Deck 8: Investment Decision Rules

Question 1

You have an investment opportunity in Germany that requires an investment of $250,000 today and will produce a cash flow of €208,650 in one year with no risk.Suppose the risk-free rate of interest in Germany is 6% and the current competitive exchange rate is €0.78 to $1.00.What is the net present value (NPV)of this project? Would you take the project?

A) NPV = 0; No
B) NPV = 2358; No
C) NPV = 2358; Yes
D) NPV = 13,650; Yes
E) NPV = $36,225; Yes

Answer 1

NPV = 2358; Yes

Question 2

A furniture store offers no money down and no payment for one year.You decide to purchase a couch,which you will take home today,and pay the $2,000 purchase price one year from now.If interest rates are 4.5%,what is the NPV of this offer?

A) -$2000
B) $2000
C) $90
D) $0
E) $86.12

Answer 2

$86.12

Question 3

Use the information for the question(s) below.
An independent film maker is considering producing a new movie. The initial cost for making this movie will be $20 million today. Once the movie is completed, in one year, the movie will be sold to a major studio for $25 million. Rather than paying for the $20 million investment entirely using its own cash, the film maker is considering raising additional funds by issuing a security that will pay investors $11 million in one year. Suppose the risk-free rate of interest is 10%.
Refer to the information above.Without issuing the new security,the net present value (NPV)for this project is closest to what amount? Should the film maker make the investment?

A) $1.7 million; Yes
B) $1.7 million; No
C) $2.7 million; Yes
D) $2.7 million; No
E) $5.0 million; Yes.

Answer 3

$2.7 million; Yes

Question 4

What is the present value (PV)of an investment?

A) the amount that an investment would yield if the benefit were realized today
B) the difference between the cost of the investment and the benefit of the investment in dollars today
C) the amount you need to invest at the current interest rate to re-create the cash flow from the investment
D) the amount by which the cash flow of an investment exceeds or falls short of the cash flow generated by the same amount of money invested at market rate
E) the amount of profit the investment would return if all benefits were realized today

Question 5

Net present value (NPV)is the difference between the present value (PV)of the benefits and the present value (PV)of the costs of a project or investment.

Question 6

A furniture store offers no money down and no payment for two years.You decide to purchase a table,which you will take home today,and pay the $1,500 purchase price two years from now.If interest rates are 7%,what is the NPV of this offer?

A) -$1500
B) $189.84
C) $98.13
D) $0
E) $217.35

Question 7

A farmer sows a certain crop.It costs $250,000 to buy the seed,prepare the ground,and sow the crop.In one year's time it will cost $110,000 to harvest the crop.If the crop will be worth $380,000,and the interest rate is 8%,what is the net present value (NPV)of this investment?

A) -$21,000
B) -$220
C) $0
D) $23,100
E) $20,000

Question 8

Use the information for the question(s) below.
An independent film maker is considering producing a new movie. The initial cost for making this movie will be $20 million today. Once the movie is completed, in one year, the movie will be sold to a major studio for $25 million. Rather than paying for the $20 million investment entirely using its own cash, the film maker is considering raising additional funds by issuing a security that will pay investors $11 million in one year. Suppose the risk-free rate of interest is 10%.
Refer to the information above.Assuming that the film maker issues the new security,the net present value (NPV)for this project is closest to what amount? Should the film maker make the investment?

A) $1.7 million; Yes
B) $1.7 million; No
C) $2.7 million; Yes
D) $2.7 million; No
E) $5.0 million; Yes

Question 9

The cash flows for five investments have been identified as follows:
Based on the above information,and with an interest rate of 6%,which is the best investment?

A) Investment A
B) Investment B
C) Investment C
D) Investment D
E) Investment E

Question 10

You have an investment opportunity that will cost $50,000 today and will return $54,000 in one year.If interest rates are 4%,what is the NPV of this investment?

A) $1,923
B) $4,000
C) $2,000
D) $50,000
E) $0

Question 11

You have an investment opportunity that will cost $10,000 today and will return $10,500 in one year.If interest rates are 8%,what is the NPV of this investment?

