Deck 5: Comparison Methods: Part Ii

Question 1

A flight school operates 5 different types of airplanes. All airplanes are outdated and require some modifications. The school has $33 000 available in the budget for airplane modification this year. An aviation engineer came up with this plan to update all airplanes. The plan's costs are shown in the following table: Which airplane modification does the school have to postpone till next year?

A)1
B)2
C)3
D)4
E)5

Answer 1

B

Question 2

What is the major advantage of the internal rate of return comparison method?

A)It gives an explicit measure of profit.
B)It has familiar meanings to decision makers.
C)It is very easy to calculate and therefore it is commonly used.
D)It takes into account the need to have capital recovered quickly.
E)It facilitates the comparison of projects of different size.

Answer 2

E

Question 3

The external rate of return must be used if

A)there are multiple internal rates of return.
B)a project involves only simple investments.
C)a project starts with cash outflow.
D)a project requires multiple investments and generates multiple benefits.
E)it is impossible to calculate the minimum acceptable rate of return.

Answer 3

A

Question 4

The following table summarizes information for five projects: The data can be interpreted in the following way: The IRR on the incremental investment between project 5 and project 4 is 16%. If all projects are independent and the company has at least $1 000 000 to invest, which projects should be undertaken if the MARR is 16%?

A)only 2
B)2 and 4
C)1, 3, and 5
D)1, 3, 4, and 5
E)1, 2, 3, 4, and 5

Question 5

A project is subject to the following cash flow diagram: What rate of return would it be appropriate to use in this case?

A)ERR
B)IRR
C)MARR
D)Market rate of return
E)Explicit rate of return

Question 6

A project is subject to the following cash flow diagram: What is its rate of return?

A)22%
B)36%
C)56%
D)60%
E)74%

Question 7

The internal rate of return (IRR)is negative if

A)a project is losing money.
B)a cash inflow exceeds a cash outflow.
C)a project just breaks even.
D)a project is a simple investment.
E)IRR cannot be negative.

Question 8

What is the major disadvantage of the internal rate of return method?

A)It complicates the comparison of projects of the different sizes.
B)It can produce more than one internal rate of return.
C)It discriminates against long-term projects.
D)It ignores the time value of money.
E)It ignores the expected service life.

Question 9

Unlike the internal rate of return method, the present and annual worth computations

A)are more complicated.
B)do not account for the time value of money.
C)give a direct measure of the profit provided by a project.
D)discriminate against long-term projects.
E)do not take into account expected service life of a project.

Question 10

The internal rate of return (IRR)is

A)the interest rate that allows an investor to recoup the initial investment.
B)the interest rate that ensures the positive cash flow of a project.
C)the interest rate that breaks even a project's costs and benefits.
D)the interest rate that measures the return from operating costs.
E)the interest rate that is set up by an investor to guarantee that the return on investment will be higher than from a bank interest rate.

Question 11

The following table summarizes information for five projects: The data can be interpreted in the following way: The IRR on the incremental investment between project 5 and project 4 is 16%. If the projects are mutually exclusive, which projects should be undertaken if the MARR is 15%?

A)3 only
B)5 only
C)3 and 5
D)3, 4, and 5
E)1, 3, 4, and 5

Question 12

Which of the following statements is TRUE with regard to the ERR?

A)The approximate ERR is just a proxy for the IRR.
B)The precise ERR is a proxy for the IRR.
C)For a simple investment, the precise ERR is greater than the IRR.
D)For a simple investment, the approximate ERR is greater than the IRR.
E)The approximate ERR can be used to evaluate a project, whether a simple investment or not.

Question 13

A project requires no initial investment. It costs $4 000 a year from now and earns $8 000 two years from now. What is its internal rate of return?

A)24%
B)50%
C)75%
D)100%
E)141%

Question 14

Two mutually exclusive alternatives are being compared. We should choose the alternative that

A)has a higher minimum acceptable rate of return assuming the lives of the alternatives are equal.
B)has a higher internal rate of return assuming the lives of the alternatives are equal.
C)has a higher internal rate of return regardless of the lives of the alternatives.
D)has an incremental investment with a rate of return equal to the minimum acceptable rate of return.
E)has an incremental investment with the rate of return exceeding minimum acceptable rate of return.

