Deck 11: Investment Decision Criteria

Question 1

Errors in capital budgeting decisions

A)tend to average out over time.
B)decrease the firm's value.
C)are diminished because the time value of money makes future cash flows less important.
D)are easily reversed.

Answer 1

B

Question 2

Capital budgeting is the decision-making process with respect to investment in working capital.

Answer 2

False

Question 3

Good capital investment opportunities are most likely to exist when

A)many firms compete to sell similar products.
B)interest rates are high and rising.
C)goods and services can be produced cheaply using readily available tools and technologies.
D)a line of business is expensive to enter and uses proprietary technology.

Answer 3

D

Question 4

Which of the following factors is least important to capital budgeting decisions?

A)The time value of money
B)The risk-return tradeoff
C)Brand reputation
D)Cash flows directly resulting from the decision

Question 5

Fitchminster Armored Car can purchase a new vehicle for $200,000 that will provide annual net cash flow over the next five years of $40,000,$45,000,$50,000,$55,000,and $60,000.The salvage value of the vehicle will be $25,000.Assume that the vehicle is sold at the end of year 5.Calculate the NPV of the armored car if the required rate of return is 9%.(Round your answer to the nearest $1. )

A)$7,390
B)$6,048
C)$6,780
D)$19,483

Question 6

Which of the following would be considered a capital budgeting decision?

A)Woolworths purchases inventory for resale to customers.
B)Rio Tinto sells bonds and uses the proceeds to repurchase stock.
C)Hancock Prospecting obtains short-term loans to finance day-to-day operations.
D)Qantas purchases new aircraft to expand its routes.

Question 7

Distinguish between revenue enhancement investments,cost-reduction investments,and mandated investments.

Question 8

Some capital budgeting decisions may be mandated by government regulations.

Question 9

Central Mass Ambulance Service can purchase a new ambulance for $200,000 that will provide an annual net cash flow of $50,000 per year for five years.Calculate the NPV of the ambulance if the required rate of return is 9%.(Round your answer to the nearest $1. )

A)$50,000
B)$(5,061)
C)$(5,517)
D)$5,517

Question 10

Which of the following is a typical capital budgeting decision?

A)Purchase of office supplies
B)Granting credit to a new customer
C)Replacement of manufacturing equipment with more modern and efficient equipment
D)Financing the firm with more long-term debt and less equity

Question 11

Errors resulting from a capital budgeting decision are not considered major since the consequences of such errors average out over the life of the investment.

Question 12

Project Sigma requires an investment of $1 million and has a NPV of $10.Project Delta requires an investment of $500,000 and has a NPV of $150,000.The projects involve unrelated new product lines.

A)Both projects should be accepted because they have positive NPV's.
B)Neither project should be accepted because they might compete with one another.
C)Only project Delta should be accepted.Alpha's NPV is too low for the investment.
D)The company should look at other investment criteria,not just NPV.

Question 13

Competitive market forces make it imperative for a firm to have a systematic strategy for generating capital-budgeting projects.

Question 14

Why is it so difficult for firms to find good investment ideas?

Question 15

Why are capital budgeting decisions among the most important decisions made by any company? Give a few examples from recent business developments.

Question 16

ABC Service can purchase a new assembler for $15,052 that will provide an annual net cash flow of $6,000 per year for five years.Calculate the NPV of the assembler if the required rate of return is 12%.(Round your answer to the nearest $1. )

A)$1,056
B)$4,568
C)$7,621
D)$6,577

Question 17

Central Mass Ambulance Service can purchase a new ambulance for $200,000 that will provide an annual net cash flow of $50,000 per year for five years.The salvage value of the ambulance will be $25,000.Assume the ambulance is sold at the end of year 5.Calculate the NPV of the ambulance if the required rate of return is 9%.(Round your answer to the nearest $1. )

A)$(10,731)
B)$10,731
C)$(5,517)
D)$5,517

Question 18

Which of the following are typical consequences of good capital budgeting decisions?

A)The firm increases in value.
B)The firm gains knowledge and experience that may be useful in future decisions.
C)Good capital budgeting decisions help a company define its business.
D)All of the above.

