Deck 8: Investment Decision Rules

Question 1

A cleaning services firm is considering two brands of industrial vacuum cleaners to equip its staff. Option A will cost $1500, will require servicing of $200 per year, and last five years. Option B will cost $1000, require servicing of $100 per year, and last three years. If the cost of capital is 8%, which is the better option, given that the firm has an ongoing requirement for vacuum cleaners?

A) Option A, since it has a lower equivalent annual annuity.
B) Option A, since it has a greater equivalent annual annuity.
C) Option B, since it has a lower equivalent annual annuity.
D) Option B, since it has a greater equivalent annual annuity.

Answer 1

Option B, since it has a greater equivalent annual annuity.

Question 2

Most corporations measure the value of a project in terms of which of the following?

A) discount factor
B) present value (PV)
C) discount value
D) future value (FV)

Answer 2

present value (PV)

Question 3

The cash flows for four investments have been identified as follows: $$\begin{array} { l c c c c } \text { Investment } & \text { A } & \text { B } & \text { C } & \text { D } \\\hline \begin{array} { l } \text { Cash Flow Today } \\\text { in thousands of dollars }\end{array} & - 8.0 & - 12.2 & - 6.0 & - 2.2 \\\begin{array} { l } \text { Cash Flow in One Year } \\\text { in thousands of dollars }\end{array} & 9.4 & 14.3 & 7.05 & 2.59\end{array}$$ Based on the above information, and with an interest rate of 6%, which is the best investment?

A) Investment A
B) Investment B
C) Investment C
D) Investment D

Answer 3

Investment B

Question 4

$\begin{array}{llllllll}\text { Time: }&\text { Year } 0 & \text { Year } 1 & \text { Year } 2 & \text { Year 3 } & \text { Year } 4 & \text { Year } 5& \text {Discount Rate }\\\text { Investment A: } & -\$ 1.5 \text { million } & \$ 300,000 & \$ 300,000 & \$ 300,000 & \$ 500,000 & \$ 500,000 & 8 \% \\\text { Investment B: } & -\$ 1.3 \text { million } & \$ 500,000 & \$ 400,000 & \$ 300,000 & \$ 200,000 & \$ 100,000 & 7 \%\end{array}$

-An investor is considering the two investments shown above. Which of the following statements about these investments is true?

A) The investor should take investment A since it has a greater internal rate of return (IRR).
B) The investor should take investment A since it has a greater net present value (NPV).
C) The investor should take investment B since it has a greater net present value (NPV).
D) Neither investment should be taken since they both have a negative net present value (NPV).

Question 5

Jenkins Security has learned that a rival has offered to supply a carpark with security for ten years for $50,000 up front and a further $20,000 per year. If Jenkins Security offers to provide security for eight years for an upfront cost of $70,000 and a separate yearly payment, what is the maximum that this yearly payment can be so that Jenkins' offer matches the equivalent annual annuity of their rival's offer? (Assume a cost of capital of 6%.)

A) $13,095
B) $15,521
C) $13,458
D) $13,995

Question 6

Mary is in contract negotiations with a publishing house for her new novel. She has two options. She may be paid $100,000 up front, and receive royalties that are expected to total $26,000 at the end of each of the next five years. Alternatively, she can receive $200,000 up front and no royalties. Which of the following investment rules would indicate that she should take the former deal, given a discount rate of 8%? Rule I? Rule

A) Rule III only
B) Rule II and III
C) Rule I and II
D) Rule I only

Question 7

Consider the following list of projects:
$\begin{array} { l r r } \hline \text { Project } & \text { Investment } & \text { NPV } \\\hline \mathrm { A } & 135,000 & 6,000 \\\hline \mathrm { B } & 200,000 & 30,000 \\\hline \mathrm { C } & 125,000 & 20,000 \\\hline \mathrm { D } & 150,000 & 2,000 \\\hline \mathrm { E } & 175,000 & 10,000 \\\hline \mathrm { F } & 75,000 & 10,000 \\\hline \mathrm { G } & 80,000 & 9,000 \\\hline \mathrm { H } & 200,000 & 20,000 \\\hline \mathrm { I } & 50,000 & 4,000 \\\hline\end{array}$

-Assume that your capital is constrained, so that you only have $500,000 available to invest in projects. If you invest in the optimal combination of projects given your capital constraint, then the total net present value (NPV) for all the projects you invest in will be closest to:

A) $58.000
B) $111,000
C) $69,000
D) $80,000

Question 8

An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $580,000 per year. If the discount rate is 7.5%, what will be the change in the value of the company if it chooses to go ahead with the sponsorship?

