Deck 9: Net Present Value and Other Investment Criteria

Question 1

Deciding which product markets to enter is a capital budgeting decision.

Answer 1

True

Question 2

Net present value is highly independent of the rate of return assigned to a particular project.

Answer 2

False

Question 3

A payback period that is less than the required period signals an accept decision.

Answer 3

True

Question 4

The payback calculation takes the time value of money into account.

Question 5

If a project has a net present value equal to zero, then the project is expected to produce only the
minimally required cash inflows.

Question 6

In actual practice, managers frequently use the payback because of its simplicity.

Question 7

A project which has a discounted payback period longer than its life also has a positive NPV.

Question 8

Net present value is the preferred method of analyzing a project even though the cash flows are
only estimates.

Question 9

The advantages of the payback method of project analysis include the bias towards liquidity.

Question 10

An increasing emphasis by financial executives on accounting values rather than financial values
may have contributed to the change in the primary methods used by chief financial officers to
evaluate projects over the past forty years.

Question 11

Determining whether to sell bonds or issue stock is a capital budgeting decision.

Question 12

NPV lets you know in today's dollars how much better off or worse off you will be if you accept a
project.

Question 13

If a project has a net present value equal to zero, then any delay in receiving the projected cash
inflows will cause the project to have a negative net present value.

Question 14

The advantages of the payback method of project analysis include the application of a discount
rate to each separate cash flow.

Question 15

The capital budgeting process addresses what products or services are offered or sold, in what
markets to compete, and what new products to introduce.

Question 16

The NPV method quickly determines the discount rate that changes an accept decision into a reject
decision and vice versa.

Question 17

Net present value is affected by the timing of each and every cash flow related to a project.

Question 18

If a project has a net present value equal to zero, then the present value of the cash inflows
exceeds the initial cost of the project.

Question 19

The advantages of the payback method of project analysis include the bias towards arbitrary cutoff
point.

Question 20

An increased availability of computers and financial calculators to handle the more complex
computations may have contributed to the change in the primary methods used by chief financial
officers to evaluate projects over the past forty years.

Question 21

Average accounting return employs some sort of arbitrary value against which the project
measurement must be compared when determining whether to accept or reject a project.

Question 22

A firm that only accepts projects for which the IRR is equal to the firm's required return will, on
average, neither create nor destroy wealth for its shareholders.

Question 23

IRR uses an arbitrary cutoff number in its decision rule.

Question 24

The average accounting return could lead to incorrect decisions when comparing mutually
exclusive investments.

Question 25

If the internal rate of return on a project is 11.24%, and the project is assigned a 9.5% discount rate,
then the profitability index will be greater than 1.0.

Question 26

In actual practice, managers frequently use the AAR because the information is so readily available.

Question 27

A disadvantage with the average accounting return is the difficulty in obtaining necessary
information to do computation.

Question 28

A disadvantage with the average accounting return is the exclusion of time value of money
considerations.

Question 29

A project is accepted if the target AAR exceeds the project AAR.

Question 30

AAR is biased in favour of liquid investments.

Question 31

Lack of consideration of the time value of money is a weakness of the average accounting return
method of analysis.

Question 32

For most projects, the average accounting return (AAR) should be less than the IRR.

Question 33

A disadvantage with the average accounting return is the accounting basis of the values used in the
computation.

Question 34

When comparing the payback and discounted payback from a financial point of view, the
discounted payback method is preferred over the payback method.

Question 35

When comparing the payback and discounted payback, the discounted payback is more difficult to
compute and thus is not as widely used as the payback method.

Question 36

Two projects that are mutually exclusive are said to be independent.

Question 37

The payback period and discounted payback are biased in favour of liquid investments.

Question 38

The AAR is based on cash flows and market values.

Question 39

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

Question 40

The average accounting return calculation takes the time value of money into account.

Question 41

The internal rate of return method of analysis should not be used for comparing two independent
projects of differing sizes.

Question 42

The IRR is the most widely used capital budgeting technique.

Question 43

The crossover point occurs where the IRR of two projects are equal.

Question 44

The internal rate of return method of analysis works best for independent projects with
conventional cash flows.

Question 45

The internal rate of return (IRR) is the rate that causes the net present value of a project to exactly
equal zero.

