Deck 7: Net Present Value and Other Investment Rules

Question 1

Payback is frequently used to analyze independent projects because:

A)it is easy and quick to calculate.
B)all relevant cash flows are included in the analysis.
C)it considers the time value of money.
D)it is the most desirable of all the available analytical methods from a financial perspective.
E)it produces better decisions than those made using either NPV or IRR.

Answer 1

it is easy and quick to calculate.

Question 2

The length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment is called the:

A)net present value.
B)internal rate of return.
C)payback period.
D)profitability index.
E)discounted cash period.

Answer 2

payback period.

Question 3

The length of time required for a project's discounted cash flows to equal the initial cost of the project is called the:

A)payback period.
B)discounted payback period.
C)net present value.
D)discounted profitability index.
E)internal rate of return.

Answer 3

discounted payback period.

Question 4

An investment is acceptable if its average accounting return (AAR):

A)is less than a target AAR.
B)exceeds a target AAR.
C)exceeds the firm's return on equity (ROE).
D)is less than the firm's return on assets (ROA).
E)is equal to zero.

Question 5

The difference between the present value of an investment and its cost is the:

A)payback period.
B)internal rate of return.
C)net present value.
D)discounted payback period.
E)profitability index.

Question 6

An investment is acceptable if the profitability index (PI)of the investment is:

A)less than one.
B)greater than one.
C)greater than the internal rate of return (IRR).
D)less than the net present value (NPV).
E)greater than a pre-specified rate of return.

Question 7

An investment's average net income divided by its average book value defines the average:

A)net present value.
B)internal rate of return.
C)accounting return.
D)profitability index.
E)payback period.

Question 8

The primary reason that a company's projects with positive net present values are considered acceptable is that:

A)the required cash inflows exceed the actual cash inflows.
B)they return the initial cash outlay within three years or less.
C)the project's rate of return exceeds the rate of inflation.
D)they create value for the owners of the firm.
E)the investment's cost exceeds the present value of the cash inflows.

Question 9

A situation in which accepting one investment prevents the acceptance of another investment is called the:

A)operational ambiguity decision.
B)net present value profile.
C)issues of scale problem.
D)mutually exclusive investment decision.
E)multiple choices of operations decision.

Question 10

The present value of an investment's future cash flows divided by the initial cost of the investment is called the:

A)average accounting return.
B)internal rate of return.
C)net present value.
D)profile period.
E)profitability index.

Question 11

An investment is acceptable if its IRR:

A)is exactly equal to its net present value (NPV).
B)is exactly equal to zero.
C)is less than the required return.
D)exceeds the required return.
E)is exactly equal to 100%.

Question 12

If a project has a net present value equal to zero,then:
I.the present value of the cash inflows exceeds the initial cost of the project.
II.the project produces a rate of return that just equals the rate required to accept the project.
III.the project is expected to produce only the minimally required cash inflows.
IV.any delay in receiving the projected cash inflows will cause the project to have a negative net present value.

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

Question 13

The possibility that more than one discount rate will make the NPV of an investment equal to zero is called the _____ problem.

A)multiple rates of return
B)scale
C)mutually exclusive investment decision
D)operational ambiguity
E)net present value profiling

Question 14

The advantages of the payback method of project analysis include the:
I.application of a discount rate to each separate cash flow.
II.bias towards liquidity.
III.ease of use.
IV.arbitrary cutoff point.

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

Question 15

Which one of the following statements is correct concerning the payback period?

A)An investment is acceptable if its calculated payback period is greater than some pre-specified period of time.
B)An investment should be accepted if the payback is positive and rejected if it is negative.
C)An investment should be rejected if the payback is positive and accepted if it is negative.
D)An investment is acceptable if its calculated payback period is less than some pre-specified period of time.
E)An investment should be accepted any time the payback period is less than the discounted payback period, given a positive discount rate.

