Deck 6: The Application of Project Evaluation Methods

Question 1

What are sunk costs?

A)Costs associated with research and development.
B)Costs associated with exploration.
C)Costs that are past outlays that should not influence the decision to continue or terminate a project.
D)Costs associated with negative net present value projects.

Answer 1

Costs that are past outlays that should not influence the decision to continue or terminate a project.

Question 2

Which of the following statements presents the correct treatment of inflation in project evaluation?

A)Estimating cash flows based on constant prices and discounting them by the nominal cost of capital.
B)Estimating cash flows without adjustment for anticipated price changes and discounting them by the real cost of capital.
C)Estimating cash flows based on anticipated price changes and discounting them by the real cost of capital.
D)All of the given options.

Answer 2

Estimating cash flows without adjustment for anticipated price changes and discounting them by the real cost of capital.

Question 3

The constant chain of replacement assumption is used when:

A)comparing mutually exclusive projects.
B)comparing independent projects.
C)the life of a project cannot be ascertained with certainty.
D)comparing mutually exclusive projects with unequal economic lives.

Answer 3

comparing mutually exclusive projects with unequal economic lives.

Question 4

A method which states that each project is assumed to be replaced at the end of its economic life by an identical project is:

A)the chain of replacement assumption.
B)the equivalent annual value assumption.
C)the constant chain of replacement assumption.
D)none of the given options.

Question 5

If an investment costing $2000 is expected to generate real cash flows of $900 p.a.for three years,prices are expected to increase at a rate of 10% p.a. ,and the nominal cost of capital is 15%,what is the net present value of the investment?

A)$520.59
B)$740.79
C)$471.97
D)$389.79

Question 6

Assume that an investment of $1000 is expected to generate cash flows of $500 at constant prices at the end of each of three years.Also,assume that prices are expected to increase at the rate of 10% p.a.and that the nominal rate of return is 15% p.a.What is the project's NPV?

A)$337
B)$373
C)$377
D)None of the given options.

Question 7

Break-even analysis can be defined as:

A)analysis of the amount by which one input variable falls before a project ceases to be profitable.
B)analysis of the amounts by which one or more input variables may fall before a project ceases to be profitable.
C)analysis of the effect of changing all of the input variables whose values are uncertain to observe the effects on the results.
D)none of the given options.

Question 8

Which of the following should be omitted from projected cash flows?

A)Incremental cash flows.
B)Sunk costs.
C)Residual value.
D)Company taxation.

Question 9

Which of the following statements is the correct treatment of finance charges in project evaluation?

A)Finance charges should be included in a project's net cash flows and in the discount rate.
B)Finance charges should be included in a project's net cash flows and excluded from the discount rate.
C)Finance charges should be excluded from a project's net cash flows and included in the discount rate.
D)None of the given options.

Question 10

Equivalent annual value can be shown as:

A)
B)
C)
D)none of the given options.

Question 11

A project's residual value is the:

A)disposal value of the project's assets less any dismantling and removal costs associated with the project's termination.
B)disposal value of the project's assets less the initial outlay.
C)disposal value of the project's assets less the project's working capital.
D)disposal value of the project's assets.

Question 12

A method of evaluation which ranks projects of unequal lives by assuming that both 'chains' continue indefinitely is referred to as the:

A)constant chain of replacement.
B)lowest common multiple method.
C)constant chain of replacement in perpetuity method.
D)equivalent annual value method.

Question 13

The NPV of the infinite chain can be shown as:

A)
B)
C)
D)

Question 14

What is the incremental cash flow for a company that forgoes $7000 p.a.rental for factory space for manufacturing a product that will return net cash inflows of $20 000 p.a.?

A)$27 000
B)$20 000
C)$10 000
D)$13 000

Question 15

If an investment costing $2000 is expected to generate real cash flows of $900 p.a.for three years and prices are expected to increase at a rate of 10% p.a. ,what is the real required rate of return if the nominal cost of capital is 15%?

A)6%
B)5%
C)1.05%
D)4.55%

Question 16

Which analysis is a form of sensitivity analysis?

