Deck 5: Net Present Value and Other Investment Criteria

Question 1

Given the following cash flows for project Z: C0 = -1,000, C1 = 600, C2 = 720 and C3 = 2000, calculate the discounted payback period for the project at a discount rate of 20%.

A) 1 year
B) 2 years
C) 3 years
D) None of the above

Answer 1

2 years

Question 2

Which of the following investment rules does not use the time value of the money concept?

A) Net present value
B) Internal rate of return
C) The payback period
D) All of the above use the time value concept

Answer 2

The payback period

Question 3

If the NPV of project A is + $120, and that of project B is -$40 and that of project C is + $40, what is the NPV of the combined project?

A) +$100
B) -$40
C) +$70
D) +$120

Answer 3

+$120

Question 4

The main advantage of the payback rule is:

A) Adjustment for uncertainty of early cash flows
B) It is simple to use
C) Does not discount cash flows
D) Both A and C

Question 5

The payback period rule accepts all projects for which the payback period is:

A) Greater than the cut-off value
B) Less than the cut-off value
C) Is positive
D) An integer

Question 6

The net present value of a project depends upon:

A) company's choice of accounting method
B) manager's tastes and preferences
C) project's cash flows and opportunity cost of capital
D) all of the above

Question 7

Given the following cash flows for project A: C0 = -1000, C1 = +600 ,C2 = +400, and C3 = +1500, calculate the payback period.

A) One year
B) Two years
C) Three years
D) None of the above

Question 8

Which of the following statements regarding the discounted payback period rule is true?

A) The discounted payback rule uses the time value of money concept.
B) The discounted payback rule is better than the NPV rule.
C) The discounted payback rule considers all cash flows.
D) The discounted payback rule exhibits the value additive property.

Question 9

The following are measures used by firms when making capital budgeting decisions except:

A) Payback period
B) Internal rate of return
C) P/E ratio
D) Net present value

Question 10

The cost of a new machine is $250,000. The machine has a 3-year life and no salvage value. If the cash flow each year is equal to 40% of the cost of the machine, calculate the payback period for the project:

A) 2 years
B) 2.5 years
C) 3 years
D) Cannot be determined because of insufficient data

Question 11

The survey of CFOs indicates that NPV method is always, or almost always, used for evaluating investment projects by:

A) 12% of firms
B) 20% of firms
C) 57% of firms
D) 75% of firms

Question 12

The following are disadvantages of using the payback rule except:

A) The payback rule ignores all cash flow after the cutoff date
B) The payback rule does not use the time value of money
C) The payback period is easy to calculate and use
D) The payback rule does not have the value additive property

Question 13

The survey of CFOs indicates that IRR method is used for evaluating investment projects by:

A) 12% of firms
B) 20% of firms
C) 76% of firms
D) 57% of firms

Question 14

The quickest way to calculate the internal rate of return (IRR) of a project is by:

A) Trial and error method
B) Using the graphical method
C) Using a financial calculator
D) Guessing the IRR

Question 15

Which of the following investment rules may not use all possible cash flows in its calculations?

A) NPV
B) Payback period
C) IRR
D) All of the above

Question 16

If the net present value (NPV) of project A is + $100, and that of project B is + $60, then the net present value of the combined project is:

A) +$100
B) +$60
C) +$160
D) None of the above

Question 17

Internal rate of return (IRR) method is also called:

A) Discounted payback period method
B) Discounted cash-flow (DCF) rate of return method
C) Modified internal rate of return (MIRR) method
D) None of the above

Question 18

Which of the following investment rules has value adding-up property?

A) The payback period method
B) Net present value method
C) The book rate of return method
D) The internal rate of return method

Question 19

You are given a job to make a decision on project X, which is composed of three independent projects A, B, and C which have NPVs of + $70, -$40 and + $100, respectively. How would you go about making the decision about whether to accept or reject the project?

A) Accept the firm's joint project as it has a positive NPV
B) Reject the joint project
C) Break up the project into its components: accept A and C and reject B
D) None of the above

Question 20

Suppose a firm has a $100 million in excess cash. It could:

A) Invest the funds in projects with positive NPVs
B) Pay high dividends to the shareholders
C) Buy another firm
D) All of the above

Question 21

Benefit-cost ratio is defined as the ratio of:

A) Net present value cash flow to initial investment
B) Present value of cash flow to initial investment
C) Net present value of cash flow to IRR
D) Present value of cash flow to IRR

Question 22

The IRR is defined as:

A) The discount rate that makes the NPV equal to zero
B) The difference between the cost of capital and the present value of the cash flows
C) The discount rate used in the NPV method
D) The discount rate used in the discounted payback period method

Question 23

Project X has the following cash flows: C0 = +2000, C1 = -1,150 and C2 = -1,150. If the IRR of the project is 9.85% and if the cost of capital is 12%, you would:

A) Accept the project
B) Reject the project
This is a loan project therefore accept.

Question 24

Given the following cash flow for project A: C0 = -3,000, C1 = +500, C2 = +1,500 and C3 = +5,000, calculate the NPV of the project using a 15% discount rate.