Question 16

The discounted payback rule states that you should accept projects:

A)which have a discounted payback period that is greater than some pre-specified period of time.
B)if the discounted payback is positive and rejected if it is negative.
C)only if the discounted payback period equals some pre-specified period of time.
D)if the discounted payback period is less than some pre-specified period of time.
E)only if the discounted payback period is equal to zero.

Question 17

The discount rate that makes the net present value of an investment exactly equal to zero is called the:

A)external rate of return.
B)internal rate of return.
C)average accounting return.
D)profitability index.
E)equalizer.

Question 18

Net present value:

A)cannot be used when deciding between two mutually exclusive projects.
B)is easy to explain to non-financial managers and thus is the primary method of analysis used by the lowest levels of management.
C)is more useful to decision makers than the internal rate of return when comparing different sized projects.
D)is very similar in its methodology to the average accounting return.
E)is not as widely used a tool as payback and discounted payback.

Question 19

All else constant,the net present value of a typical investment project increases when:

A)the discount rate increases.
B)each cash inflow is delayed by one year.
C)the initial cost of a project increases.
D)the rate of return decreases.
E)all cash inflows occur during the last year of a project's life instead of periodically throughout the life of the project.

Question 20

Which one of the following statements concerning net present value (NPV)is correct?

A)An investment should be accepted if, and only if, the NPV is exactly equal to zero.
B)An investment should be accepted only if the NPV is equal to the initial cash flow.
C)An investment should be accepted if the NPV is positive and rejected if it is negative.
D)An investment with greater cash inflows than cash outflows, regardless of when the cash flows occur, will always have a positive NPV and therefore should always be accepted.
E)Any project that has positive cash flows for every time period after the initial investment should be accepted.

Question 21

The discounted payback period of a project will decrease whenever the:

A)initial cash outlay of the project is increased.
B)discount rate applied to the project is increased.
C)amount of each projected cash inflow is increased.
D)time period of the project is increased.
E)costs of the fixed assets utilized in the project increase.

Question 22

When two projects both require the total use of the same limited economic resource,the projects are generally considered to be:

A)marginally profitable.
B)independent.
C)acceptable.
D)mutually exclusive.
E)internally profitable.

Question 23

Which one of the following is the best example of two mutually exclusive projects?

A)Planning to build a warehouse and a retail outlet side by side
B)Buying sufficient equipment to manufacture both desks and chairs simultaneously
C)Using an empty warehouse for storage or renting it entirely out to another firm
D)Using the company sales force to promote sales of both shoes and socks
E)Buying both inventory and fixed assets using funds from the same bond issue

Question 24

No matter how many forms of investment analysis you perform:

A)a project will never be accepted unless the payback period is met.
B)the internal rate of return will always produce the most reliable results.
C)the actual results from a project may vary significantly from the expected results.
D)only the first three years of a project ever affect its final outcome.
E)the initial costs will generally vary considerably from the estimated costs.

Question 25

Given that the net present value (NPV)is generally considered to be the best method of analysis,why should you still use the other methods?

A)You need to use other methods because the net present value method is unreliable when a project has unconventional cash flows.
B)You need to use the other methods since conventional practice dictates that you only accept projects after you have generated three accept indicators.
C)The other methods provide results that are generally easier to understand than a net present value analysis.
D)The average accounting return must always indicate acceptance since this is the best method from a financial perspective.
E)The discounted payback method must always be computed to determine if a project returns a positive cash flow since NPV does not measure this aspect of a project.

Question 26

When the present value of the cash inflows exceeds the initial cost of a project,then the project should be:

A)accepted because the internal rate of return is positive.
B)rejected because the net present value is negative.
C)rejected because the internal rate of return is negative.
D)accepted because the profitability index is negative.
E)accepted because the profitability index is greater than 1.

Question 27

If you want to compare the present value of the future cash inflows of a project with its initial cost,you should use the _______ method of analysis.