A)Break-even analysis.
B)Simulation analysis.
C)None of the given options.
D)Decision-tree analysis.

Question 17

Residual value is:

A)past outlay of a project that has no bearing on future costs or benefits.
B)the portion of initial capital outlay that will be recovered.
C)past outlay,which should not influence the decision between continuing and terminating a project.
D)cost associated with exploration.

Question 18

Which analysis involves assessing the effect of changes or errors in the estimated variables on the NPV of a project?

A)Simulation analysis.
B)Project analysis.
C)Sensitivity analysis.
D)Break-even analysis.

Question 19

A method which involves calculating the annual cash flow of an annuity that has the same life as the project and whose present value equals the NPV of the project is:

A)the chain of replacement method.
B)the equivalent annual value method.
C)the constant chain of replacement method.
D)none of the given options.

Question 20

Sunk costs can be defined as:

A)incremental costs.
B)opportunity costs.
C)cost that has already been incurred but is relevant to future decision making.
D)cost that has already been incurred and is irrelevant to future decision making.

Question 21

Using the constant chain of replacement in perpetuity method,calculate the net present value of a project with the following cash flows:
Assume the cost of capital is 10% p.a.

A)$38,159
B)$153,444
C)$381,596
D)$148,308

Question 22

Which of the following statements is false?

A)Simulation,unlike sensitivity analysis,allows the manager to determine the effects of changing all the uncertain variables.
B)Sensitivity analysis results can be difficult to interpret.
C)Decision-tree analysis evaluates a series of decisions.
D)External capital rationing refers to management'sinability to raise funds from the capital market to fund its projects.

Question 23

Equipment should be retired when:

A)it is in poor condition.
B)the net present value of future cash flows is negative.
C)the net present value of future cash flows is equal to or less than zero.
D)a better model becomes available.

Question 24

A company may not accept a new project with a positive net present value because of difficulties with hiring new staff and training them.Such limitation to investments is referred to as:

A)internal capital rationing.
B)capital rationing.
C)external capital rationing.
D)duration of resource constraints.

Question 25

The break-even point can be defined as:

A)that volume of sales whereby total revenues from a project are equal to total variable costs.
B)that volume of sales whereby total revenues from a project are equal to total variable costs plus total fixed and investment costs.
C)that volume of sales whereby the present value of revenues from a project are equal to the summation of present values of total variable and fixed costs and the initial outlay.
D)that volume of sales whereby the present value of revenues from a project are equal to the summation of present values of total variable costs.

Question 26

Given the following information,calculate how many years this project should be run before it is retired.Assume the cost of capital is 10% p.a.

A)Two years.
B)Three years.
C)Four years.
D)Five years.

Question 27

Given that a project with an estimated life of eight years has a net present value of $125 000,calculate its equivalent annual value if the required rate of return is 9% p.a.

A)$11 250 p.a.
B)$250 937 p.a.
C)$22 584 p.a.
D)$125 000 p.a.

Question 28

Luxury Fleet operates a fleet of limousines.It is currently considering replacing them with a new model.It plans to evaluate options based on the following information:
Which of the four following options should management choose?

A)Replace the old limousines now with the standard limousines and operate for seven years,replaced in perpetuity.
B)Replace the old limousines in three years' time with the standard limousines and operate for seven years,replaced in perpetuity.
C)Replace the old limousines in three years' time with the deluxe limousines and operate for nine years,replaced in perpetuity.
D)Replace the old limousines now with the deluxe limousines and operate for nine years,replaced in perpetuity.

Question 29

Given the data below,calculate the net present value using the equivalent annual value method.Assume the cost of capital is 10% p.a.

A)$14 831
B)$38 159
C)$15 344
D)$153 443

Question 30

Which of the following methods should be applied when comparing independent projects with different lives?

A)The constant chain of replacement method only.
B)Either the constant chain of replacement method or the equivalent annual value method only.
C)The constant chain of replacement method using the real cost of capital only.
D)The net present value method is adequate.