Question 19

The size of capital investments and the difficulty in reversing them once they are made make capital-budgeting decisions very important to the firm.

Question 20

The primary objective of all capital budgeting decisions is to increase the size of the firm.

Question 21

Which of the following is a correct Excel formula to solve for the net present value of a project?

A)=NPV (k,CF1,CF2,...CFn)+CF0
B)=NPV (k,CF0,CF1,CF2,...CFn)
C)=NPV (CF0,CF1,CF2,...CFn)
D)=NPV (CF1,CF2,...CFn)+CF0

Question 22

Which of the following is a correct equation to solve for the NPV of the project that has an initial outlay of $30,000,followed by incremental cash inflows in the next 3 years of $15,000,$20,000,and $30,000? Assume a discount rate of 10%.

A)NPV = - $30,000 + $15,000(1.10)1 + $20,000(1.10)2 + $30,000(1.10)3
B)NPV = - $30,000 + $15,000/(1.10)1 + $20,000/(1.10)2 + $30,000/(1.10)3
C)NPV = - $30,000 + $15,000/(1.01).10 + $20,000/(1.02).10 + $30,000/(1.03).10
D)NPV = - $30,000 + $15,000/(1.1).10 + $20,000(1.2).10 + $30,000(1.3).10

Question 23

Project H requires an initial investment of $100,000 and the produces annual cash flows of $50,000,$40,000,and $30,000.Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000,$40,000,and $50,000.If the required rate of return is greater than 0% and the projects are mutually exclusive

A)H will always be preferable to T.
B)T will always be preferable to H.
C)H and T are equally attractive.
D)The project rankings will change with different discount rates.

Question 24

A machine has a cost of $5,575,000.It will produce cash inflows of $1,825,000 (Year 1);$1,775,000 (Year 2);$1,630,000 (Year 3);$1,585,000 (Year 4);and $1,650,000 (Year 5).At a discount rate of 16.25%,the project should be

A)accepted.
B)rejected.
C)discounted at a lower rate.
D)abandoned after the first year.

Question 25

You have been asked to analyse a capital investment proposal.The project's cost is $2,775,000.Cash inflows are projected to be $925,000 in Year 1;$1,000,000 in Year 2;$1,000,000 in Year 3;$1,000,000 in Year 4;and $1,225,000 in Year 5.Assume that your firm discounts capital projects at 15.5%.What is the project's NPV?

A)$101,247
B)$285,106
C)$473,904
D)$582,380

Question 26

A machine costs $1,000,has a three-year life,and has an estimated salvage value of $100.It will generate after-tax annual cash flows (ACF)of $600 a year,starting next year.If your required rate of return for the project is 10%,what is the NPV of this investment? (Round your answer to the nearest $10. )

A)$490
B)$570
C)$900
D)-$150

Question 27

Project EH! requires an initial investment of $50,000,and has a net present value of $12,000.Project BE requires an initial investment of $100,000,and has a net present value of $13,000.The projects are mutually exclusive.The firm should accept

A)project EH!.
B)project BE.
C)both projects.
D)neither project.

Question 28

Project Full Moon has an initial outlay of $30,000,followed by positive cash flows of $10,000 in year 1,$15,000 in year 2,and $15,000 in year 3.The project should be accepted if the required rate of return is

A)greater than 0.
B)less than 14.6%.
C)less than 16.25%.
D)greater than 12%.

Question 29

Which of the following is the correct equation to solve for the NPV of the project that has an initial outlay of $30,000,followed by three years of $20,000 in incremental cash inflow? Assume a discount rate of 10%.

A)NPV = -30,000 + (3 × 20,000)/(1.10)3
B)NPV = -$30,000 + $20,000/(1.10)1 + $20,000/(1.10)2 + $20,000/(1.10)3
C)NPV = -$30,000 + $20,000/(1.01).10 + $20,000/(1.02).10 + $20,000/(1.03).10
D)NPV = -$30,000 + $20,000/(1.1).10 + $20,000(1.2).10 + $20,000(1.3).10

Question 30

Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years.Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1,$40,000 in year 2,and $70,000 in year 3.If the discount rate is 10% and the projects are mutually exclusive

A)Project H should be chosen.
B)Project T should be chosen.
C)H and T are equally attractive.
D)Both projects should be chosen.