A)payback
B)incremental IRR
C)profitability index
D)average accounting return
E)internal rate of return

Question 28

The internal rate of return for a project will increase if:

A)the required rate of return is reduced.
B)each cash inflow is moved such that it occurs one year later than originally projected.
C)the total amount of the cash inflows is reduced.
D)the initial cost of the project can be reduced.
E)the salvage value of the project is omitted from the analysis.

Question 29

Analysis using the profitability index:

A)frequently conflicts with the accept and reject decisions generated by the application of the net present value rule.
B)is useful as a decision tool when investment funds are limited.
C)cannot be used to aid capital structure decisions.
D)utilizes the same basic variables as those used in the average accounting return.
E)produces results which typically are difficult to comprehend or apply.

Question 30

Matt is analyzing two mutually exclusive projects of similar size and has prepared the following data.Both projects have 5 year lives. Matt has been asked for his best recommendation given this information.His recommendation should be to accept:

A)project B because it has the shortest payback period.
B)project A and reject project B based on their net present values.
C)both projects as they both have positive net present values.
D)project B and reject project A based on their average accounting returns.
E)project B and reject project A based on both the payback period and the averageaccounting return.

Question 31

The internal rate of return (IRR):
I.rule states that a typical investment project with an IRR that is less than the required rate should be accepted.
II.is the rate generated solely by the cash flows of an investment.
III.is the rate that causes the net present value of a project to exactly equal zero.
IV.can effectively be used to analyze all investment scenarios.

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

Question 32

The profitability index is closely related to:

A)payback.
B)discounted payback.
C)net present value.
D)average accounting return.
E)internal rate of return.

Question 33

Graphing the NPVs of mutually exclusive projects over different discount rates helps demonstrate:

A)how decisions concerning mutually exclusive projects are derived.
B)how the incremental IRR varies with changes in the discount rate.
C)how the payback period and the initial cash outflow of a project are related.
D)how the duration of a project affects the decision as to which project to accept.
E)how the profitability index and the net present value are related.

Question 34

The Liberty Co.is considering two projects.Project A consists of building a wholesale book outlet on lot #169 of the Englewood Retail Center.Project B consists of building a sit-down restaurant on lot #169 of the Englewood Retail Center.When trying to decide whether to build the book outlet or the restaurant,management should rely most heavily on the analysis results from the _____ method of analysis.

A)profitability index
B)net present value
C)payback
D)internal rate of return
E)accounting rate of return

Question 35

All else equal,the payback period for a project will decrease whenever the:

A)duration of a project is lengthened.
B)cash inflows are moved earlier in time.
C)assigned discount rate decreases.
D)required return for a project increases.
E)initial cost increases.

Question 36

In actual practice,managers frequently use the:
I.AAR because the necessary accounting numbers are readily available.
II.IRR because the results are easy to communicate and understand.
III.payback because of its simplicity.
IV.net present value because it is considered by many to be the best method of analysis.

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

Question 37

The discounted payback rule may cause:

A)the most liquid projects to be rejected in favor of less liquid projects.
B)some positive net present value projects to be rejected.
C)projects to be incorrectly accepted due to ignoring the time value of money.
D)projects with negative net present values to be accepted.
E)Both B and D

Question 38

The internal rate of return tends to be:

A)ignored by most financial analysts.
B)extremely accurate even when cash flow estimates are faulty.
C)easier for managers to comprehend than the net present value.
D)utilized in project analysis only when multiple net present values apply.
E)used primarily to differentiate between mutually exclusive projects.

Question 39

The internal rate of return is:

A)more reliable as a decision making tool than net present value whenever you are considering mutually exclusive projects.
B)equivalent to the discount rate that makes the net present value equal to one.
C)a better methodology than net present value when dealing with unconventional cash flows.
D)dependent upon the interest rates offered in the marketplace.
E)cumbersome to compute without the use of either a financial calculator or a computer.

Question 40

You are trying to determine whether to accept project A or project B.These projects are mutually exclusive.As part of your analysis,you should compute the incremental IRR by determining:

A)the discount rate that equates the discounted payback periods for each project.
B)the net present value of each project using the internal rate of return as the discount rate.
C)the internal rate of return for the cash flows of each project.
D)the internal rate of return for the differences in the cash flows of the two projects.
E)the discount rate that makes the net present value of each project equal to 1.