A) $508,305
B) $740,000
C) $863,000
D) $808,786

Question 9

Which of the following is NOT a limitation of the payback rule?

A) It does not consider the time value of money.
B) It is difficult to calculate.
C) It lacks a decision criterion that is economically based.
D) It does not consider cash flows occurring after the payback period.

Question 10

Use the table for the question(s) below.
Consider the following two projects:
$\begin{array} { l c c c c c c } \hline \text { Project } &\text { Year 0 } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Year 4 } & \text { Discount } \\&\text { Cash Flow }&\text { Cash Flow }&\text { Cash Flow }&\text { Cash Flow }&\text { Cash Flow }&\text { rate }\\\hline \text { A } & - 100 & 40 & 50 & 60 & \text { N/A } & 0.15 \\\hline \text { B } & - 73 & 30 & 30 & 30 & 30 & 0.15 \\\hline\end{array}$

-The net present value (NPV) of project B is closest to?

A) 15.0
B) 12.6
C) 12.0
D) 23.3

Question 11

Which of the following statements is FALSE?

A) If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate.
B) If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.
C) The internal rate of return (IRR) can provide information on how sensitive your analysis is to errors in the estimate of your cost of capital.
D) In general, the difference between the cost of capital and the internal rate of return (IRR) is the maximum amount of estimation error in the cost of capital estimate that can exist without altering the original decision.

Question 12

Which of the following decision rules is best defined as the amount of time it takes to pay back the initial investment?

A) profitability index
B) payback period
C) internal rate of return (IRR)
D) net present value (NPV)

Question 13

Use the table for the question(s) below.
Consider a project with the following cash flows:
$\begin{array} { l c } \hline \text { Year } & \text { Cash Flow } \\\hline 0 & - 10,000 \\\hline 1 & 4000 \\\hline 2 & 4000 \\\hline 3 & 4000 \\\hline 4 & 4000 \\\hline\end{array}$

-If the appropriate discount rate for this project is 15%, then the net present value (NPV) is closest to?

A) $6000
B) $1420
C) $867
D) -$867

Question 14

A firm has an opportunity to invest $100,000 today that will yield $115,000 in one year. If interest rates are 6%, what is the net present value (NPV) of this investment?

A) $9000
B) $15,000
C) $8491
D) $14,151

Question 15

Martin is offered an investment where for $5000 today, he will receive $5250 in one year. He decides to borrow $5000 from the bank to make this investment. What is the maximum interest rate the bank needs to offer on the loan if Martin is at least to break even on this investment?

A) 5.0%
B) 3.2%
C) 4.8%
D) 5.6%

Question 16

Use the table for the question(s) below.
Consider the following two projects:
$\begin{array} { l c c c c c c } \hline \text { Project } &\text { Year 0 } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Year 4 } & \text { Discount } \\&\text { Cash Flow }&\text { Cash Flow }&\text { Cash Flow }&\text { Cash Flow }&\text { Cash Flow }&\text { rate }\\\hline \text { A } & - 100 & 40 & 50 & 60 & \text { N/A } & 0.15 \\\hline \text { B } & - 73 & 30 & 30 & 30 & 30 & 0.15 \\\hline\end{array}$

-The profitability index for project A is closest to?

A) 21.65
B) 12.04
C) 0.17
D) 0.12

Question 17

Which of the following is true regarding the profitability index?

A) It is unreliable when used for choosing between different projects.
B) Attention must be taken when using it to make sure that all of the constrained resource is used.
C) It does not use the net present value (NPV) to assess benefits.
D) It is very simple to compute.

Question 18

Use the table for the question(s) below.
Consider the following list of projects:
$\begin{array} { l r r } \hline \text { Project } & \text { Investment } & \text { NPV } \\\hline \mathrm { A } & 135,000 & 6,000 \\\hline \mathrm { B } & 200,000 & 30,000 \\\hline \mathrm { C } & 125,000 & 20,000 \\\hline \mathrm { D } & 150,000 & 2,000 \\\hline \mathrm { E } & 175,000 & 10,000 \\\hline \mathrm { F } & 75,000 & 10,000 \\\hline \mathrm { G } & 80,000 & 9,000 \\\hline \mathrm { H } & 200,000 & 20,000 \\\hline \mathrm { I } & 50,000 & 4,000 \\\hline\end{array}$

-Assume that your capital is constrained, so that you only have $600,000 available to invest inprojects. If you invest in the optimal combination of projects given your capital constraint, then the total net present value (NPV) for all the projects you invest in will be closest to:

A) $80,000
B) $65,000
C) $69,000
D) $111,000

Question 19

A garage is comparing the cost of buying two different car hoists. Hoist A will cost $20,000, will require servicing of $1000 every two years, and last ten years. Hoist B will cost $15,000, require servicing of $800 per year, and last eight years. If the cost of capital is 7%, which is the better option, given that the firm has an ongoing requirement for a hoist?