Question 31

Project Eh! requires an initial investment of $50,000,and has a net present value of $12,000.Project B requires an initial investment of $100,000,and has a net present value of $13,000.The projects are proposals for increasing revenue and are not mutually exclusive.The firm should accept

A)project Eh!.
B)project B.
C)both projects.
D)neither project.

Question 32

Warchester Inc.is considering the purchase of copying equipment that will require an initial investment of $15,000 and $4,000 per year in annual operating costs over the equipment's estimated useful life of 5 years.The company will use a discount rate of 8.5%.What is the equivalent annual cost?

A)$4,000
B)$7,000
C)$6,152.51
D)$7,806.49

Question 33

Artie's Soccer Ball Company is considering a project with the following cash flows: Initial outlay = $750,000
Incremental after-tax cash flows from operations Years 1-4 = $250,000 per year
Compute the NPV of this project if the company's discount rate is 12%.

A)$9,337
B)$7,758
C)$4,337
D)$2,534

Question 34

Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years.Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1,$40,000 in year 2,and $70,000 in year 3.If the discount rate increases from 10% to 16%

A)Project T should be chosen.
B)Both projects should be rejected.
C)H and T are equally attractive.
D)The project rankings will change.

Question 35

WSU Inc.has various options for replacing a piece of manufacturing equipment.The present value of costs for option Ell is $84,000.Option Ell has a useful life of 5 years;annual operating costs were discounted at 9%.What is the equivalent annual cost?

A)$16,800
B)$21,595.77
C)$14,035.77
D)$18,312

Question 36

Suppose you determine that the NPV of a project is $1,525,855.What does that mean?

A)In all cases,investing in this project would be better than investing in a project that has an NPV of $850,000.
B)The project would add value to the firm.
C)Under all conditions,the project's payback would be less than the profitability index.
D)Other investment criteria might need to be considered.

Question 37

The present value of the total costs over a five-year period for Project April is $50,000.The net present value of total costs over a 4-year period for Project October is $40,000.The company uses a discount rate of 9%.Which project should it choose and why?

A)April because it has a higher net present value (NPV).
B)April because it has a higher equivalent annual cost (EAC).
C)October because it has a shorter life.
D)October because it has a lower equivalent annual cost (EAC).

Question 38

A machine has a cost of $5,375,000.It will produce cash inflows of $1,825,000 (Year 1);$1,775,000 (Year 2);$1,630,000 (Year 3);$1,585,000 (Year 4);and $1,650,000 (Year 5).At a discount rate of 16.25%,what is the NPV?

A)$81,724
B)$257,106
C)$416,912
D)$190,939

Question 39

Project January has a NPV of $50,000,and project December has a NPV of $40,000.Which of the following circumstances could make it possible to choose December over January?

A)January has a shorter payback period.
B)The projects are mutually exclusive.
C)The projects have unequal lives.
D)The projects are mandated.

Question 40

Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years.Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1,$40,000 in year 2,and $70,000 in year 3.If the discount rate is 10% and the projects are not mutually exclusive

A)Project H should be chosen.
B)Project T should be chosen.
C)H and T are equally attractive.
D)Both projects should be accepted.

Question 41

If a project has a profitability index greater than 1

A)the NPV will also be positive.
B)the IRR will be higher than the required rate of return.
C)the present value of future cash flows will exceed the amount invested in the project.
D)all of the above.

Question 42

Dieyard Battery Recyclers is considering a project with the following cash flows:
Initial outlay = $13,000
Cash flows: Year 1 = $5,000
Year 2 = $3,000
Year 3 = $9,000
If the appropriate discount rate is 15%,compute the NPV of this project.

Question 43

Consider a project with the following cash flows: After-Tax After-Tax
Accounting Cash Flow
Year Profits from Operations
1 $799 $750
2 $150 $1,000
3 $200 $1,200
Initial outlay = $1,500
Terminal cash flow = 0
Compute the profitability index if the company's discount rate is 10%.