Question 41

A project will have more than one IRR if:

A)the IRR is negative.
B)the IRR is positive.
C)the NPV is zero.
D)the cash flow pattern exhibits exactly one sign change.
E)the cash flow pattern exhibits more than one sign change.

Question 42

The discounted payback period rule:

A)discounts the cutoff point.
B)considers the time value of money.
C)is preferred to the NPV rule.
D)ignores uncertain cash flows.
E)None of the above.

Question 43

A mutually exclusive project is a project whose:

A)acceptance or rejection has no effect on other projects.
B)NPV is always negative.
C)IRR is always negative.
D)acceptance or rejection affects other projects.
E)cash flow pattern exhibits more than one sign change.

Question 44

Which of the following methods of project analysis are biased towards short-term projects?
I.internal rate of return
II.accounting rate of return
III.payback
IV.discounted payback

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

Question 45

Accepting positive NPV projects benefits the stockholders because:

A)it is the most easily understood valuation process.
B)the present value of the expected cash flows are equal to the cost.
C)the present value of the expected cash flows are greater than the cost.
D)it is the most easily calculated.
E)None of the above.

Question 46

The problem of multiple IRRs can occur when:

A)there is only one sign change in the cash flows.
B)the first cash flow is always positive.
C)the cash flows decline over the life of the project.
D)there is more than one sign change in the cash flows.
E)None of the above.

Question 47

The payback period rule is a convenient and useful tool because:

A)it provides a quick estimate of how rapidly the initial investment will be recouped.
B)results of a short payback rule decision will be quickly seen.
C)it does not have to take into account time value of money.
D)All of the above.
E)None of the above.

Question 48

The investment decision rule that relates average net income to average investment is the:

A)average payback method.
B)average profitability index.
C)discounted cash flow method.
D)average accounting return method.
E)None of the above.

Question 49

The payback period rule:

A)determines a cutoff point so that all projects accepted by the NPV rule will be accepted by the payback period rule.
B)determines a cutoff point so that depreciation is just equal to positive cash flows in the payback year.
C)requires an arbitrary choice of a cutoff point.
D)varies the cutoff point with the interest rate.
E)Both A and D.

Question 50

The average accounting return is determined by:

A)dividing the yearly cash flows by the investment.
B)dividing the average cash flows by the investment.
C)dividing the average net income by the average investment.
D)dividing the average net income by the initial investment.
E)dividing the net income by the cash flow.

Question 51

Modified internal rate of return:

A)handles the multiple IRR problem by combining cash flows until only one change in sign change remains.
B)requires the use of a discount rate.
C)does not require the use of a discount rate.
D)Both A and B.
E)Both A and C.

Question 52

Which of the following does not characterize NPV?

A)NPV discounts all future cash flows.
B)NPV incorporates all cash flow information.
C)NPV uses all of the project's cash flows.
D)NPV does not explicitly incorporate risk into the analysis.
E)Using NPV will lead to decisions that maximize shareholder wealth.

Question 53

The shortcoming(s)of the average accounting return (AAR)method is (are):

A)the use of net income instead of cash flows.
B)the pattern of income flows has no impact on the AAR.
C)there is no clear-cut decision rule.
D)All of the above.
E)None of the above.

Question 54

Using internal rate of return,a conventional project should be accepted if the internal rate of return is:

A)equal to the discount rate.
B)greater than the discount rate.
C)less than the discount rate.
D)negative.
E)positive.

Question 55

The payback period rule:

A)discounts cash flows.
B)ignores initial cost.
C)always uses all possible cash flows in its calculation.
D)Both A and C.
E)None of the above.

Question 56

If a project is assigned a required rate of return equal to zero,then:

A)the project will always be rejected.
B)the project will always be accepted.
C)the timing of the project's cash flows has no bearing on the value of the project.
D)whether the project is accepted or rejected will depend on the timing of the cash flows.
E)the project can never add value for the shareholders.