A) Hoist B, since it has a greater equivalent annual annuity.
B) Hoist A, since it has a greater equivalent annual annuity.
C) Hoist B, since it has a greater present value (PV).
D) Hoist A, since it has a greater present value (PV).

Question 20

$\begin{array} { l c c c c } \text { Time: } & 0 & 1 & 2 & 3 \\\text { Investment A: } & - \$ 1 \text { million } & \$ 300,000 & \$ 400,000 & \$ 500,000 \\\text { Investment B: } & - \$ 1 \text { million } & \$ 500,000 & \$ 400,000 & \$ 300,000\end{array}$
An investor is considering the two investments shown above. Her cost of capital is 9%. Which of the following statements about these investments is true?

A) The investor should take investment B since it has a greater net present value (NPV).
B) The investor should take investment B since it has a greater internal rate of return (IRR).
C) The investor should take investment A since it has a greater net present value (NPV).
D) The investor should take investment A since it has a greater internal rate of return (IRR).

Question 21

Use the table for the question(s) below.
Consider the following list of projects:
$\begin{array} { l r r } \hline \text { Project } & \text { Investment } & \text { NPV } \\\hline \text { A } & 135,000 & 6,000 \\\hline \text { B } & 200,000 & 30,000 \\\hline \mathrm { C } & 125,000 & 20,000 \\\hline \mathrm { D } & 150,000 & 2,000 \\\hline \mathrm { E } & 175,000 & 10,000 \\\hline \mathrm { F } & 75,000 & 10,000 \\\hline \mathrm { G } & 80,000 & 9,000 \\\hline \mathrm { H } & 200,000 & 20,000 \\\hline \mathrm { I } & 50,000 & 4,000 \\\hline\end{array}$

-Assuming that your capital is constrained, which project should you invest in first?

A) Project F
B) Project C
C) Project B
D) Project G

Question 22

Use the table for the question(s) below.
Consider the following two projects:
$\begin{array} { l c c c c c c } \hline \text { Project } &\text { Year 0 } & \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Year 4 } & \text { Discount } \\&\text { Cash Flow }&\text { Cash Flow }&\text { Cash Flow }&\text { Cash Flow }&\text { Cash Flow }&\text { rate }\\\hline \text { A } & - 100 & 40 & 50 & 60 & \text { N/A } & 0.15 \\\hline \text { B } & - 73 & 30 & 30 & 30 & 30 & 0.15 \\\hline\end{array}$

-The net present value (NPV) of project A is closest to?

A) 15.0
B) 12.6
C) 42.9
D) 12.0

Question 23

A convenience store owner is contemplating putting a large neon sign over his store. It would cost $50,000, but is expected to bring an additional $24,000 of profit to the store every year for five years. Would this project be worthwhile if evaluated using a payback period of two years or less and if the cost of capital is 10%?

A) Yes, since it will pay back its initial investment in two years.
B) No, since the value of the cash flows over the first two years are less than the initial investment.
C) Yes, since the cash flows after two years are greater than the initial investment.
D) Yes, since the value of the cash flows into the store, in present dollars, are greater than the initial investment.

Question 24

A mining company plans to mine a beach for zirconium sands. Doing so will cost $10 million up front and then produce cash flows of $3 million per year for five years. At the end of the sixth year the company will incur shut-down and clean-up costs of $2 million. If the cost of capital is 11%, then what is the MIRR for this project?

A) 8.52%
B) 11.03%
C) 12.5%
D) 10.92%

Question 25

According to Truong, Partington, and Peat's 2004 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs of listed Australian firms are, in order

A) Profitability index, NPV, IRR.
B) NPV, Payback, IRR.
C) NPV, IRR, MIRR.
D) NPV, IRR, Payback.

