Question 1

The ____ of an investment is the period of time for the ____ to equal the initial cash outlay.

Accepted Answer

A)   profitability index; present value of the cash inflows
B)   payback period; cumulative cash inflows
C)   payback period; present value of the cash inflows
D)   none of the above B

Question 2

Colex wishes to bid on a contract that is expected to yield after-tax net cash flows of $25,000 in year 1, $30,000 in year 2, and $35,000 per year in years 3 - 8. To obtain the contract, Colex will need to invest $110,0000 to reconfigure a packaging system, $20,000 (after-tax) to retrain current employees, and $15,000 (after-tax) on an environmental impact study that is required to be completed on acceptance of the contract. What is the project's internal rate of return?

Accepted Answer

A)   16.7%
B)   14.1%
C)   16.2%
D)   14.9% D

Question 3

Calculate the net present value for an investment project with the following cash flows using a 12 percent cost of capital:

Accepted Answer

A)   $56,560
B)   $30,000
C)   $13,840
D)   cannot be determined with information given C

Question 4

Which of the following investment decision rules (if any) assumes that the cash flows generated are reinvested over the life of the project at the firm's cost of capital?

Accepted Answer

A)   payback period
B)   internal rate of return
C)   accounting rate of return
D)   none of the above

Question 5

The "value additivity principle" means that the

Accepted Answer

A)   firm should accept all projects with a positive net present value.
B)   firm's value is the sum of the value of all the projects undertaken
C)   firm will grow through the addition of new projects
D)   positive net present value is added to the firm's net worth

Question 6

One weakness of the internal rate of return approach is that:

Accepted Answer

A)   it does not directly consider the timing of the cash flows from a project
B)   it fails to provide a straightforward decision-making criterion
C)   it implicitly assumes that the firm is able to reinvest the interim cash flows from a project at the firm's cost of capital.
D)   none of the above

Question 7

In the absence of capital rationing, the ____ method is normally superior to the ____ method when choosing among mutually exclusive investments.

Accepted Answer

A)   net present value, internal rate of return
B)   internal rate of return, profitability index
C)   net present value, profitability index
D)   a and c

Question 8

The profitability index (PI) approach:

Accepted Answer

A)   fails to directly consider the timing of a project's cash flows
B)   considers only a project's contributions to net income and does not consider cash flow effects
C)   always gives the same accept-reject decisions for independent projects as does NPV and IRR
D)   always gives the same accept-reject decisions for mutually exclusive projects as does NPV and IRR

Question 9

In the case of mutually exclusive projects, NPV and PI are likely to yield conflicting decisions when:

Accepted Answer

A)   the projects require the same net investment
B)   the projects are significantly different in size
C)   multiple rates of return are a possibility
D)   none of the above

Question 10

What is the internal rate of return for a project that has a net investment of $370,000 and net cash flows of $60,000 in year 1, $75,000 in year 2, and $85,000 in years 3 through 8?

Accepted Answer

A)   15.5%
B)   13.6%
C)   17.4%
D)   none of the above are correct

Question 11

Which of the following would increase the net present value of a project?

Accepted Answer

A)   increase in the net investment
B)   use of straight line depreciation rather than MACRS
C)   decrease in the expected accounts payable
D)   decrease in the discount rate

Question 12

Multiple internal rates of return can occur when there is (are):

Accepted Answer

A)   large abandonment costs at the end of a project's life
B)   a major shutdown and rebuilding of a facility sometime during its life
C)   more than one sign change in the pattern of cash flows over a project's life.
D)   all of the above are correct

Question 13

TexMex is considering replacing its tortilla machine with a new model that sells for $46,000 including the cost of installation. The old machine has been fully depreciated and has a $0 salvage value. The new machine will be depreciated as a 3-year MACRS asset. Revenues are expected to increase $18,000 per year over the 5 year life of the new machine. At the end of 5 years the new machine is expected to have no salvage value. What is the IRR for this project if TexMex has a required rate of return of 14% and a marginal tax rate of 40%. Operating costs are not expected to increase from the current level of $8,000 per year.

Accepted Answer

A)   21.0%
B)   14.0%
C)   19.3%
D)   5.7%

Question 14

Calculate the profitability index for a project that has a net present value equal to -$10,000. The project's net investment is $20,000, and the firm has a 40 percent marginal tax rate.

Accepted Answer

A)   -0.5
B)   0
C)   0.8
D)   None of the above

Question 15

An investment project requires a net investment of $100,000. The project is expected to generate annual net cash inflows of $28,000 for the next 5 years. The firm's cost of capital is 12 percent. Determine the internal rate of return for the project (to the nearest tenth of one percent).

Accepted Answer

A)   12.0%
B)   12.6%
C)   3.6%
D)   12.4%

Question 16

The ____ measures the present value return for each dollar of initial investment.

Accepted Answer

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

Question 17

The profitability index is the ratio of the ____ to the ____.

Accepted Answer

A)   net present value, net investment
B)   net investment, net present value
C)   present value of future net cash flows, net investment
D)   net investment, present value of future net cash flows

Question 18

The payback method is at best a crude measure of the risk of a project because it fails to consider the ____ of a project's returns.

Accepted Answer

A)   liquidity
B)   variability
C)   timing
D)   magnitude

Question 19

The internal rate of return method assumes that the cash flows over the life of the project are reinvested at:

Accepted Answer

A)   the risk-free rate
B)   the firm's cost of capital
C)   the computed internal rate of return
D)   the market capitalization rate

Question 20

The payback method has all of the following advantages EXCEPT:

Accepted Answer

A)   It considers the time value of money
B)   It determines a firm's financial exposure
C)   It is easy to calculate
D)   It determines if the project under consideration will be able to replace the start-up costs.

Exam 10: Capital Budgeting: Decision Criteria and Real Option Considerations

The of an investment is the period of time for the to equal the initial cash outlay.