Deck 5: Net Present Value and Other Investment Criteria

Question 1

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.

Answer 1

P/E ratio.

Question 2

The payback period rule

A)varies the cut-off point with the interest rate.
B)determines a cut-off point so that all projects accepted by the NPV rule will be accepted by the payback period rule.
C)requires an arbitrary choice of a cut-off point.
D)varies the cut-off point with the interest rate and requires an arbitrary choice of a cut-off point.

Answer 2

requires an arbitrary choice of a cut-off point.

Question 3

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

A)Net present value
B)Internal rate of return
C)The payback period
D)Profitability index

Answer 3

The payback period

Question 4

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 projects is

A)+$100.
B)+$60.
C)+$160.
D)+$6,000.

Question 5

The main advantage of the payback rule is that it

A)adjusts for uncertainty of early cash flows.
B)is simple to use.
C)does not discount cash flows.
D)better accounts for salvage costs at the end of a project.

Question 6

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

A)12 percent of firms.
B)20 percent of firms.
C)57 percent of firms.
D)75 percent of firms.

Question 7

If the cash flows for project A are C₀ = -1,000; C₁ = +600; C₂ = +400; and C₃ = +1,500, calculate the payback period.

A)One year
B)Two years
C)Three years
D)Cannot be determined

Question 8

You are given a job to make a decision on project X, which is composed of three independent projects A, B, and C that 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 project X as it has a positive NPV.
B)Reject project X.
C)Break up the project into its components: Accept A and C, but reject B.
D)Break up the project into its components: Accept C.

Question 9

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

A)12 percent of firms.
B)20 percent of firms.
C)75 percent of firms.
D)57 percent of firms.

Question 10

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)positive.
D)an integer.

Question 11

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

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

Question 12

The cost of a new machine is $250,000.The machine has a five-year life and no salvage value.If the cash flow each year is equal to 25 percent of the cost of the machine, calculate the payback period for the project.

A)2.0 years
B)2.5 years
C)3.0 years
D)4.0 years

Question 13

If the cash flows for project Z are C₀ = -1,000; C₁ = 600; C₂ = 720; and C₃ = 2,000, calculate the discounted payback period for the project at a discount rate of 20 percent.

A)1 year
B)2 years
C)3 years
D)>3 years

Question 14

If the NPV of project A is + $120, 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

Question 15

Which of the following investment rules has the value additivity property?

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

Question 16

Suppose a firm has $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)do all of the options.

Question 17

The following are disadvantages of using the payback rule except the rule

A)ignores all cash flow after the cut-off date.
B)does not use the time value of money.
C)is easy to calculate and use.
D)does not have the value additivity property.

Question 18

If the NPV of project A is + $30 and that of project B is -$60, then the NPV of the combined projects is

A)+$30.
B)-$60.
C)-$30.
D)-$1,800.

Question 19

The net present value of a project depends upon the

A)company's choice of accounting method.
B)manager's tastes and preferences.
C)project's cash flows and opportunity cost of capital.
D)company's profitability index.

Question 20

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

A)NPV
B)Payback period
C)IRR
D)Profitability index

Question 21

The IRR is defined as

A)the discount rate that makes a project's 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 22

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

A)one IRR.
B)two IRRs.
C)three IRRs.
D)four IRRs.

Question 23

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.However, at the end of the fourth year, the project will generate -$500,000 of after-tax cash flow due to dismantling costs.Calculate the MIRR (modified internal rate of return) for the project if the cost of capital is 15 percent.

A)8.1 percent
B)12.6 percent
C)28.2 percent
D)20.4 percent

Question 24

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 percent.

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

Question 25

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 percent
B)18.6 percent
C)20.2 percent
D)23.4 percent

Question 26

Project X has the following cash flows: C₀ = +2,000, C₁ = -1,150, and C₂ = -1,150.If the IRR of the project is 9.85 percent and if the cost of capital is 12.00 percent, you would

A)accept the project.
B)reject the project.

Question 27

If the cash flows for Project M are C₀ = -1,000; C₁ = +200; C₂ = +700; and C₃ = +698, calculate the IRR for the project.

A)23 percent
B)21 percent
C)19 percent
D)17 percent

Question 28

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 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 29

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

A)discounted payback period method.
B)discounted cash flow (DCF) rate of return method.
C)modified internal rate of return (MIRR) method.
D)book rate of return method.

Question 30

Project X has the following cash flows: C₀ = +2,000, C₁ = -1,300, and C₂ = -1,500.If the IRR of the project is 25 percent and if the cost of capital is 18 percent, you would

A)accept the project.
B)reject the project.

Question 31

One can use the profitability index most usefully for which situation?

A)When capital rationing exists
B)Evaluation of exceptionally long-term projects
C)Evaluation of nonnormal projects
D)When a project has unusually high cash flow uncertainty

Question 32

If the cash flows for project A are C₀ = -3,000, C₁ = +500; C₂ = +1,500; and C₃ = +5,000, calculate the NPV of the project using a 15 percent discount rate.