A) $462.96
B) $500
C) -$277.78
D) -$462.96
E) $0

Question 12

You have an investment opportunity in Germany that requires an investment of $250,000 today and will produce a cash flow of €208,650 in one year with no risk.Suppose the risk-free rate of interest in Germany is 7% and the current competitive exchange rate is €0.78 to $1.00.What is the net present value (NPV)of this project? Would you take the project?

A) NPV = 0; No
B) NPV = $2358; No
C) NPV = $2358; Yes
D) NPV = $13,650; Yes
E) NPV = $36,225; Yes

Question 13

Which of the following formulas regarding net present value (NPV)is correct?

A) NPV + PV(benefits) = PV(Cost)
B) NPV - PV(costs) = PV(benefits)
C) NPV = PV(all project cash flows)
D) NPV = PV(benefits) + PV(costs)
E) NPV -PV(benefits) - PV(costs) = 0

Question 14

Martin is offered an investment where for $5000 today,he will receive $5250 in one year.He decides to borrow $5000 from the bank to make this investment.What is the maximum interest rate the bank needs to offer on the loan if Martin is at least to break even on this investment?

A) 3.2%
B) 4.8%
C) 5.0%
D) 5.6%
E) 2.5%

Question 15

Preference for cash today versus cash in the future in part determines net present value (NPV).

Question 16

A delivery service is buying 600 tires for its fleet of vehicles.One supplier offers to supply the tires for $85 per tire,payable in one year.Another supplier will supply the tires for $20,000 down today,then $50 per tire,payable in one year.What is the difference in PV between the first and the second offer,assuming interest rates are 8.5%?

A) $1000
B) $276
C) $645
D) -$1000
E) -$645

Question 17

A security firm is offered $80,000 in one year for providing CCTV coverage of a property.The cost of providing this coverage to the security firm is $74,000,payable now,and the interest rate is 8.5%.Should the firm take the contract?

A) Yes, since net present value (NPV) is positive.
B) It does not matter whether the contract is taken or not, since NPV = 0.
C) Yes, since net present value (NPV) is negative.
D) No, since net present value (NPV) is negative.
E) No, since net present value (NPV) is positive.

Question 18

A car dealership offers a car for $14,000,with up to one year to pay for the car.If the interest rate is 7%,what is the net present value (NPV)of this offer to buyers who elect not to pay for the car for one year?

A) $916
B) $1896
C) $13,084
D) $14,000
E) $980

Question 19

Most corporations measure the value of a project in terms of which of the following?

A) discount value
B) discount factor
C) future value (FV)
D) present value (PV)
E) market value

Question 20

Peter has a business opportunity that requires him to invest $10,000 today,and receive $12,000 in one year.He can either use $10,000 that he already has for this investment or borrow the money from his bank at an interest rate of 10%.However,the $10,000 he has right now is needed for urgent repairs to his home,repairs that will cost at least $15,000 if he delays them for a year.Should Peter undertake the investment?

A) No, since the net present value (NPV) of the investment, should he take it, is less than the net present value (NPV) of the home repairs if he delays them for one year.
B) Yes, since he can borrow the $10,000 from a bank, repair his home, invest $10,000 in the business opportunity, which, since it has a NPV > 0 will mean he will still come out ahead after repaying the loan.
C) Yes, since the net present value (NPV) of the investment is greater than zero he can invest the $10,000 in the business opportunity, and then next year use this money plus the benefit from this money to make the necessary home repairs.
D) Yes, since the net present value (NPV) of the investment, should he take it, is greater than the net present value (NPV) of the home repairs if he delays them for one year.
E) No, since the net present value (NPV) of both the investment and the repairs are the same.

Question 21

Use the information for the question(s) below.

A communications company installs cable to service a new area.They estimate the cost of installing the cable is $17 million,but they will receive a cash flow of $1.4 million per year indefinitely.The net present value (NPV)of this investment at a cost of capital of 6.5% indicates that this is a worthwhile investment.By how much would the cost of capital have to increase for the NPV to be zero?