Question 57

The internal rate of return may be defined as:

A)the discount rate that makes the NPV cash flows equal to zero.
B)the difference between the market rate of interest and the NPV.
C)the market rate of interest less the risk-free rate.
D)the project acceptance rate set by management.
E)None of the above.

Question 58

The two fatal flaws of the internal rate of return rule are:

A)arbitrary determination of a discount rate and failure to consider initial expenditures.
B)arbitrary determination of a discount rate and failure to correctly analyze mutually exclusive investment projects.
C)arbitrary determination of a discount rate and the multiple rate of return problem.
D)failure to consider initial expenditures and failure to correctly analyze mutually exclusive investment projects.
E)failure to correctly analyze mutually exclusive investment projects and the multiple rate of return problem.

Question 59

You are considering a project with the following data: Which one of the following is correct given this information?

A)The discount rate used in computing the net present value must have been less than 8.7%.
B)The discounted payback period will have to be less than 2.44 years.
C)The discount rate used to compute the profitability ratio was equal to the internal rate of return.
D)This project should be accepted based on the profitability ratio.
E)This project should be rejected based on the internal rate of return.

Question 60

The payback period rule accepts all investment projects in which the payback period for the cash flows is:

A)equal to the cutoff point.
B)greater than the cutoff point.
C)less than the cutoff point.
D)positive.
E)None of the above.

Question 61

You are considering two independent projects both of which have been assigned a discount rate of 8%.Based on the profitability index,what is your recommendation concerning these projects?

A)You should accept both projects since both of their PIs are positive.
B)You should accept project A since it has the higher PI.
C)You should accept both projects since both of their PIs are greater than 1.
D)You should only accept project B since it has the largest PI and the PI exceeds 1.
E)Neither project is acceptable.

Question 62

You are considering two mutually exclusive projects with the following cash flows.Will your choice between the two projects differ if the required rate of return is 8% rather than 11%? If so,what should you do?

A)Yes; Select A at 8% and B at 11%.
B)Yes; Select B at 8% and A at 11%.
C)Yes; Select A at 8% and select neither at 11%.
D)No; Regardless of the required rate, project A always has the higher NPV.
E)No; Regardless of the required rate, project B always has the higher NPV.

Question 63

What is the net present value of a project that has an initial cash outflow of $12,670 and the following cash inflows? The required return is 12.5%.

A)$-218.68
B)$-124.46
C)$-76.10
D)$549.65
E)$671.02

Question 64

A project has an initial cost of $2,300.The cash inflows are $300,$500,$900,and $700 over the next four years,respectively.What is the payback period?

A)2.71 years
B)2.98 years
C)3.11 years
D)3.86 years
E)Never

Question 65

Graham and Harvey (2001)found that ___ and ___ were the two most popular capital budgeting methods.

A)Internal Rate of Return; Payback Period
B)Internal Rate of Return; Net Present Value
C)Net Present Value; Payback Period
D)Modified Internal Rate of Return; Internal Rate of Return
E)Modified Internal Rate of Return; Net Present Value

Question 66

Based on the profitability index (PI)rule,should a project with the following cash flows be accepted if the discount rate is 7%? Why or why not?

A)Yes; because the PI is 1.008
B)Yes; because the PI is .992
C)Yes; because the PI is .999
D)No; because the PI is 1.008
E)No; because the PI is .992

Question 67

Jack is considering adding toys to his general store.He estimates that the cost of inventory will be $4,200.The remodeling expenses and shelving costs are estimated at $1,500.Toy sales are expected to produce net cash inflows of $1,300,$1,600,$1,700,and $1,750 over the next four years,respectively.Should Jack add toys to his store if he assigns a three-year payback period to this project?

A)Yes; because the payback period is 2.94 years
B)Yes; because the payback period is 2.02 years
C)Yes; because the payback period is 3.63 years
D)No; because the payback period is 2.02 years
E)No; because the payback period is 3.63 years

Question 68

Which of the following statement is true?