Question 26

Use the table for the question(s) below.
Consider the following two projects:
$\begin{array} { l c c c c c c c c c } \hline \text { Project } & \begin{array} { c } \text { Year 0 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 1 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 2 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 3 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 4 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 5 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 6 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 7 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Discount } \\\text { Rate }\end{array} \\\hline \text { Alpha } & - 79 & 20 & 25 & 30 & 35 & 40 & \text { N/A } & \text { N/A } & 15 \% \\\hline \text { Beta } & - 80 & 25 & 25 & 25 & 25 & 25 & 25 & 25 & 16 \% \\\hline\end{array}$

-The net present value (NPV) for project beta is closest to?

A) $16.92
B) $20.96
C) $24.01
D) $14.41

Question 27

Use the table for the question(s) below.
Consider the following two projects:
$\begin{array} { l c c c c c c } \hline \text { Project } & \begin{array} { c } \text { Year 0 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 1 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 2 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 3 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 4 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Discount } \\\text { Rate }\end{array} \\\hline \mathrm { A } & - 100 & 40 & 50 & 60 & \text { N/A } & 0.15 \\\hline \mathrm { B } & - 73 & 30 & 30 & 30 & 30 & 0.15 \\\hline\end{array}$

-The payback period for project A is closest to?

A) 2.5 years
B) 2.2 years
C) 2.0 years
D) 2.4 years

Question 28

When comparing two projects with different lives, why do you compute an annuity with an equivalent present value (PV) to the net present value (NPV)?

A) to ensure that cash flows from the project with a longer life that occur after the project with the shorter life has ended are considered
B) to reduce the danger that changes in the estimate of the discount rate will lead to choosing the project with a shorter timeframe
C) so that the projects can be compared on their cost or value created per year
D) so that you can see which project has the greatest net present value (NPV)

Question 29

Use the table for the question(s) below.
Consider the following two projects:
$\begin{array} { l c c c c c c } \hline \text { Project } & \begin{array} { c } \text { Year 0 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 1 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 2 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 3 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 4 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Discount } \\\text { Rate }\end{array} \\\hline \mathrm { A } & - 100 & 40 & 50 & 60 & \text { N/A } & 0.15 \\\hline \mathrm { B } & - 73 & 30 & 30 & 30 & 30 & 0.15 \\\hline\end{array}$

-The profitability index for project B is closest to?

A) 0.17
B) 0.12
C) 23.34
D) 12.64

Question 30

Use the table for the question(s) below.
Consider the following list of projects:
$\begin{array} { l r r } \hline \text { Project } & \text { Investment } & \text { NPV } \\\hline \text { A } & 135,000 & 6,000 \\\hline \text { B } & 200,000 & 30,000 \\\hline \mathrm { C } & 125,000 & 20,000 \\\hline \mathrm { D } & 150,000 & 2,000 \\\hline \text { E } & 175,000 & 10,000 \\\hline \text { F } & 75,000 & 10,000 \\\hline \text { G } & 80,000 & 9,000 \\\hline \text { H } & 200,000 & 20,000 \\\hline \mathrm { I } & 50,000 & 4,000 \\\hline\end{array}$

-Assuming that your capital is constrained, so that you only have $600,000 available to invest in projects, which projects should you invest in and in what order?

A) CBFG
B) CBGF
C) CBFH
D) BCFG

Question 31

Use the table for the question(s) below.
Consider the following list of projects:
$\begin{array} { l r r } \hline \text { Project } & \text { Investment } & \text { NPV } \\\hline \text { A } & 135,000 & 6,000 \\\hline \mathrm { B } & 200,000 & 30,000 \\\hline \mathrm { C } & 125,000 & 20,000 \\\hline \mathrm { D } & 150,000 & 2,000 \\\hline \mathrm { E } & 175,000 & 10,000 \\\hline \mathrm { F } & 75,000 & 10,000 \\\hline \mathrm { G } & 80,000 & 9,000 \\\hline \mathrm { H } & 200,000 & 20,000 \\\hline \mathrm { I } & 50,000 & 4,000 \\\hline\end{array}$

-Assuming that your capital is constrained, what is the fifth project that you should invest in?

A) Project B
B) Project I
C) Project A
D) Project H

Question 32

Which of the following is NOT a valid method of modifying cash flows to produce a MIRR?

A) Discount all of the negative cash flows to the present and compound all of the positive cash flows to the end of the project.
B) Discount all of the negative cash flows to time 0 and leave the positive cash flows alone.
C) Leave the initial cash flow alone and compound all of the remaining cash flows to the final period of the project.
D) Turn multiple negative cash flows into a single negative cash flow by summing all negative cash flows over the project's lifetime.