A) 0.83%
B) 1.74%
C) 3.25%
D) 5.37%
E) 8.24%

Question 22

Use the table for the question(s) below.
Consider a project with the following cash flows:

If the appropriate discount rate for this project is 15%,then the net present value (NPV)is closest to:

A) $6000
B) -$867
C) $1420
D) $867
E) $3431

Question 23

Use the information for the question(s) below.

A manufacturer of video games develops a new game over two years.This costs $850,000 per year with one payment made immediately and the other at the end of two years.When the game is released,it is expected to make $1.2 million per year for three years after that.What is the net present value (NPV)of this decision if the cost of capital is 9%?

A) $991,220
B) $1,071,432
C) $1,564,559
D) $1,841,093
E) $1,234,870

Question 24

Use the information for the question(s) below.

The owner of a hair salon spends $1,000,000 to renovate its premises,estimating that this will increase her cash flow by $220,000 per year.She constructs the above graph,which shows the net present value (NPV)as a function of the discount rate.At what discount rate does her decision to renovate become untenable?

A) 3.0%
B) 3.3%
C) 4.0%
D) 4.8%
E) 5.0%

Question 25

A steel company wishes to replace the lighting in its warehouse with an energy efficient LED system.Installing the new lighting system will cost $1.5 million,but is expected to generate a cost savings of $140,000 per year for the next 25 years,when the new lights will need to be replaced.If the steel company has a cost of capital of 6%,what is the NPV of this investment?

A) $289,670
B) $2 million
C) -$1.5 million
D) $140,000
E) $1,789,670

Question 26

The owners of a chain of fast-food restaurants spend $28 million installing donut makers in all their restaurants.This is expected to increase cash flows by $10 million per year for the next five years.If the discount rate is 6.5%,were the owners correct in making the decision to install donut makers?

A) No, as it has a net present value (NPV) of -$2.25 million.
B) No, as it has a net present value (NPV) of-$1.68 million.
C) Yes, as it has a net present value (NPV) of $8.74 million.
D) Yes, as it has a net present value (NPV) of $13.56 million.
E) No, as it has a net present value (NPV) of-1.14 million.

Question 27

Use the information for the question(s) below.

A mining company will spend $28 million in order to exploit a low-grade placer deposit of gold ore.They estimate the deposit will produce profits of $6 million per year for six years.They calculate the net present value (NPV)using an estimated cost of capital of 6%.What is the maximum that the cost of capital can deviate from this estimate that still makes the decision to mine worthwhile?

A) 1.60%
B) 1.66%
C) 1.69%
D) 1.72%
E) 1.76%

Question 28

Use the information for the question(s) below.

The owner of a hair salon spends $1,000,000 to renovate its premises,estimating that this will increase her cash flow by $220,000 per year.She constructs the above graph,which shows the net present value (NPV)as a function of the discount rate.At what dollar value should the NPV profile cross the vertical axis?

A) $780,000
B) $1,000,000
C) $220,000
D) The vertical axis crossing point cannot be calculated since the cash inflows are a perpetuity.
E) Cannot be determined because inadequate information is given.

Question 29

How do you apply the Net Present Value rule when multiple projects are available and you have the added constraint of accepting only one project?

Question 30

Should personal preferences for cash today versus cash tomorrow play a role in the net present value (NPV)decision-making process?

Question 31

Use the table for the question(s) below.
Consider a project with the following cash flows:

Given the cash flows in the table above,the point at which the NPV profile crosses the vertical axis is:

A) $6000
B) -$867
C) 22.0%
D) 15.0%
E) $0

Question 32

You have an investment opportunity in the United Kingdom that requires an investment of $500,000 today and will produce a cash flow of £320,000 in one year with no risk.Suppose the risk-free rate of interest in the United Kingdom is 6% and the current competitive exchange rate is $1.70/£.What is the net present value (NPV)of this project? Would you take the project?

Question 33

The Net Present Value rule implies that we should compare a projects net present value (NPV)to zero.