Question 15

The fundamental idea behind comparison of mutually exclusive projects on the basis of incremental IRR is

A)different fractions of investments are associated with different levels of productivity.
B)all investments are non-simple.
C)some investments are not productive.
D)multiple IRRs.
E)high uncertainty.

Question 16

A project requires an initial investment of $100 000 and immediately pays $25 000. The next year this project requires an additional investment of $50 000 and does not pay anything. In the following year the project pays $150 000. The internal rate of return (i)for this project can be obtained by

A)using a present worth factor.
B)solving a quadratic equation.
C)calculating an external rate of return.
D)solving a system of two equations.
E)solving an ith degree polynomial equation.

Question 17

What economic concept is used as background for the external rate of return?

A)a present worth
B)a net cash flow
C)an internal rate of return
D)a payback period
E)an opportunity cost

Question 18

A project is represented by the following graphs: What is the internal rate of return for this project?

A)0%
B)4%
C)10%
D)14%
E)15%

Question 19

Dealing with mutually exclusive projects, we start with some current alternative. How do we chose it?

A)the alternative with the highest internal rate of return
B)the alternative with a zero net benefit
C)the alternative with the benefit-cost ratio of one
D)the "do nothing" alternative
E)the alternative with the smallest first cost

Question 20

What is the difference between the internal rate of return (IRR)and the external rate of return (ERR)?

A)The IRR is earned by a project whereas the ERR is earned outside of it.
B)The ERR equals the difference between the IRR and the MARR.
C)The IRR usually equals the MARR whereas the ERR is always higher than the MARR.
D)The ERR is earned when a project's return is used for the purpose of further reinvestment while the IRR is typically used for calculating the net return of a project.
E)For a given explicit rate of return, a project can have more than one value for its ERR but can have only one value for its IRR.

Question 21

You can buy a car for $40 000 paying cash now or you can finance it through a bank loan paying $700 per month for 5 years. What is the IRR of the financing option in annual terms?

Question 22

You are considering the following project: It pays you $5 000 at the end of the first year, costs $10 000 by the end of the second year and brings $4 000 next year. What is the project's internal rate of rate, external rate of return and the approximate external rate of return if current market interest rate is 25%? Comment on the project acceptability on the basis of the given information.

Question 23

A two-year project has $100 million as initial investment and generates net savings of $60 million per year. What is the project's IRR?

A)10.1%
B)11.1%
C)12.1%
D)13.1%
E)14.1%

Question 24

For two mutually exclusive projects with equal lives, the one with

A)a higher IRR should be chosen.
B)a higher incremental PW at the MARR should be chosen.
C)a higher incremental FW at the MARR should be chosen.
D)a higher incremental IRR than the MARR should be chosen.
E)a higher incremental AW at the MARR should be chosen.

Question 25

When does the problem of multiple IRRs arise and what are possible solutions to the problem?

Question 26

If you can invest money at 10% interest, what is the approximate ERR corresponding to this cashflow diagram?

A)15%
B)20%
C)25%
D)30%
E)35%

Question 27

What is the difference between the internal rate of return and the minimum acceptable rate of return?

Question 28

In general, the IRR comparison method and the PW comparison method

A)produce the same results for independent projects but not for mutually exclusive projects.
B)produce the same results for mutually exclusive projects but not for independent projects.
C)produce different results for both independent projects and mutually exclusive projects.
D)produce the same results for independent projects and mutually exclusive projects with unequal lives.
E)produce the same results for independent projects and mutually exclusive projects with equal lives.

Question 29

Suppose that a project pays $5 000 on odd years and costs $5 000 on even years. If the life of the project is 6 years, what is its approximate external rate of return if the MARR is 10%? Would you accept or reject such a project?

Question 30

I sign a contract that guarantees me an immediate payment of $2 000, but then I have to invest $800 a year for ten years. At the end of the tenth year I get a further payment of $8 000. What is my internal rate of return on the contract?

A)There are two solutions: 8% and 16%.
B)There are two solutions: 13% and 25%.
C)There are two solutions, 15% and 30%.
D)There are two solutions: 18% and 24%.
E)There is a single solution: about 22%.

Question 31

What is the IRR corresponding to this cashflow diagram?

A)about 9%
B)about 12%
C)about 19%
D)about 22%
E)about 25%

Question 32

I sign a contract that guarantees me an immediate payment of $2 000, but then I have to invest $800 a year for ten years. At the end of the tenth year I get a further payment of $8 000. If I can invest money at 10% interest, what is my approximate external rate of return on the contract?