A)15.8
B)1.61
C)1.81
D)0.62

Question 44

Project Black Swan requires an initial investment of $115,000.It has positive cash flows of $140,000 for each of the next two years.Because of major demolition and environmental cleanup costs,cash flow for the third and final year of the project is $(170,000).

A)All possible IRR's for this project are negative.
B)It is not possible to compute an IRR for this project.
C)This project might have more than one IRR,but only one MIRR.
D)The project is unacceptable at any required rate of return.This project might have more than one IRR.

Question 45

Compute the payback period for a project with the following cash flows,if the company's discount rate is 12%. Initial outlay = $450
Cash flows: Year 1 = $325
Year 2 = $65
Year 3 = $100

A)3.43 years
B)3.17 years
C)2.88 years
D)2.6 years

Question 46

The higher the discount rate,the greater the importance of the early cash flows.

Question 47

What is the NPV of a $45,000 project that is expected to have an after-tax cash flow of $14,000 for the first two years,$10,000 for the next two years,and $8,000 for the fifth year? Use a 10% discount rate.Would you accept the project?

Question 48

Your company is considering a project with the following cash flows: Initial outlay = $1,748.80
Cash flows Years 1-6 = $500
Compute the IRR on the project.

A)9%
B)11%
C)18%
D)24%

Question 49

Two projects are under consideration by the same company at the same time.Project Alpha has a NPV of $20 million and an estimated useful life of 10 years.Project Beta has a NPV of $12 million and also an estimated useful life of 10 years.What should the company's decision be
a)if the project's involve unrelated expansion decisions or
b)if the project's are mutually exclusive because they would have to occupy the same space?

Question 50

Initial Outlay Cash Flow in Period 1 2 3 4
-$4,000 $1,546.17 $1,546.17 $1,546.17 $1,546.17
The IRR (to the nearest whole percent)is

A)10%.
B)18%.
C)20%.
D)16%.

Question 51

Webley Corp.is considering two expansion options,but does not have enough capital to undertake both.Project W requires an investment of $100,000 and has an NPV of $10,000.Project D requires an investment of $80,000 and has an NPV of $8,200.If Webley uses the profitability index to decide,it would

A)choose D because it has a higher profitability index.
B)choose W because it has a higher profitability index.
C)choose D because it has a lower profitability index.
D)choose W because it has a lower profitability index.

Question 52

Project Black Swan requires an initial investment of $115,000.It has positive cash flows of $140,000 for each of the next two years.Because of major demolition and environmental cleanup costs,cash flow for the third and final year of the project is $(170,000).If the company 's required rate of return is 12%,the project should be

A)rejected because the IRR is less than 12%.
B)accepted because the NPV is positive at 12%.
C)the project is unacceptable at any discount rate.
D)rejected because there may be more than one IRR.

Question 53

Project Black Swan requires an initial investment of $115,000.It has positive cash flows of $140,000 for each of the next two years.Because of major demolition and environmental cleanup costs,cash flow for the third and final year of the project is $(170,000).The company accepts all projects with a payback period of 2 years or less.

A)The payback rule would reject this project because of its risks are too high.
B)The payback rule would reject this project because all negative cash flows are added together.
C)If strictly applied,the payback rule would reject this project.
D)If strictly applied,the payback rule would accept this project.

Question 54

The required rate of return represents the cost of capital for a project.

Question 55

Project Black Swan requires an initial investment of $115,000.It has positive cash flows of $140,000 for each of the next two years.Because of major demolition and environmental cleanup costs,cash flow for the third and final year of the project is $(170,000).

A)All possible IRR's for this project are negative.
B)It is not possible to compute an IRR for this project.
C)The project is unacceptable at any required rate of return.
D)This project might have more than one IRR.

Question 56

Given the following annual net cash flows,determine the IRR to the nearest whole percent of a project with an initial outlay of $1,800. Year Net Cash Flow
1 $1,000
2 $750
3 $500

A)14%
B)12%
C)8%
D)25%

Question 57

A project has an initial outlay of $4,000.It has a single payoff at the end of Year 4 of $6,996.46.What is the IRR for the project (round to the nearest percent)?