Question 33

Which of the following situations can lead to IRR giving a different decision than NPV?

A) delayed investment
B) differences in project scale
C) multiple IRRs
D) All of the above can lead to IRR giving a different decision than NPV.

Question 34

What is the present value (PV) of an investment?

A) the amount by which the cash flow of an investment exceeds or falls short of the cash flow generated by the same amount of money invested at the market rate
B) the amount you need to invest at the current interest rate to re-create the cash flow from the investment
C) the difference between the cost of the investment and the benefit of the investment in dollars today
D) the amount that an investment would yield if the benefit were realised today

Question 35

Two mutually exclusive investment opportunities require an initial investment of $5 million. Investment A then generates $1.5 million per year in perpetuity, while investment B pays $1 million in the first year, with cash flows increasing by 3% per year after that. At what cost of capital would an investor regard both opportunities as being equivalent?

A) 9%
B) 10%
C) 3%
D) 6%

Question 36

Which of the following is a disadvantage of the Net Present Value rule?

A) not necessarily consistent with maximising shareholder wealth
B) ignores cash flows after the cutoff point
C) relies on an accurate estimate of the discount rate
D) can be misleading if inflows come before outflows

Question 37

$\begin{array} { l c l } & \text { Initial Investment } & { \text { Cash flow } } \\\text { Project A } & \text { \$5 million } & \$ 2 \text { million per year for four years } \\\text { Project B } & \$ 3 \text { million } & \$ 1 \text { million per year for five years } \\\text { Project C } & \text { \$2 million } & \$ 1 \text { million per year for four years } \\\text { Project D } & \$ 3 \text { million } & \$ 1.5 \text { million per year for three years }\end{array}$
An investor has a budget of $5 million. He can invest in the projects shown above. If the cost of capital is 6%, what investment or investments should he make?

A) Project A
B) Project B
C) Project B and Project C
D) Project C and Project D

Question 38

An investor has the opportunity to invest in four new retail stores. The amount that can be invested in each store, along with the expected cash flow at the end of the first year, the growth rate of the concern, and the cost of capital is shown for each case. It is assumed each investment will operate in perpetuity after the initial investment. Which investment should the investor choose?

A) Initial investment: $100,000; Cash flow in year 1: $12,000; Growth Rate: 1.25%; Cost of Capital: 9.0%
B) Initial investment: $90,000; Cash flow in year 1: $10,000; Growth Rate: 1.50%; Cost of Capital: 9.0%
C) Initial investment: $80,000; Cash flow in year 1: $8000; Growth Rate: 1.75%; Cost of Capital:8.0%
D) Initial investment: $60,000; Cash flow in year 1: $6000; Growth Rate: 2.50%; Cost of Capital: 7.5%

Question 39

Of the following four mutually exclusive investments, which is the best investment?

A) Initial investment: $1.1 million; Cash flow in year 1: $160,000; Annual Growth Rate: 2%; Cost of Capital: 9.0%
B) Initial investment: $1.2 million; Cash flow in year 1: $150,000; Annual Growth Rate: 2%; Cost of Capital:7.0%
C) Initial investment: $1.3 million; Cash flow in year 1: $160,000; Annual Growth Rate: 1%; Cost of Capital: 6%
D) Initial investment: $1.4 million; Cash flow in year 1: $150,000; Annual Growth Rate: 2%; Cost of Capital: 8%

Question 40

Which of the following is NOT a limitation of the payback period rule?

A) It is difficult to calculate.
B) It does not account for changes in the discount rate.
C) It ignores cash flows after payback.
D) It does not account for the time value of money.

Question 41

A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year and, estimating that the discount rate across this period will be 6%, decides to take the money at the end of each year. Was her decision correct?

A) Yes, because it agrees with the Net Present Value rule.
B) No, because it disagrees with the Net Present Value rule.
C) Yes, because it agrees with both the Net Present Value rule and the payback rule.
D) Yes, because it agrees with the payback rule.