Question 31

Which of the following statements best describes the role of qualitative factors,such as company image,in the selection of projects?

A)They are ignored because they are subjective.
B)They are useful to decision-makers but management is unable to quantify them.
C)They must be quantified in some manner before they can be of some use.
D)They are only to be used when deciding between projects with identical net present values.

Question 32

Which of the following statements is false?

A)The rejection of positive net present value projects by management is inconsistent with the objective of maximising shareholder wealth even if the reason for rejection is due to internal capital rationing.
B)Management may select a project with a lower net present value because qualitative factors may render the other project less attractive.
C)The equivalent annual value of a project is equal to the net present value of a project held in perpetuity,divided by the required rate of return.
D)None of the given options

Question 33

Consider a machine that costs $20 000,has an estimated useful life of five years with cash flows of $10 000 p.a.and a cost of capital of 10% p.a.A company is considering whether the machine should be replaced every one,two,three,four or five years.The net present value (assuming constant chain of replacement)under each alternative is given as follows:
NPV(1)= $20 000
NPV(2)= $29 000
NPV(3)= $35 000
NPV(4)= $25 000
NPV(5)= $19 000
What is the appropriate action for the firm?

A)Go ahead with the project.
B)Do not go ahead with the project.
C)Go ahead with the project and replace the machine every five years.
D)Go ahead with the project and replace the machine every three years.

Question 34

A manager is considering investing in a new machine that costs $2.5 million.He identifies four uncertain variables: sales,fixed costs,advertising costs and the life of the new machine.The required rate of return is 15% p.a.Given the following information,determine which variable is most sensitive to changes or errors:

A)Sales.
B)Fixed costs.
C)Advertising costs.
D)Life of machine.

Question 35

Break-even analysis is used in situations when:

A)the decision-maker is a non-profit organisation.
B)the decision-maker is concerned with questions such as 'What will be the net present value if sales are 20% lower than expected?'
C)the project under consideration is an item that does not generate positive cash flows.
D)the decision-maker is concerned with questions such as 'How low can sales go before the project starts losing money?'

Question 36

A manager is considering whether to purchase a new company vehicle that costs $50 000.She identifies two uncertain variables: net cash flows and the life of the vehicle.Assuming that the required rate of return is 10% p.a. ,evaluate which of the two variables is less sensitive to changes or errors using the following information:

A)Net cash flows.
B)Life of vehicle.
C)Both are equally sensitive.
D)Not enough information.

Question 37

Which of the following statements best describes simulation analysis?

A)Simulation analysis involves changing one variable at a time.
B)Simulation analysis involves changing all relevant variables at the one time.
C)Simulation analysis requires examination of cash flows under alternate values for the cost of capital.
D)Simulation analysis involves determining the level of sales or output that determines the break-even point.

Question 38

Under the equivalent annual value method,the criterion for project acceptance is:

A)the project with the higher equivalent annual value is preferred.
B)the project with the lower equivalent annual value is preferred.
C)the project with the shorter life is preferred.
D)the project with the higher equivalent annual value is preferred,provided that both projects have the same cost of capital.

Question 39

Pineapple Ltd is considering replacing its current stock of computers with a new model.It plans to evaluate three options based on the following information:
Management is considering three options:
(i)Replace the old computers now and operate Model XA for four years,then replace with Model XD and operate for eight years,to be replaced in perpetuity;
(ii)Replace the old computers now and operate Model XXD for 12 years,to be replaced in perpetuity;
(iii)Replace the old computers now and undertake Model XA for three times its estimated life.
Which option should management choose?

A)Option (i).
B)Option (ii).
C)Option (iii).
D)Indifferent between options (i)and (ii).

Question 40

Red Brick Ltd is considering replacing its existing fleet of trucks with a fleet of new trucks.It plans to evaluate two options based on the following information:
Management is considering two options:
i.Option (i)Replace the old trucks now and operate the new trucks for five years,to be replaced in perpetuity;
ii.Option (ii)Replace the old trucks in five years' time and operate the new trucks for five years,to be replaced in perpetuity.
Which option should the management choose?