A)16%
B)13%
C)21%
D)15%

Question 58

Manheim Candles is considering a project with the following incremental cash flows.Assume a discount rate of 10%. Year Cash Flow
0 ($20,000)
1 0
2 $30,000
3 $30,000
Calculate the project's MIRR.(Round to the nearest whole percentage. )

A)31%
B)47%
C)53%
D)61%

Question 59

The equivalent annual cost (EAC)method is appropriate for choosing between two different accessibility projects mandated by the Disability Discrimination Act that have unequal lives.

Question 60

The equivalent annual cost (EAC)method is helpful for mutually exclusive projects with unequal economic lives.

Question 61

MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000.The project will generate after-tax cash flows of $33,100 in Year 1,$31,500 in Year 2,and $31,200 in Year 3.Assume that the firm's proper rate of discount is 10% and that the firm's tax rate is 40%.What is the project's payback?

A)0.33 years
B)1.22 years
C)2.33 years
D)Three years

Question 62

Which of the following series of cash flows could have more than one IRR? (Negative cash flows are in parentheses. )

A)$(XX,XXX),$X,XXX ,$X,XXX,$X,XXX
B)$(XX,XXX),$X,XXX ,$X,XXX,$X,XXX,$(XX,XXX)
C)$X,XXX,$X,XXX ,$X,XXX,$X,XXX,$(XX,XXX)
D)$XX,XXX,$X,XXX ,$X,XXX,$X,XXX

Question 63

You have been asked to analyse a capital investment proposal.The project's cost is $2,775,000.Cash inflows are projected to be $925,000 in Year 1;$1,000,000 in Year 2;$1,000,000 in Year 3;$1,000,000 in Year 4;and $1,225,000 in Year 5.Assume that your firm discounts capital projects at 15.5%.What is the project's MIRR?

A)12.62%
B)10.44%
C)16.73%
D)19.99%

Question 64

Aroma Candles,Inc.is evaluating a project with the following cash flows.The project involves a new product that will not affect the sales of any other project.Which two methods would always lead to the same accept/reject decision for this project,regardless of the discount rate? Year Cash Flows
0 ($120,000)
1 $30,000
2 $70,000
3 $90,000

A)Payback and Discounted Payback
B)NPV and Payback
C)NPV and IRR
D)Discounted Payback and IRR

Question 65

Frazier Fudge has a project with an initial outlay of $40,000,followed by three years of annual incremental cash flows of $35,000.At the end of the third year,equipment will be sold producing additional cash flow of $10,000.Assuming a cost of capital of 10%,calculate the MIRR of the project.

A)46.5%
B)51.3%
C)62.9%
D)74.7%

Question 66

Frazier Fudge has a project with an initial outlay of $40,000,followed by three years of annual incremental cash flows of $35,000.At the end of the third year,equipment will be sold producing additional cash flow of $10,000.Assuming a discount rate of 10%,which of the following is the correct equation to solve for the IRR of the project?

A)$40,000 = $35,000(1.12)1 + $35,000(1.12)2 + $45,000(1.12)3
B)$40,000 = $35,000(1 + IRR)1 + $35,000(1 + IRR)2 + $45,000(1 + IRR)3
C)$40,000 = $35,000/(1.12)IRR + $35,000/(1.12)IRR + $45,000/(1.12)IRR
D)$40,000 = $35,000/(1 + IRR)+ $35,000/(1.IRR)+ $45,000/(1 + IRR)

Question 67

Which of the following is considered to be a deficiency of the IRR?

A)It fails to properly rank capital projects.
B)It could produce more than one rate of return.
C)It fails to utilize the time value of money.
D)It is not useful in accounting for risk in capital budgeting.

Question 68

The director of capital budgeting of South Park Development Corporation is evaluating a project that will cost $200,000;it is expected to last for 10 years and produce after-tax cash flows,including depreciation,of $44,503 per year.If the firm's cost of capital is 14% and its tax rate is 40%,what is the project's IRR?

