late cash inflows. 
D) that have negative NPVs. 
A)  with short lives. 
B)  with long lives. 
C)  with late cash inflows. 
D) that have negative NPVs. B

Question 2

You can continue to use your less efficient machine at a cost of $8,000 annually for the next 5 years. Alternatively, you can purchase a more efficient machine for $12,000 plus $5,000 annual maintenance. At a cost of capital of 15%, you should:

Accepted Answer

A)  buy the new machine and save $600 in equivalent annual costs. 
B)  buy the new machine and save $388 in equivalent annual costs. 
C)  keep the old machine and save $388 in equivalent annual costs. 
D) keep the old machine and save $580 in equivalent annual costs. 
A)  buy the new machine and save $600 in equivalent annual costs. 
B)  buy the new machine and save $388 in equivalent annual costs. 
C)  keep the old machine and save $388 in equivalent annual costs. 
D) keep the old machine and save $580 in equivalent annual costs. D

Question 3

If a project has a cost of $50,000 and a profitability index of .4, then:

Accepted Answer

A)  its cash inflows are $70,000. 
B)  the present value of its cash inflows is $20,000. 
C)  its IRR is 20%. 
D) its NPV is $20,000. 
A)  its cash inflows are $70,000. 
B)  the present value of its cash inflows is $20,000. 
C)  its IRR is 20%. 
D) its NPV is $20,000. D

Question 4

The modified internal rate of return can be used to correct for:

Accepted Answer

A)  negative NPV calculations. 
B)  multiple internal rates of return. 
C)  undefined payback periods. 
D) borrowing projects. 
A)  negative NPV calculations. 
B)  multiple internal rates of return. 
C)  undefined payback periods. 
D) borrowing projects.

Question 5

Projects with an NPV of zero decrease shareholders' wealth by the cost of the project.

Accepted Answer

A) True 
 B)False

Question 6

If a project has a payback period of 5 years and a cost of capital of 10%, then the discounted payback will:

Accepted Answer

A)  exceed 5 years. 
B)  be less than 5 years. 
C)  decrease if the cost of capital increases. 
D) decrease if the payback period increases due to revised cash flows. 
A)  exceed 5 years. 
B)  be less than 5 years. 
C)  decrease if the cost of capital increases. 
D) decrease if the payback period increases due to revised cash flows.

Question 7

Both the NPV and the internal rate of return methods recognize that the timing of cash flows affects project value.

Accepted Answer

A) True 
 B)False

Question 8

What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years?

Accepted Answer

A)  0.57% 
B)  1.21% 
C)  5.69% 
D) 12.10% 
A)  0.57% 
B)  1.21% 
C)  5.69% 
D) 12.10%

Question 9

One method that can be used to increase the NPV of a project is to decrease the:

Accepted Answer

A)  project's payback period. 
B)  profitability index. 
C)  time until the receipt of cash inflows. 
D) number of project IRRs. 
A)  project's payback period. 
B)  profitability index. 
C)  time until the receipt of cash inflows. 
D) number of project IRRs.

Question 10

A firm is considering a project with the following cash flows: Time 0 = +$20,000, Years 1-5 = -$4,500. Should the project be accepted if the cost of capital is 10%?

Accepted Answer

A)  Yes; The IRR of the project is 4.06%. 
B)  Yes; The IRR of the project is 12.5%. 
C)  No; The IRR of the project is 4.06%. 
D) No; The IRR of the project is 12.5%. 
A)  Yes; The IRR of the project is 4.06%. 
B)  Yes; The IRR of the project is 12.5%. 
C)  No; The IRR of the project is 4.06%. 
D) No; The IRR of the project is 12.5%.

Question 11

What is the profitability index for a project costing $40,000 and returning $15,000 annually for 4 years at an opportunity cost of capital of 12%?

Accepted Answer

A)  0.139 
B)  0.320 
C)  0.500 
D) 0.861 
A)  0.139 
B)  0.320 
C)  0.500 
D) 0.861

Question 12

A polisher costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 10% and the polisher will last for 5 years, what is the equivalent annual cost of the tool?