A) $5,000
B) $2,352
C) $3,201
D) $1,857

Question 25

Which of the following methods of evaluating capital investment projects incorporates the time value of money concept?
I. Payback Period
II) Discounted Payback Period
III) Net Present Value (NPV)
IV) Internal Rate of Return

A) I, II, and III only
B) II, III, and IV only
C) III and IV only
D) I, II, III, and IV

Question 26

Profitability index is the ratio of:

A) Future value of cash flows to investment
B) Net present value of cash flows to investment
C) Net present value of cash flows to IRR
D) Present value of cash flows to IRR

Question 27

A project will have only one internal rate of return if:

A) The net present value is positive
B) The net present value is negative
C) The cash flows decline over the life of the project
D) There is a one sign change in the cash flows

Question 28

Mass Company is investing in a giant crane. It is expected to cost 6.6 million in initial investment and it is expected to generate an end of year cash flow of 3.0 million each year for three years. Calculate the MIRR for the project if the cost of capital is 12% APR.

A) 17.3%
B) 15.3%
C) 23.8%
D) 22.1%

Question 29

Muscle Company is investing in a giant crane. It is expected to cost 6.5 million in initial investment and it is expected to generate an end of year cash flow of 3.0 million each year for three years. Calculate the IRR approximately.

A) 14.6 %
B) 16.4 %
C) 18.2 %
D) 22.1%

Question 30

Music Company is considering investing in a new project. The project will need an initial investment of $2,400,000 and will generate $1,200,000 (after-tax) cash flows for three years. Calculate the NPV for the project if the cost of capital is 15%.

A) $169, 935
B) $1,200,000
C) $339,870
D) $125,846

Question 31

If an investment project (normal project) has IRR equal to the cost of capital, the NPV for that project is:

A) Positive
B) Negative
C) Zero
D) Unable to determine

Question 32

If the sign of the cash flows for a project changes two times then the project has:

A) one IRR
B) two IRRs
C) three IRRs
D) None of the above

Question 33

Story Company is investing in a giant crane. It is expected to cost 6.0 million in initial investment and it is expected to generate an end of year cash flow of 3.0 million each year for three years. Calculate the NPV at 12% (approximately).

A) 2.4 million
B) 1.2. million
C) 0.80 million
D) 0.20 million

Question 34

The following are some of the shortcomings of the IRR method except:

A) IRR is conceptually easy to communicate
B) Projects can have multiple IRRs
C) IRR method cannot distinguish between a borrowing project and a lending project
D) It is very cumbersome to evaluate mutually exclusive projects using the IRR method

Question 35

Project X has the following cash flows: C0 = +2000, C1 = -1,300 and C2 = -1,500. If the IRR of the project is 25% and if the cost of capital is 18%, you would:

A) Accept the project
B) Reject the project
This is a loan project therefore reject.

Question 36

Dry-Sand Company is considering investing in a new project. The project will need an initial investment of $1,200,000 and will generate $600,000 (after-tax) cash flows for three years. Calculate the MIRR (modified internal rate of return) for the project if the cost of capital is 15%.

A) 14.5%
B) 18.6%
C) 20.2%
D) 23.4%

Question 37

Driscoll Company is considering investing in a new project. The project will need an initial investment of $2,400,000 and will generate $1,200,000 (after-tax) cash flows for three years. Calculate the IRR for the project.

A) 14.5%
B) 18.6%
C) 20.2%
D) 23.4%

Question 38

Given the following cash flows for Project M: C0 = -1,000, C1 = +200, C2 = +700, C3 = +698, calculate the IRR for the project.

A) 23%
B) 21%
C) 19%
D) None of the above

Question 39

Project Y has following cash flows: C0 = -800; C1 = +5,000; C2 = -5,000; Calculate the IRRs for the project:

A) 25% & 400%
B) 125% & 500%
C) -44% & 11.6%
D) None of the above

Question 40

Profitability index is useful under:

A) Capital rationing
B) Mutually exclusive projects
C) Non-normal projects
D) None of the above

Question 41

Discuss some of the disadvantages of the payback rule.

Question 42

A positive NPV will always generate a profitability index above 0.

Question 43

The IRR rule states that firms should accept any project offering an internal rate of return in excess of the cost of capital.

Question 44

Briefly discuss capital rationing.

Question 45

The benefit-cost ratio is equal to profitability index plus one.

Question 46

In what way is the modified internal rate of return (MIRR) method better than the IRR method?

Question 47

The profitability index can be used for ranking projects under:

A) Soft capital rationing
B) Hard capital rationing
C) Capital rationing at t = 0
D) Both A and B

Question 48

Briefly explain the value adding-up property.

Question 49

The profitability index will always be below 1.

Question 50

What are some of the disadvantages of using the IRR method?

Question 51

The payback rule ignores all cash flows after the cutoff date.

Question 52

Decommissioning and clean-up cost for any project is always insignificant and should always be ignored.

Question 53

Briefly explain the term "soft rationing".

Question 54

Present values have value adding-up property.

Question 55

What would be the weighted average profitability index of the following two investments, given the firm only has $250 to invest?
Project A: Cost = $120, NPV = 80
Project B: Cost = $100, NPV = 75

A) .62
B) .67
C) .75
D) .79

Question 56

The internal rate of return is the discount rate that makes the PV of a project's cash inflows equal to zero.

Question 57

There can never be more than one value of IRR for any cash flow.

Question 58

The discounted payback rule calculates the payback period and then discounts it at the opportunity cost of capital.

Question 59

In case of a loan project, one should accept the project if the IRR is more than the cost of capital.

Question 60

Discuss some of the advantages of using the payback method.

Question 61

When calculating a weighted average profitability index should you apply an index of 0 to left over money?