Question 42

Use the table for the question(s) below.
Consider a project with the following cash flows:
$\begin{array} { l c } \hline \text { Year } & \text { Cash Flow } \\\hline 0 & - 10,000 \\\hline 1 & 4000 \\\hline 2 & 4000 \\\hline 3 & 4000 \\\hline 4 & 4000 \\\hline\end{array}$

-Assume the appropriate discount rate for this project is 15%. The profitability index for this project is closest to:

A) 0.15
B) 0.22
C) 0.60
D) 0.14

Question 43

Use the table for the question(s) below.
Consider the following two projects:
$\begin{array} { l c c c c c c c c c } \hline \text { Project } & \begin{array} { c } \text { Year 0 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 1 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 2 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 3 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 4 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 5 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 6 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 7 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Discount } \\\text { Rate }\end{array} \\\hline \text { Alpha } & - 79 & 20 & 25 & 30 & 35 & 40 & \text { N/A } & \text { N/A } & 15 \% \\\hline \text { Beta } & - 80 & 25 & 25 & 25 & 25 & 25 & 25 & 25 & 16 \% \\\hline\end{array}$

-The net present value (NPV) for project alpha is closest to?

A) $20.96
B) $16.92
C) $14.41
D) $24.01

Question 44

A consultancy calculates that it can supply crude oil assaying services to a small oil producer for $120,000 per year for five years. There are some upfront costs the consultancy will require the oil producer to absorb. What is the maximum that these upfront costs could be, if the equivalent annual annuity to the oil company is to be under $150,000, given that the cost of capital is 10%?

A) $150,000
B) $128,698
C) $113,724
D) $30,000

Question 45

You are opening up a brand new shopping centre. You presently have more potential retail outlets wanting to locate in your centre than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space?

A) profitability index
B) internal rate of return (IRR)
C) net present value (NPV)
D) payback period

Question 46

$\begin{array} { c c c c c } & 0 & 1 & 2 & 3 \\\text { Investment B: } & - \$ 1 \text { million } & \$ 500,000 & \$ 400,000 & \$ 300,000\end{array}$
The timeline of an investment is shown above. If the cost of capital is 5%, what is the profitability index of this investment?

A) 0.256
B) 0.098
C) 0.105
D) 0.368

Question 47

A farmer spends $100,000 to plant fruit trees. It will take four years for the trees to provide a usable crop. He estimates that every year for 20 years after that he will receive a crop worth $10,000 per year. If the discount rate is 8%, what is the net present value (NPV) of this investment?

A) $108
B) -$12,897
C) $3268
D) -$27,834

Question 48

Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favours liquidity?

A) equivalent annual annuity
B) payback period
C) profitability index
D) MIRR

Question 49

Use the table for the question(s) below.
Consider the following two projects:
$\begin{array} { l c c c c c c } \hline \text { Project } & \begin{array} { c } \text { Year 0 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 1 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 2 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 3 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 4 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Discount } \\\text { Rate }\end{array} \\\hline \text { A } & - 100 & 40 & 50 & 60 & \text { N/A } & 0.15 \\\hline \mathrm { B } & - 73 & 30 & 30 & 30 & 30 & 0.15 \\\hline\end{array}$

-Assume that projects A and B are mutually exclusive. The correct investment decision and the best rationale for that decision is to

A) invest in project A, since NPVA > 0.
B) invest in project B, since IRRB > IRRA.
C) invest in project B, since NPVB > NPVA > 0.
D) invest in project A, since NPVB < NPVA.

Question 50

A company buys a color printer that will cost $18,000 to buy, and last 5 years. It is assumed that it will require servicing costing $500 each year. What is the equivalent annual annuity of this deal, given a cost of capital of 12%?

A) -$4002
B) -$5493
C) -$3983
D) -$4957

Question 51

Use the table for the question(s) below.
Consider the following two projects:
$\begin{array} { l c c c c c c } \hline \text { Project } & \begin{array} { c } \text { Year 0 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 1 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 2 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 3 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Year 4 } \\\text { Cash Flow }\end{array} & \begin{array} { c } \text { Discount } \\\text { Rate }\end{array} \\\hline \text { A } & - 100 & 40 & 50 & 60 & \text { N/A } & 0.15 \\\hline \mathrm { B } & - 73 & 30 & 30 & 30 & 30 & 0.15 \\\hline\end{array}$

-The payback period for project B is closest to?

A) 2.4 years
B) 2.0 years
C) 2.5 years
D) 2.2 years

Question 52

Use the information for the question(s) below.
The Sisyphean Company is planning on investing in a new project. This will involve the purchase of some
new machinery costing $450,000. The Sisyphean Company expects cash inflows from this project as
detailed below:
$\begin{array} { c c c c } \hline \text { Year 1 } & \text { Year 2 } & \text { Year 3 } & \text { Year 4 } \\\hline \$ 200,000 & \$ 225,000 & \$ 275,000 & \$ 200,000 \\\hline\end{array}$
The appropriate discount rate for this project is 16%.

-The net present value (NPV) for this project is closest to?