Accepted Answer

A)  $17,163.04 
B)  $22,187.84 
C)  $22,637.98 
D) $19,411.15 
A)  $17,163.04 
B)  $22,187.84 
C)  $22,637.98 
D) $19,411.15

Question 13

Sometimes, comparing project NPVs properly can be surprisingly tricky. What are three important, but often challenging decisions which managers commonly face?

Accepted Answer

• The investment timing decision. Should

Question 14

The payback rule states that a project is acceptable if you get your money back within a specified period.

Accepted Answer

A) True 
 B)False

Question 15

NPV fails as a decision rule when the firm encounters:

Accepted Answer

A)  capital rationing. 
B)  mutually exclusive projects. 
C)  long-lived projects. 
D) independent projects. 
A)  capital rationing. 
B)  mutually exclusive projects. 
C)  long-lived projects. 
D) independent projects.

Question 16

Soft rationing should never cost the firm anything.

Accepted Answer

A) True 
 B)False

Question 17

The profitability index selects projects based on the:

Accepted Answer

A)  highest net discounted value at time zero. 
B)  highest internal rate of return. 
C)  largest dollar investment per rate of return. 
D) largest return per dollar invested. 
A)  highest net discounted value at time zero. 
B)  highest internal rate of return. 
C)  largest dollar investment per rate of return. 
D) largest return per dollar invested.

Question 18

Use of a profitability index to evaluate mutually exclusive projects in the absence of capital rationing:

Accepted Answer

A)  will provide the same rankings as an NPV criterion. 
B)  will maximize NPV, but not IRR. 
C)  can result in misguided selections. 
D) is technically impossible. 
A)  will provide the same rankings as an NPV criterion. 
B)  will maximize NPV, but not IRR. 
C)  can result in misguided selections. 
D) is technically impossible.

Question 19

To justify postponing a project for one year, the NPV needs to increase over that year by a rate that is equal to or greater than:

Accepted Answer

A)  the project's IRR. 
B)  the risk-free rate. 
C)  the cost of capital. 
D) zero. 
A)  the project's IRR. 
B)  the risk-free rate. 
C)  the cost of capital. 
D) zero.

Question 20

A project's opportunity cost of capital is:

Accepted Answer

A)  the foregone return from investing in the project. 
B)  the return earned by investing in the project. 
C)  equal to the average return on all company projects. 
D) designed to be less than the project's IRR. 
A)  the foregone return from investing in the project. 
B)  the return earned by investing in the project. 
C)  equal to the average return on all company projects. 
D) designed to be less than the project's IRR.

Exam 8: Net Present Value and Other Investment Criteria

Firms that make investment decisions based on the payback rule may be biased toward rejecting projects:

You can continue to use your less efficient machine at a cost of $8,000 annually for the next 5 years. Alternatively, you can purchase a more efficient machine for $12,000 plus $5,000 annual maintenance. At a cost of capital of 15%, you should:

If a project has a cost of $50,000 and a profitability index of .4, then:

The modified internal rate of return can be used to correct for:

Projects with an NPV of zero decrease shareholders' wealth by the cost of the project.

If a project has a payback period of 5 years and a cost of capital of 10%, then the discounted payback will:

Both the NPV and the internal rate of return methods recognize that the timing of cash flows affects project value.

What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years?

One method that can be used to increase the NPV of a project is to decrease the:

A firm is considering a project with the following cash flows: Time 0 = +$20,000, Years 1-5 = -$4,500. Should the project be accepted if the cost of capital is 10%?

What is the profitability index for a project costing $40,000 and returning $15,000 annually for 4 years at an opportunity cost of capital of 12%?

A polisher costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 10% and the polisher will last for 5 years, what is the equivalent annual cost of the tool?

Sometimes, comparing project NPVs properly can be surprisingly tricky. What are three important, but often challenging decisions which managers commonly face?

The payback rule states that a project is acceptable if you get your money back within a specified period.

NPV fails as a decision rule when the firm encounters:

Soft rationing should never cost the firm anything.

The profitability index selects projects based on the:

Use of a profitability index to evaluate mutually exclusive projects in the absence of capital rationing:

To justify postponing a project for one year, the NPV needs to increase over that year by a rate that is equal to or greater than:

A project's opportunity cost of capital is:

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