A)about 9%
B)about 10%
C)about 11%
D)about 12%
E)There are two solutions, about 8% and about 12%.

Question 33

Logistics Inc is considering buying an new cube van for $150 000 which will have a scrap value of $10 000 after its 8 year life. The total savings due to the new van compared with continuing without will be $12 000 the first year increasing by $6 000 each year thereafter. The total extra costs due to the van is estimated to be $5 000 per year. Logistics Inc has a MARR of 10%. Using the IRR for Independent Projects method determine if the van should be purchased.

Question 34

What is the IRR corresponding to this cashflow diagram?

A)About 10.5%
B)About 11.5%
C)About 12.5%
D)About 13.5%
E)About 14.5%

Question 35

A project involves an immediate expenditure of $1 000, and will require additional expenditures of $100 a year for the next ten years, starting one year from now. After ten years it yields an income of $3 000. What is its rate of return?

A)3.5%
B)4.5%
C)5.5%
D)6.5%
E)7.5%

Question 36

You have two ways to invest $1 000 000 you won in a lottery: (i)to buy government bonds that earn 4% annually, or (ii)to buy an apartment building that brings you $100 000 per year in revenues. Compare the two options in terms of their internal rates of return.

Question 37

If you invest $1 000 now, you will receive this amount back in two years plus dividends of $200 each year. What is the IRR of this investment?

Question 38

What projects are called simple investments?

A)projects that consist of one inflow at the start followed by only one outflow
B)projects that have only two internal rates of return
C)projects that have a stream of revenues at the start followed by a stream of investments
D)projects that have one or more periods of outflows at the start followed by one or more periods of inflows
E)projects that require calculation of the external rate of return

Question 39

A project involves an immediate expenditure of $2 000, and will require additional expenditures of $150 a year for the next ten years, starting one year from now. After ten years it yields an income of $8 000, but a year later a further expenditure of $1 000 will be required to close down the project. What is its rate of return?

A)9%
B)10%
C)11%
D)12%
E)13%

Question 40

Consider two mutually exclusive investments with a MARR of 60%:
The first has an initial investment of $15 000 and returns $30 000 at the end of a year.
The second costs $45 000 and returns $85 500 at the end of a year. Which is the preferred investment?

Question 41

YVY Consulting group received a contract to evaluate a new technological line to produce shoes. The project is subject to the following cash flows:
If the market price of a pair of shoes is $70 and the MARR is 15%, is this a good investment on the basis of the IRR?

Question 42

Explain how you would compare two mutually exclusive projects on the basis of the internal rate of return.

Question 43

Steve is a professional web-site designer. He just bought a powerful computer for $5 000. According to the existing market, he will be able to sell this computer for $1 000 three years from now. In order for Steve to get 10% internal rate of return on his computer, what annual revenue should he generate over the three-year period?

Question 44

Suppose that Maria borrowed $5 000 from a bank to be repaid in five equal annual payments of $1 250. What is the IRR of this transaction?

Question 45

Assume that Stan takes a student loan of $5 000 at the beginning of his first year at Miskatonic University and graduates at the end of year 5. After graduation, a 7% interest rate on the debt is applied. If Stan makes four equal annual payments to re-pay the debt in four years after graduation, what is the IRR on his loan?

Question 46

Suppose that you can buy a car now for $20 000. On the other hand, you can lease it at $350 per month for 60 months. If you buy a car now, then you will be able to sell it at the end of the fifth year for $8 000. If you choose to lease, what is the monthly and annual IRR of the lease compared to the buying a car now?

Question 47

There are two options to buy a plot of land for construction: (i)upfront payment of $250 000, or (ii)four equal payments of $50 000 in years 1-4 and the fifth payment of $150 000 in year 5. What is the implied IRR of choosing the second option over the first?

Question 48

An investor has the following properties to invest in over a period of three years and uses a MARR of 9%:
Using incremental IRR, which property, if any, should she invest in?

Question 49

What are the advantages and disadvantages of the comparison method based on the IRR against the present worth comparison method?

Question 50

Sarah is considering the purchase of ski equipment for $300. It could save her the $60 per year of rental fees she envisions over the six year life of the ski equipment. What is the IRR of investing in the ski equipment?