A) $123,420
B) $450,000
C) $179,590
D) $176,270

Question 53

Use the table for the question(s) below.
Consider the following two projects:
$\begin{array} { l c c c c c c c c c } \hline \text { Project } & \begin{array} { c } \text { Year 0 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 1 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 2 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 3 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 4 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 5 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 6 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Year 7 } \\\text { C/F }\end{array} & \begin{array} { c } \text { Discount } \\\text { Rate }\end{array} \\\hline \text { Alpha } & - 79 & 20 & 25 & 30 & 35 & 40 & \text { N/A } & \text { N/A } & 15 \% \\\hline \text { Beta } & - 80 & 25 & 25 & 25 & 25 & 25 & 25 & 25 & 16 \% \\\hline\end{array}$

-Assume that projects Alpha and Beta are mutually exclusive. The correct investment decision and the best rationale for that decision is to

A) invest in project Alpha, since NPVBeta < NPVAlpha.
B) invest in project Beta, since IRRB > IRRA.
C) invest in project Beta, since NPVBeta > NPVAlpha > 0.
D) invest in project Beta, since NPVBeta > 0.

Question 54

A florist is buying a number of motorcycles to expand its delivery service. These will cost $87,000, but are expected to increase profits by $3000 per month over the next four years. What is the payback period in this case?

A) 24 months
B) 18 months
C) 12 months
D) 29 months

Question 55

A security firm is offered $80,000 in one year for providing CCTV coverage of a property. The cost of providing this coverage to the security firm is $74,000, payable now, and the interest rate is 8.5%. Should the firm take the contract?

A) Yes, since net present value (NPV) is negative.
B) It does not matter whether the contract is taken or not, since NPV = 0.
C) No, since net present value (NPV) is negative.
D) Yes, since net present value (NPV) is positive.

Question 56

A security company offers to provide CCTV coverage for a parking garage for ten years for an initial payment of $50,000 and additional payments of $20,000 per year. What is the equivalent annual annuity of this deal, given a cost of capital of 6%?

A) -$20,000
B) -$14,720
C) -$19,720
D) -$26,793

Question 57

A firm is considering several mutually exclusive investment opportunities. The best way to choose between them is which of the following?

A) payback period
B) internal rate of return (IRR)
C) profitability index
D) net present value (NPV)

Question 58

Which of the following statements is FALSE?

A) An internal rate of return (IRR) will always exist for an investment opportunity.
B) The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea.
C) A net present value (NPV) will always exist for an investment opportunity.
D) In general, there can be as many internal rates of return (IRRs) as the number of times the project's cash flows change sign over time.

Question 59

Use the table for the question(s) below.
Consider the following list of projects:
$\begin{array} { l r r } \hline \text { Project } & \text { Investment } & \text { NPV } \\\hline \text { A } & 135,000 & 6,000 \\\hline \mathrm { B } & 200,000 & 30,000 \\\hline \mathrm { C } & 125,000 & 20,000 \\\hline \mathrm { D } & 150,000 & 2,000 \\\hline \mathrm { E } & 175,000 & 10,000 \\\hline \mathrm { F } & 75,000 & 10,000 \\\hline \mathrm { G } & 80,000 & 9,000 \\\hline \mathrm { H } & 200,000 & 20,000 \\\hline \mathrm { I } & 50,000 & 4,000 \\\hline\end{array}$

-Assuming that your capital is constrained, which investment tool should you use to determine the correct investment decisions?

A) profitability index
B) incremental IRR
C) internal rate of return (IRR)
D) net present value (NPV)

Question 60

A company has identified the following investments as looking promising. Each requires an initial investment of $1.2 million. Which is the best investment?

A) an investment that generates a cash flow of $200,000 at the end of each of the next ten years, when the cost of capital is 6%
B) a perpetuity that generates a cash flow at the end of year 1 of $100,000, has a growth rate of 1.25%, and a cost of capital of 10%
C) a perpetuity that generates a cash flow at the end of year 1 of $800,000, has a growth rate of 2.25%, and a cost of capital of 12%
D) an investment that generates a cash flow of $400,000 at the end of each of the next five years, when the cost of capital is 6%

Question 61

The Net Present Value rule implies that we should compare a project's net present value (NPV) to zero.

Question 62

Tanner is choosing between two investment options. He can invest $500 now and get $550 in one year, or invest $500 now and get $531.40 back later today. The risk-free rate is 3.5%. Which investment should Tanner prefer?