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

Question 33

Mass Company is investing in a giant crane.It is expected to cost $6 million in initial investment, and it is expected to generate an end-of-year cash flow of $3 million each year for three years.At the end of the fourth year, there will be a $1 million disposal cost.Calculate the MIRR for the project if the cost of capital is 12 percent.

A)17.8 percent
B)15.3 percent
C)23.8 percent
D)22.1 percent

Question 34

Which of the following methods of evaluating capital investment projects incorporates the time value of money concept?

A)Payback period, discounted payback period, and net present value (NPV) only
B)Discounted payback period, net present value (NPV),and internal rate of return only
C)Net present value (NPV) and internal rate of return only
D)Payback period, discounted payback period, net present value (NPV), and internal rate of return

Question 35

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

A)positive.
B)negative.
C)zero.
D)unable to be determined.

Question 36

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

A)25 percent and 400 percent.
B)125 percent and 500 percent.
C)-44 percent and 11.6 percent.
D)No IRRs exist for this project.

Question 37

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.

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

Question 38

Story Company is investing in a giant crane.It is expected to cost $6 million in initial investment, and it is expected to generate an end-of-year after-tax cash flow of $3 million each year for three years.Calculate the NPV at 12 percent.

A)$2.40 million
B)$1.20 million
C)$0.80 million
D)$0.20 million

Question 39

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 40

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)doubling the opportunity cost of capital.

Question 41

The benefit-cost ratio is defined as the ratio of

A)net present value cash flows to initial investment.
B)present value of cash flows to initial investment.
C)net present value of cash flows to IRR.
D)present value of cash flows to IRR.

Question 42

Which investment analysis technique is used the least by CFOs?

A)Net present value
B)Internal rate of return
C)Payback
D)Book rate of return

Question 43

Decommissioning and clean-up costs for any project are always insignificant and should typically be ignored.

Question 44

The following table gives the available projects (in $millions) for a firm. $\begin{array} { r r r r r r r l } \underline { \mathrm { A } } & \underline { \mathrm { B } } & \underline { \mathrm { C } } & \underline { \mathrm { D } } & \underline { \mathrm { E } } & \underline { \mathrm { F } } & \underline { \mathrm { G } } & \\90 & 20 & 60 & 50 & 150 & 40 & 20 & \text { Initial investment } \\140 & 70 & 65 & - 10 & 30 & 32 & 10 & \mathrm { NPV }\end{array}$
If the firm has a limit of $210 million to invest, what is the maximum NPV the company can obtain?

A)200
B)283
C)307
D)347

Question 45

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

Question 46

Soft rationing may be used to control managerial behavior.

Question 47

The profitability index is the ratio of the

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 48

The following table gives the available projects (in $millions) for a firm. $\begin{array}{rrrrrrll}\underline { \mathrm { A }} & \underline { \mathrm { B } } & \underline { \mathrm { C } } & \underline { \mathrm { D } } & \underline { \mathrm { E } } & \underline { \mathrm { F } } & \underline { \mathrm { G } } & \\5.0 & 4.0 & 5.0 & 1.0 & 2.0 & 7.0 & 8.0 & \text { Initial investment } \\1.5 & -0.5 & 1.0 & 0.5 & 0.5 & 1.0 & 1.0 & \mathrm{NPV}\end{array}$ The firm has only $20 million to invest.What is the maximum NPV that the company can obtain?

A)3.5
B)4.0
C)4.5
D)5.0

Question 49

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

Question 50

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

Question 51

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

Question 52

The profitability index of a positive NPV project is always positive.

Question 53

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

Question 54

How does modified internal rate of return (MIRR) differ from IRR?

A)MIRR does not consider cash flows occurring after the cut-off date.
B)MIRR uses NPV, IRR does not.
C)MIRR calculates the PV of cash inflows and then divides by the PV of the investment.
D)MIRR reduces the number of sign changes in a cash flow sequence.

Question 55

The profitability index is always less than 1.

Question 56

The payback rule ignores all cash flows after the cut-off date.

Question 57

Present values have the value additivity property.

Question 58

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

Question 59

There can never be more than one value of the IRR for any sequence of cash flows.

Question 60

What is the profitability index of an investment with cash flows in years 0 thru 4 of -340, 120, 130, 153, and 166, respectively, and a discount rate of 16 percent?

A).15
B).22
C).35
D).42

Question 61

Briefly explain the term hard rationing.

Question 62

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

Question 63

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

Question 64

Discuss some of the advantages of using the payback method.

Question 65

The denominator of the profitability index is the present value of the investment.

Question 66

Briefly explain the value additivity property.

Question 67

Discuss some of the disadvantages of the payback rule.

Question 68

Briefly explain the term soft rationing.

Question 69

A project's internal rate of return depends on its level of risk.

Question 70

A project's "book value" represents, essentially, the market valuation of the project.

Question 71

Accounting earnings from a firm's income statement, prepared according to generally accepted accounting principles (GAAP), are typically the best data source for calculating a project's NPV.

Question 72

The discounted payback method will never accept a negative-NPV project.

Question 73

The discounted payback method discounts cash flows at the opportunity cost of capital and then calculates the payback period.

Question 74

Briefly discuss capital rationing.