A)8%
B)14%
C)18%
D)-5%

Question 69

MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000.The project will generate after-tax cash flows of $33,100 in Year 1,$31,500 in Year 2,and $31,200 in Year 3.Assume that the appropriate discount rate is 10% and that the firm's tax rate is 40%.What is the project's discounted payback period?

A)2.81 years
B)2.33 years
C)1.22 years
D)The project never reaches payback.

Question 70

Dizzyland Enterprises has been presented with an investment opportunity that will yield end-of-year cash flows of $30,000 per year in Years 1 through 4,$35,000 per year in Years 5 through 9,and $40,000 in Year 10.This investment will cost the firm $150,000 today,and the firm's cost of capital is 10%.What is the profitability index for this investment?

A)1.34
B)0.87
C)1.85
D)0.21

Question 71

Project Ell requires an initial investment of $50,000 and the produces annual cash flows of $30,000,$25,000,and $15,000.Project Ess requires an initial investment of $60,000 and then produces annual cash flows of $25,000 per year for the next ten years.The company ranks projects by their payback periods.

A)Projects with unequal lives cannot be ranked using the payback method.
B)Ess will be ranked higher than Ell.
C)Ell and Ess will be ranked equally.
D)Ell will be ranked higher than Ess.

Question 72

Analysis of a machine indicates that it has a cost of $5,375,000.The machine is expected to produce cash inflows of $1,825,000 in Year 1;$1,775,000 in Year 2;$1,630,000 in Year 3;$1,585,000 in Year 4;and $1,650,000 in Year 5.What is the machine's IRR?

A)12.16%
B)17.81%
C)23.00%
D)11.11%

Question 73

The owner of a small construction business has asked you to evaluate the purchase of a new front-end loader.You have determined that this investment has a large,positive NPV but are afraid that your client will not understand the method.A good alternative method in this circumstance might be

A)the payback method.
B)the profitability index.
C)the internal rate of return.
D)the modified internal rate of return.

Question 74

Project H requires an initial investment of $100,000 and produces annual cash flows of $50,000,$40,000,and $30,000.Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000,$40,000,and $50,000.The projects are mutually exclusive.The company accepts projects with payback periods of 3 years or less.

A)Project H will be accepted.
B)Project T will be accepted.
C)H and T will both be accepted.
D)Neither projected will be accepted.

Question 75

Whenever the IRR on a project equals that project's required rate of return

A)the NPV equals 0.
B)The NPV equals the initial investment.
C)The profitability index equals 0.
D)The NPV equals 1.

Question 76

What is the payback period for a $20,000 project that is expected to return $6,000 for the first two years and $3,000 for Years 3 through 5?

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

Question 77

We compute the profitability index of a capital budgeting proposal by

A)multiplying the IRR by the cost of capital.
B)dividing the present value of the annual after-tax cash flows by the cost of capital.
C)dividing the present value of the annual after-tax cash flows by the cost of the project.
D)multiplying the cash inflow by the IRR.

Question 78

A new forklift under consideration by Home Warehouse requires an initial investment of $100,000 and produces annual cash flows of $50,000,$40,000,and $30,000.Which of the following will not change if the required rate of return is increased from 10% to 12%.

A)The net present value.
B)The internal rate of return.
C)The profitability index.
D)The modified internal rate of return.

Question 79

Aroma Candles,Inc.is evaluating a project with the following cash flows.Calculate the IRR of the project.(Round to the nearest whole percentage. ) Year Cash Flows
0 ($120,000)
1 $30,000
2 $70,000
3 $90,000

A)18%
B)23%
C)28%
D)33%

Question 80

The Brisbane Corporation has been presented with an investment opportunity that will yield cash flows of $30,000 per year in Years 1 through 4,$35,000 per year in Years 5 through 9,and $40,000 in Year 10.This investment will cost the firm $100,000 today,and the firm's cost of capital is 10%.Assume cash flows occur evenly during the year.

A)5.23 years
B)4.26 years
C)4.35 years
D)3.72 years