A) $531.40 later today, since $1 today is worth more than $1 in one year.
B) $550 in one year, since it is $50 more than he invested rather than $31.40 more than he invested.
C) Neither-both investments have a negative NPV.
D) Tanner should be indifferent between the two investments, since both are equivalent to the same amount of cash today.

Question 63

Should personal preferences for cash today versus cash tomorrow play a role in the net present value (NPV) decision-making process?

Question 64

Use the table for the question(s) below.
Consider a project with the following cash flows:
$\begin{array} { l c } \hline \text { Year } & \text { Cash Flow } \\\hline 0 & - 10,000 \\\hline 1 & 4000 \\\hline 2 & 4000 \\\hline 3 & 4000 \\\hline 4 & 4000 \\\hline\end{array}$

-Assume the appropriate discount rate for this project is 15%. The payback period for this project is closest to:

A) 4
B) 2
C) 2.5
D) 3

Question 65

When different projects put different demands on a limited resource, then net present value (NPV) is always the best way to choose the best project.

Question 66

A farmer sows a certain crop. It costs $250,000 to buy the seed, prepare the ground, and sow the crop. In one year's time it will cost $110,000 to harvest the crop. If the crop will be worth $380,000, and the interest rate is 8%, what is the net present value (NPV) of this investment?

A) -$21,000
B) $0
C) -$220
D) $23,100

Question 67

Net present value (NPV) is the difference between the present value (PV) of the benefits and the present value (PV) of the costs of a project or investment.

Question 68

A manufacturer of video games develops a new game over two years. This costs $850,000 per year with one payment made immediately and the other at the end of two years. When the game is released, it is expected to make $1.2 million per year for three years after that. What is the net present value (NPV) of this decision if the cost of capital is 9%?

A) $991,220
B) $1,071,432
C) $1,841,093
D) $1,564,559

Question 69

The profitability index can break down completely when dealing with multiple resource restraints?

Question 70

An investor is considering a project that will generate $800,000 per year for four years. In addition to upfront costs, at the completion of the project at the end of the fifth year there will be shut-down costs of $500,000. If the cost of capital is 5%, based on the MIRR, at what upfront costs does this project cease to be worthwhile?

A) $2.84 million
B) $2.32 million
C) $2.58 million
D) $2.44 million

Question 71

A delivery service is buying 600 tires for its fleet of vehicles. One supplier offers to supply the tires for $85 per tire, payable in one year. Another supplier will supply the tires for $20,000 down today, then $50 per tire, payable in one year. What is the difference in PV between the first and the second offer, assuming interest rates are 8.5%?

A) -$1000
B) $1000
C) $645
D) $276

Question 72

Which of the following best describes the Net Present Value rule?

A) When choosing among any list of investment opportunities where resources are limited, always choose those projects with the highest net present value (NPV).
B) Take any investment opportunity where the net present value (NPV) is not negative; turn down any opportunity when it is negative.
C) Take any investment opportunity where the net present value (NPV) exceeds the opportunity cost of capital; turn down any opportunity where the cost of capital exceeds the net present value (NPV)
D) If the difference between the present cost of an investment and the present value (PV) of its benefits after a fixed number of years is positive, the investment should be taken; otherwise it should be rejected.

Question 73

When comparing mutually exclusive projects which have different scales, you must know the dollar impact of each investment rather than percentage returns.

Question 74

The payback rule is based on the idea that an opportunity that pays back its initial investment quickly is a worthwhile opportunity.

Question 75

The owners of a chain of fast-food restaurants spend $28 million installing donut makers in all their restaurants. This is expected to increase cash flows by $10 million per year for the next five years. If the discount rate is 6.5%, were the owners correct in making the decision to install donut makers?

A) Yes, as it has a net present value (NPV) of $8.74 million.
B) No, as it has a net present value (NPV) of-1.68 million.
C) No, as it has a net present value (NPV) of -$2.25 million.
D) Yes, as it has a net present value (NPV) of $13.56 million.

Question 76

What is the Net Present Value rule?

Question 77

A car dealership offers a car for $14,000, with up to one year to pay. If the interest rate is 7%, what is the net present value (NPV) of this offer to buyers who elect not to pay for the car for one year?

A) $13,084
B) $916
C) $1896
D) $14,000

Question 78

When an alternative decision rule disagrees with the net present value (NPV), the NPV should be followed.

Question 79

When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule.

Question 80

Net present value (NPV) is usually supplemented by internal rate of return (IRR), since IRR gives a good indication of the sensitivity of any decision made to changes in the discount rate.