Question 34

Use the information for the question(s) below.
An independent film maker is considering producing a new movie. The initial cost for making this movie will be $20 million today. Once the movie is completed, in one year, the movie will be sold to a major studio for $25 million. Rather than paying for the $20 million investment entirely using its own cash, the film maker is considering raising additional funds by issuing a security that will pay investors $11 million in one year. Suppose the risk-free rate of interest is 10%.
Refer to the information above.What is the net present value (NPV)of this project if the film maker does not issue the new security? What is the net present value (NPV)if the film maker issues the new security?

A) $1.7 million; $1.7 million
B) $1.7 million; $2.7 million
C) $2.7 million; $1.7 million
D) $2.7 million; $2.7 million
E) $5.0 million; $5.0 million

Question 35

A brewery is considering adding a new line of craft beers to its product mix.The new beer will require additional brewing and bottling capacity at a cost of $15 million,but is expected to generate new sales of $5 million per year for the next 5 years.If the brewery has a cost of capital of 6%,what is the NPV of this investment?

A) $6.1 million
B) $10 million
C) -$15 million
D) $8.6 million
E) $3.7 million

Question 36

What is the Net Present Value rule?

Question 37

You wish to buy a new lawnmower and you are deciding between a gas powered lawn mower and an electric mower.The electric mower costs $275 more than the gas mower,but you estimate that it will save you $40 per year by using cheaper electricity relative to gasoline.If the expected lifetime of both mowers is 30 years,and the cost of capital of 5%,what is the NPV of getting an electric mower instead of a gas mower?

A) $40
B) $340
C) -$235
D) -$275
E) $925

Question 38

Use the information for the question(s) below.

The owner of a hair salon spends $1,000,000 to renovate its premises,estimating that this will increase her cash flow by $220,000 per year.She constructs the above graph,which shows the net present value (NPV)as a function of the discount rate.If her discount rate is 6%,should she accept the project?

A) Yes, because the NPV is positive at that rate.
B) No, because the NPV is negative at that rate.
C) No, because the NPV is positive at that rate.
D) Yes, because the NPV is negative at that rate.
E) Cannot be determined from the information given.

Question 39

A restaurant is contemplating replacing its service staff with an electronic ordering process.Installing computers at each table will cost $150,000,but is expected to generate a cost savings of $40,000 per year for the next 10 years,when the computers will need to be replaced.If the restaurant has a cost of capital of 10%,what is the NPV of this investment?

A) -$90,000
B) $250,000
C) $95,783
D) -$150,000
E) $213,636

Question 40

Use the information for the question(s) below.

A manufacturer of video games develops a new game over two years.This costs $850,000 per year with one payment made immediately and the other at the end of two years.When the game is released,it is expected to make $1.2 million per year for three years after that.The net present value (NPV)of this investment at a cost of capital of 9% indicates that this is a worthwhile investment.By how much would the cost of capital have to increase for the NPV to be zero?

A) 7%
B) 9%
C) 12%
D) 16%
E) 19%

Question 41

A convenience store owner is contemplating putting a large neon sign over his store.It would cost $50,000,but is expected to bring an additional $24,000 of profit to the store every year for five years.Would this project be worthwhile if evaluated using a payback period of two years or less and if the cost of capital is 10%?

A) Yes, since it will pay back its initial investment in two years.
B) Yes, since the value of the cash flows into the store, in present dollars, are greater than the initial investment.
C) Yes, since the cash flows after two years are greater than the initial investment.
D) No, since the value of the cash flows over the first two years are less than the initial investment.
E) Yes, since the NPV is positive.

Question 42

The payback rule is based on the idea that an opportunity that pays back its initial investment quickly is a worthwhile opportunity.

Question 43

A florist is buying a number of motorcycles to expand its delivery service.These will cost $87,000,but are expected to increase profits by $3000 per month over the next four years.What is the payback period in this case?

A) 12 months
B) 18 months
C) 24 months
D) 29 months
E) 36 months

Question 44

A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years.The winner calculates the internal rate of return (IRR)of taking the money at the end of each year and,estimating that the discount rate across this period will be 6%,decides to take the money at the end of each year.Was her decision correct?

A) Yes, because it agrees with the Net Present Value rule.
B) Yes, because it agrees with the payback rule.
C) Yes, because it agrees with both the Net Present Value rule and the payback rule.
D) No, because it disagrees with the Net Present Value rule.
E) No, because it disagrees with the payback rule.