A)One must know the discount rate to compute the NPV of a project but one can compute the IRR without referring to the discount rate.
B)One must know the discount rate to compute the IRR of a project but one can compute the NPV without referring to the discount rate.
C)Payback accounts for time value of money.
D)There will always be one IRR regardless of cash flows.
E)Average accounting return is the ratio of total assets to total net income.

Question 69

A project will produce cash inflows of $1,750 a year for four years.The project initially costs $10,600 to get started.In year five,the project will be closed and as a result should produce a cash inflow of $8,500.What is the net present value of this project if the required rate of return is 14.75%?

A)-$5,474.76
B)-$1,306.18
C)-$935.56
D)$1,011.40
E)$5,474.76

Question 70

The profitability index is the ratio of:

A)average net income to average investment.
B)present value of cash flows to initial investment cost.
C)net present value of cash flows to internal rate of return.
D)net present value of cash flows to average accounting return.
E)internal rate of return to current market interest rate.

Question 71

What is the internal rate of return on an investment with the following cash flows?

A)7.93%
B)7.96%
C)8.04%
D)8.09%
E)9.07%

Question 72

If there is a conflict between mutually exclusive projects due to the IRR,one should:

A)drop the two projects immediately.
B)spend more money on gathering information.
C)depend on the NPV as it will always provide the most value.
D)depend on the AAR because it does not suffer from these same problems.
E)None of the above.

Question 73

What is the profitability index for an investment with the following cash flows given a 9% required return?

A).96
B).98
C)1.00
D)1.02
E)1.04

Question 74

You are considering an investment with the following cash flows.If the required rate of return for this investment is 13.5%,should you accept it based solely on the internal rate of return rule? Why or why not?

A)Yes; because the IRR exceeds the required return
B)Yes; because the IRR is a positive rate of return
C)No; because the IRR is less than the required return
D)No; because the IRR is a negative rate of return
E)You can not apply the IRR rule in this case because there are multiple IRRs.

Question 75

An investment has the following cash flows.Should the project be accepted if it has been assigned a required return of 9.5%? Why or why not?

A)Yes; because the IRR exceeds the required return by about 0.39%
B)Yes; because the IRR is less than the required return by about 3.9%
C)Yes; because the IRR is positive
D)No; because the IRR exceeds the required return by about 3.9%
E)No; because the IRR is 9.89%

Question 76

You are considering a project with an initial cost of $4,400.What is the payback period for this project if the cash inflows are $550,$970,$2,800,and $500 a year over the next four years,respectively?

A)2.04 years
B)2.36 years
C)2.89 years
D)3.16 years
E)3.36 years

Question 77

You would like to invest in the following project. Victoria,your boss,insists that only projects that can return at least $1.10 in today's dollars for every $1 invested can be accepted.She also insists on applying a 10% discount rate to all cash flows.Based on these criteria,you should:

A)accept the project because it returns almost $1.22 for every $1 invested.
B)accept the project because it has a positive PI.
C)accept the project because the NPV is $2,851.
D)reject the project because the PI is 1.05.
E)reject the project because the IRR exceeds 10%.

Question 78

It will cost $2,600 to acquire a small ice cream cart.Cart sales are expected to be $1,400 a year for three years.After the three years,the cart is expected to be worthless as that is the expected remaining life of the cooling system.What is the payback period of the ice cream cart?

A).86 years
B)1.46 years
C)1.86 years
D)2.46 years
E)2.86 years

Question 79

The elements that cause problems with the use of the IRR in projects that are mutually exclusive are:

A)the discount rate and scale problems.
B)timing and scale problems.
C)the discount rate and timing problems.
D)scale and reversing flow problems.
E)timing and reversing flow problems.

Question 80

What is the net present value of a project with the following cash flows and a required return of 12%?

A)-$287.22
B)-$177.62
C)$177.62
D)$204.36
E)$287.22