Question 46

When multiple IRR's exist, a project must have a negative NPV at the highest IRR.

Question 47

In actual practice, managers frequently use the IRR because the results are easy to communicate
and understand.

Question 48

The internal rate of return method of analysis is generally more popular in practice than NPV.

Question 49

The internal rate of return (IRR) is the rate generated solely by the cash flows of an investment.

Question 50

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 percent 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.

Question 51

NPV and IRR can lead to different decisions in situations investment decision involves mutually
exclusive choices.

Question 52

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

Question 53

NPV and IRR can lead to different decisions in situations where project cash flow are conventional.

Question 54

NPV and IRR can lead to different decisions in situations where the IRR is negative.

Question 55

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

Question 56

The internal rate of return (IRR) rule states that a project with an IRR that is less than the required
rate should be accepted.

Question 57

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

Question 58

The internal rate of return method of analysis may produce multiple rates of return for a single
project.

Question 59

The internal rate of return method of analysis may lead to incorrect decisions when comparing
mutually exclusive projects.

Question 60

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

Question 61

In actual practice, managers frequently use the net present value because it is considered by many
to be the best method of analysis.

Question 62

AAR and payback use an arbitrary cutoff number in their decision rules.

Question 63

You are comparing two mutually exclusive projects. The crossover point is 9 percent. You determine
that you should accept project A if the required return is 6 percent. This implies that you should
always accept project A anytime the discount rate is less than 9 percent.

Question 64

A 25- year project has a cost of $1,500,000 and has annual cash flows of $400,000 in years 1-15, and $200,000 in years 16-25. The company's required rate is 14%. Given this information, calculate
The NPV of the project.

A) $0.50 million
B) $0.70 million
C) $0.87 million
D) $1.00 million
E) $1.10 million

Question 65

A project costs $12,500 to initiate. Cash flows are estimated as $2,500 a year for the first two years and $3,100 a year for the next three years. The discount rate is 11.25%. The net present value for
This project is _____ and the internal rate of return is _________ the discount rate.

A) -$2,138.52; more than
B) -$2,138.52; less than
C) $1,800.00; more than
D) $1,800.00; less than
E) $2,138.52; less than

Question 66

You are comparing two mutually exclusive projects. The crossover point is 9 percent. You determine
that you should accept project A if the required return is 6 percent. This implies that you should
always accept project A and always reject project

Question 67

If financial managers only invest in projects that have a profitability index greater than one, then
share price will be maximized.

Question 68

The IRR method can produce multiple rates of return if the cash flows are nonconventional.

Question 69

The use of the internal rate of return could lead to incorrect decisions in comparing mutually
exclusive investments.

Question 70

If financial managers only invest in projects that have a profitability index greater than one, then firm
value will be maximized.

Question 71

The profitability index calculation takes the time value of money into account.

Question 72

Profitability index employs some sort of arbitrary value against which the project measurement must
be compared when determining whether to accept or reject a project.

Question 73

The use of either the internal rate of return or the profitability index could lead to incorrect
decisions when comparing mutually exclusive investments.

Question 74

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

Question 75

If financial managers only invest in projects that have a profitability index greater than one, then
shareholder wealth will be maximized.

Question 76

Projects should be accepted when the profitability index is less than 1.

Question 77

You are considering a project that costs $300 and has expected cash flows of $110, $121, and $133.10 over the next three years. If the appropriate discount rate for the project's cash flows is 10%,
What is the net present value of this project?

A) ($8.58)
B) $0.00
C) $0.71
D) $19.79
E) $64.10

Question 78

Calculate the NPV of a 20-year project with a cost of $400,000 and annual cash flows of $50,000 in years 1-10 and $25,000 in years 11-20. The company's required rate of return is 10%.

A) ($33,547)
B) ($18,547)
C) $0
D) $18,547
E) $33,547

Question 79

If the internal rate of return on a project is 11.24%, and the project is assigned a 9.5% discount rate,
then the project will have a negative net present value.

Question 80

You are comparing two mutually exclusive projects. The crossover point is 9 percent. You determine
that you should accept project A if the required return is 6 percent. This implies that you should
always reject project B if the required return is 6 percent.