Question 45

Use the table for the question(s) below.
Consider the following two projects:

How can you calculate the y-intercept of a net present value (NPV)profile without using TVM concepts?

Question 46

Use the information for the question(s) below.

If WiseGuy Inc.uses the IRR rule to choose projects,which of the projects will rank highest?

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

Question 47

You are considering an investment opportunity that will cost you $20,000 up front,but return $5,000 per year for the next 10 years.What is the IRR for this investment?

A) 21.4%
B) 250%
C) 20%
D) 25%
E) 22.5%

Question 48

Use the information for the question(s) below.

If WiseGuy Inc.uses the payback period rule to choose projects,which of the projects will rank highest?

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

Question 49

You are considering an investment opportunity that will cost you $15,000 up front,and return $5,000 per year for 10 years,with the first payment 5 years from today.What is the IRR for this investment?

A) 13.4%
B) 12.3%
C) 12.8%
D) 14.4%
E) 15%

Question 50

Use the information for the question(s) below.

If WiseGuy Inc.uses the NPV rule with a cost of capital of 8% to choose projects,which of the projects will rank highest?

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

Question 51

Use the table for the question(s) below.
Consider the following two projects:

The net present value (NPV)of project B is closest to:

A) 12.6
B) 23.3
C) 12.0
D) 15.0
E) 14.2

Question 52

According to Graham and Harvey's 2001 survey (Figure 7.2 in the text),the most popular decision rules for capital budgeting used by CFOs are

A) NPV, Profitability index, payback period.
B) Profitability index, IRR, Payback period.
C) IRR, NPV, Payback period.
D) Profitability index, NPV, IRR.
E) NPV, IRR, discounted payback period.

Question 53

The internal rate of return (IRR)rule will agree with the Net Present Value rule even when positive cash flows precede negative cash flows.

Question 54

Use the table for the question(s) below.
Consider the following two projects:

The net present value (NPV)of project A is closest to:

A) 12.0
B) 12.6
C) 15.0
D) 42.9
E) 14.2

Question 55

You are considering an investment opportunity that will cost you $8,000 up front,but return a single cash flow of $18,000 6 years from now.What is the IRR for this investment?

A) 125%
B) 12.3%
C) 14.5%
D) 37.5%
E) 15%

Question 56

Use the table for the question(s) below.
Consider the following two projects:

The net present value (NPV)for project alpha is closest to:

A) $20.96
B) $16.92
C) $24.01
D) $14.41
E) $12.06

Question 57

You are considering an investment opportunity that will cost you $50,000 up front,and return two payments of $30,000,with the first payment 4 years from today.What is the IRR for this investment?

A) 3.4%
B) 4.1%
C) 7.6%
D) 20%
E) 15%

Question 58

Investment A:
Investment B:

Investment C:

Investment D:

Investment E:

The cash flows for three projects are shown above.The cost of capital is 7.5%.If an investor decided to take projects with a payback period two years or less,which of these projects would he take?

A) Investment A
B) Investment B
C) Investment C
D) Investment D
E) Investment E

Question 59

Use the information for the question(s) below.
The Sisyphean Company is planning on investing in a new project.This will involve the purchase of some new machinery costing $450,000. The Sisyphean Company expects cash inflows from this project as detailed below:

The appropriate discount rate for this project is 16%.
The net present value (NPV)for this project is closest to:

A) $176,270
B) $123,420
C) $450,000
D) $179,590
E) $497,062

Question 60

Use the table for the question(s) below.
Consider the following two projects:

The net present value (NPV)for project beta is closest to:

A) $24.01
B) $16.92
C) $20.96
D) $14.41
E) $12.06

Question 61

Under what situation can the net present value (NPV)profile be upward sloping?