A)Option (i).
B)Option (ii).
C)Indifferent between the two options.
D)Not enough information.

Question 41

The inclusion of ______________ as cash flows in a net present value analysis would result in double counting.

Question 42

One of the limitations of decision-tree analysis is that it does not take into account the time value of money.

Question 43

Decision-tree analysis takes into account the ________ of alternative events occurring and the effects those events have on the expected net present value of a project.

Question 44

An investment of $1.5 million is expected to generate cash flows of $600 000 p.a. ,at constant prices,over the next three years.Given that the nominal required rate of return is 12% p.a.and that prices are expected to increase at the rate of 5% p.a. ,the project's net present value is:

A)($58 901)
B)$84 229
C)(187 031)
D)$13 154

Question 45

A major flaw of simulation analysis is that it fails to consider the possibility that risk may be removed through diversification.

Question 46

The constant chain of replacement method of project evaluation can compare mutually exclusive projects that have different ________.

Question 47

Which of the following statements is false?

A)The constant chain of replacement model assumes that the incumbent machines and their replacements are absolutely identical.
B)The different lives 'problem' in the constant chain of replacement model arises only for independent projects.
C)Retirement decisions involve evaluating when to abandon a project.
D)The constant chain of replacement assumption may be used to evaluate projects of unequal lives.

Question 48

An investment of $1.5 million is expected to generate cash flows of $625 000 p.a. ,at constant prices,over the next three years.The required rate of return,assuming zero inflation,is 17% p.a.If prices are expected to increase at the rate of 10% p.a. ,the project's net present value is:

A)($119 009)
B)$159 456
C)($343 856)
D)$19 090

Question 49

Which of the following statements in regard to simulation is false?

A)Simulation allows managers to evaluate many aspects of the risk associated with a project.
B)Simulation typically involves results from thousands of runs in the computer.
C)Specifying the simulation model takes a small amount of time as the computer selects specific values from the distribution of each of the variables.
D)None of the given options.

Question 50

Which of the following costs should be excluded from incremental cash flows?

A)The wage costs related to producing the new product.
B)The cost of establishing a new plant.
C)The consultant's fee for the feasibility study of the project.
D)The plant operating costs.

Question 51

Sensitivity analysis examines the effect of changing one or more ______________ to observe the effect on results.

Question 52

A limitation of the chain of replacement methods of project evaluation is the unrealistic assumption that replacement assets in a chain are identical.

Question 53

The term ________________ is used to describe a situation where the firm is prevented,through a shortage of funds,from undertaking all acceptable projects.

Question 54

Which of the following costs should not be included in the allocated costs of the project?

A)The wage costs related to producing the new product.
B)The cost of water and electricity connections in the new plant.
C)The portion of the cost of leasing the office space for the firm's human resources department.
D)The operating costs associated with the proposed new plant.

Question 55

The ___________________ method of project evaluation involves calculating the annual cash flow of an annuity that has the same life and present value as the project.

Question 56

The formula for the equivalent annual value method is:

Question 57

The net present value rule is a valid method for determining the retirement of assets.

Question 58

If a firm is faced with a need to make a sequence of decisions over time,it could use:

A)break-even analysis.
B)simulation analysis.
C)decision-tree analysis.
D)none of the given answers.

Question 59

Head office costs should be included in a net present value analysis.

Question 60

The equivalent annual value method of project evaluation cannot be used to compare projects with different lives.

Question 61

Mulch-it Ltd owns an asset that is 7 years old and has estimated the remaining physical life is no more than 4 years.The table provides the cash flows and residual value estimated for the asset.
The required rate of return is 9% p.a.When should the asset be retired?

Question 62

How would you go about conducting sensitivity analysis?

Question 63

How can we compare mutually exclusive projects with different timeframes?

Question 64

A company is to evaluate the following mutually exclusive investment proposals that involve the purchase of assets with different initial values and useful lives.The required rate of return is 10%.

A.Using the constant chain of replacement method which project should be chosen?
B.Using the equivalent annual value method which project should be chosen?