Deck 10: Investing in Risk-Free Projects

Question 1

Which of the following is the appropriate IRR rule?

A)When there are multiple IRRs,select the one with the smallest IRR.
B)When there are multiple IRRs,select the one with the largest IRR.
C)In the absence of constraints,a project with a delayed cash flow stream should be adopted only if its IRR is less than the hurdle rate.
D)In the absence of constraints,a project with an early cash flow stream should be adopted only if the hurdle rate exceeds the IRR of the project.

Answer 1

D

Question 2

Which of the following is a characteristic of the payback period?

A)It ignores cash flows that occur after the project is paid off.
B)It accounts for the time value of money.
C)It is always consistent with the acceptance rule of the NPV method.
D)It cannot be applied to the projects with inconsistent cash flows.

Answer 2

A

Question 3

What is net present value?

Answer 3

The net present value (NPV)of an investment project is the difference between the project's present value (PV),the value of a portfolio of financial instruments that track the project's future cash flows,and the cost of implementing the project.Projects that create value are those,whose PVs exceed their costs,and thus represent situations where a future cash flow pattern can be produced more cheaply,internally,within the firm,than externally,by investing in financial assets.These are called positive NPV investments.Adopting a project at a cost less than the PV of its future cash flows,i.e positive NPV,means that financing the project by short-selling this tracking portfolio leaves surplus cash in the firm today.Since the future cash that needs to be paid out on the shorted tracking portfolio matches the cash flows coming in from the project,the firm that adopts the positive-NPV project creates wealth risklessly.In short,adopting a risk less project with a positive NPV and financing it in this manner is an arbitrage opportunity for the firm.The wealth-maximizing NPV criterion is that: (1)all projects with positive NPVs should be accepted (2)all projects with negative NPVs should be rejected.

Question 4

The per-period yield to maturity of a zero-coupon bond:

A)is the discount rate that makes the discounted value of its coupon payments equal to its current market price.
B)is the discount rate that makes the discounted value of its face amount equal to its par value.
C)is the discount rate that makes the discounted value of its coupon payments equal to its face value.
D)is the discount rate that makes the discounted value of its face amount equal to its current market price.

Question 5

Which of the following is true of project evaluations based on the NPV method?

A)It is flawed as it does not account for the time value of money.
B)For mutually exclusive projects,the project with the highest positive NPV should be accepted.
C)The market value of a project?s tracking portfolio should be more than the discounted value of all present and future cash flows of the accepted project.
D)It is flawed as it does consider working capital requirements.

Question 6

What is the profitability index? Explain the project acceptance criteria.

Question 7

A company plans to invest in a project and is considering four mutually exclusive projects.The NPV and IRR are given as follows.Based on the information,the company should accept _____.

A)Project A
B)Project B
C)Project C
D)Project D

Question 8

The initial investment of a project is £165,000.The annual cash flows for the four years are £48,000,£46,000,£56,000 and £68,000.Find the NPV of the project if the expected rate of return is 11%.

A)-£5,300
B)£5,300
C)£1,318
D)-£1,318

Question 9

Explain the internal rate of return method.

Question 10

The _____ method measures the arbitrage profits associated with an investment project,and recommends projects for which arbitrage profits are positive.

A)accounting rate of return
B)discounted payback method
C)payback period
D)net present value

Question 11

Which of the following is true of the economic value added?

A)It is the present value of a project?s future cash flows divided by the initial cost of the project.
B)It represents the additional value from next period cash flows per unit of cash invested in the initial period.
C)It accounts both the cost of debt and equity capital.
D)It is measured as the difference between a project?s present value and the cost of implementing the project.

Question 12

Which of the following projects will likely result in multiple IRRs?

A)Project A
B)Project B
C)Project C
D)Project D

Question 13

Which of the following is true of the IRR method?

A)IRR of a project is the rate of return which makes the net present value equal to zero.
B)When IRR and NPV methods give conflicting results in the selection of mutually exclusive projects,the project selection should be based on IRR.
C)When IRR gives multiple values,the IRR with the higher value should be accepte
D)If there is no cash outflow after the initial investment,IRR will take multiple values.

Question 14

Assume there are four mutually exclusive projects with a rate of return of 10%.Based on the following information,which of the following projects has the highest profitability index?

A)Project A
B)Project B
C)Project C
D)Project D

Question 15

What is economic value added?

Question 16

Which of the following is the correct algebraic expression of net profitability rate?

A)Net profitability rate = (1 + Risk-free rate)? (Profitability index)- 1
B)Net profitability rate = (1 - Risk-free rate)? (Profitability index)- 1
C)Net profitability rate = (1 + Risk-free rate)? (Profitability index)+ 1
D)Net profitability rate = (1 - Risk-free rate)? (Profitability index)+ 1

Question 17

Which of the following is true of sunk costs?

A)They are the costs incurred whether or not the project is adopted.
B)They are the costs of an alternative investment that must be forgone if invested in a particular investment.
C)They are the costs of carrying inventory.
D)They are the costs incurred to produce one additional unit of a product.

Question 18

Profitability index is the:

A)difference between a present value of the project?s future cash flows and the cost of implementing the project.
B)present value of a project?s future cash flows divided by the initial cost of the project.
C)ratio of initial cost of a project to the total cash inflows from the project.
D)accounting profit earned on a project divided by the amount invested to acquire the project?s assets.

Question 19

The appropriate hurdle rate for comparison with the IRR is:

A)that which makes the sum of the discounted future cash flows and initial investment of the project equal to the undiscounted value of the tracking portfolio of the future cash flows.
B)that which makes the sum of the undiscounted future cash flows and initial investment of the project equal to the selling price of the tracking portfolio of the future cash flows.
C)that which makes the sum of the discounted future cash flows and initial investment of the project equal to the selling price of the tracking portfolio of the future cash flows.
D)that which makes the sum of the discounted future cash flows of the project equal to the undiscounted value of the tracking portfolio of the future cash flows.