Question 62

Use the table for the question(s) below.
Consider a project with the following cash flows:

Assume the appropriate discount rate for this project is 15%.The payback period for this project is closest to:

A) 3
B) 2.5
C) 2
D) 4
E) 1

Question 63

A local government awards a landscaping company a contract worth $1.2 million per year for five years for maintaining public parks.The landscaping company will need to buy some new machinery before they can take on the contract.If the cost of capital is 7%,what is the most that this equipment could cost if the contract is to be worthwhile for the landscaping company?

A) $4.55 million
B) $4.61 million
C) $4.92 million
D) $5.26 million
E) $6.00 million

Question 64

What can you comment about the shape of the net present value (NPV)profile of a multiple IRR project?

Question 65

What is the decision criteria using the Net Present Value rule?

Question 66

Use the table for the question(s) below.
Consider the following two projects:

The payback period for project B is closest to:

A) 2.5 years
B) 2.0 years
C) 2.2 years
D) 2.4 years
E) 3.0 years

Question 67

Internal rate of return (IRR)can reliably be used to choose between mutually exclusive projects.

Question 68

Mary is in contract negotiations with a publishing house for her new novel.She has two options.She may be paid $100,000 up front,and receive royalties that are expected to total $26,000 at the end of each of the next five years.Alternatively,she can receive $200,000 up front and no royalties.Which of the following investment rules would indicate that she should take the former deal,given a discount rate of 8%? Rule I: The Net Present Value rule
Rule II: The Payback Rule with a payback period of two years
Rule III: The internal rate of return (IRR)Rule

A) Rule I only
B) Rule III only
C) Rules II and III
D) Rules I and II
E) Rules I and III

Question 69

A mining company plans to mine a beach for rutile.To do so will cost $10 million up front and then produce cash flows of $3 million per year for five years.At the end of the sixth year the company will incur shut-down and clean-up costs of $2 million.If the cost of capital is 11%,then what is the NPV for this project?

A) -$99,212
B) $12,304
C) $18,409
D) $82,416
E) $111,389

Question 70

When comparing mutually exclusive projects which have different scales,you must know the dollar impact of each investment rather than percentage returns.

Question 71

What is the decision criteria using internal rate of return (IRR)rule?

Question 72

An investor is considering a project that will generate $800,000 per year for four years.In addition to upfront costs,at the completion of the project at the end of the fifth year there will be shut-down costs of $500,000.If the cost of capital is 5%,based on the NPV,at what upfront costs does this project cease to be worthwhile?

A) $2.32 million
B) $2.44 million
C) $2.58 million
D) $2.84 million
E) $2.96 million

Question 73

The cash flows for four projects are shown below,along with the cost of capital for these projects.If these projects are mutually exclusive,which one should be taken?

A)
Cost of Capital: 8%
B)
Cost of Capital: 7%
C)
Cost of Capital: 7.5%
D)
Cost of Capital: 5%
E)
Cost of Capital: 12%

Question 74

Use the table for the question(s) below.
Consider the following two projects:

The payback period for project A is closest to:

A) 2.0 years
B) 2.4 years
C) 2.5 years
D) 2.2 years
E) 3.0 years

Question 75

What is the general shape of the net present value (NPV)profile?

Question 76

What is the decision criteria while using the payback rule?

Question 77

If WiseGuy Inc is choosing one of the above mutually exclusive projects (Project A or Project B),given a discount rate of 8%,which should the company choose?

A) Project A
B) Project B
C) Neither project, - both have a NPV of 0.
D) Both projects - both have positive NPV.
E) Neither project - both have negative NPV.

Question 78

Use the table for the question(s) below.
Consider a project with the following cash flows:

What is the IRR for this project?

A) 4.59%
B) 8.63%
C) 15.91%
D) 21.86%
E) 44.63%

Question 79

Use the information for the question(s) below.
The Sisyphean Company is planning on investing in a new project.This will involve the purchase of some new machinery costing $450,000. The Sisyphean Company expects cash inflows from this project as detailed below:

The appropriate discount rate for this project is 16%.
The internal rate of return (IRR)for this project is closest to:

A) 18.9%
B) 22.7%
C) 34.1%
D) 39.1%
E) 42.3%

Question 80

When different investment rules give conflicting answers,then decisions should be based on the Net Present Value rule,as it is the most reliable and accurate decision rule.