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Questions in Chapter 9 Concept - QZ
Questions in Chapter 9 Concept - QZ
qz
1) _____ quantifies in dollar terms how stockholder wealth will be affected by undertaking a
project under consideration.
[A] :This measures a project in terms of time, not in dollar terms. Review section 9.3.
[B] :This measures a project as a ratio of net income to book value, not in dollar terms. Review
section 9.4.
[C] :This measures a project as a rate of return, not in dollar terms. Review section 9.5.
[D] :You are correct!
[E] :This measures a project as a benefit-to-cost ratio, not in dollar terms. Review section 9.6.
2) A project has a required return of 15 percent, conventional cash flows and a five-year life. Of
the following values that have been computed, which value is inconsistent with the other four?
[A] :Since the discounted payback is exactly five years, what is the NPV? Review section 9.3.
[B] :You are correct! The PI needs to equal 1 to be consistent with the other four.
[C] :Since choices C and E say the same thing, neither one is the correct answer. Also, if the
NPV is $0, this would be consistent with the IRR being equal to the required return, so D can't be
correct. That only leaves two choices. Which one is not consistent with C, D, and E? Review
sections 9.3 and 9.6.
[D] :Since choices C and E say the same thing, neither one is the correct choice. Also, if the NPV
is $0, this would be consistent with the IRR being equal to the required return, so D can't be
correct. That only leaves two choices. Which one is not consistent with C, D, and E? Review
sections 9.3 and 9.6.
[E] :Since choices C and E say the same thing, neither one is the correct choice. Also, if the NPV
is $0, this would be consistent with the IRR being equal to the required return, so D can't be
correct. That only leaves two choices. Which one is not consistent with C, D, and E? Review
sections 9.3 and 9.6.
3) A disadvantage of the payback rule and the average accounting return is that both ignore the
time value of money.
[A] True
[B] False
[A] :How do you compute the discounted cash flows? Review section 9.3.
[B] :How do you compute the present value of the cash inflows? Review section 9.6.
[C] :How do you compute net present value? Review section 9.1.
[D] :How do you compute the internal rate of return? Review section 9.5.
[E] :You are correct!
5) A project costs $475 and has cash flows of $100 for the first three years and $75 in each of the
project's last five years. If the discount rate is 10 percent, what is the discounted payback period
for the project?
6) To use the payback rule, the average accounting return or the profitability index you must first
set an arbitrary cutoff.
[A] True
[B] False
[A] :This is true for the first two, but not for the profitability index. Review section 9.6.
[B] :You are correct!
7) Very few large U.S. firms use the payback rule when making capital budgeting decisions.
[A] True
[B] False
[A] :On the contrary, the payback rule is one of the most popular decision rules in practice
despite its rather significant shortcomings. Review section 9.7.
[B] :You are correct!
8) To find the _____ we begin by setting the net present value of a project equal to zero.
I. payback
II. discounted payback
III. profitability index
IV. internal rate of return
[A] I only
[B] II only
[C] IV only
[D] II and IV only
[E] III and IV only
[A] :This rule ignores the time value of money so it can't be related to the NPV. Review section
9.2.
[B] :This rule does not require all project cash flows be considered but the NPV does. Review
section 9.3.
[C] :You are correct!
[D] :At least one of these choices is incorrect. Review sections 9.3 and 9.5.
[E] :At least one of these choices is incorrect. Review sections 9.5 and 9.6.
9) Both the internal rate of return and the profitability index decision rules may lead to incorrect
decisions when comparing mutually exclusive investments.
[A] True
[B] False
10) Complete the following decision rule: A project should be accepted if its ________ exceeds
the firm's required rate of return.
11) For projects with conventional cash flows and positive discount rates, the payback period will
be shorter than the discounted payback period.
[A] True
[B] False
[A] :Don’t the other methods provide additional information that either confirms or conflicts with
the NPV decision? Review section 9.8.
[B] :Where do you find net present values of projects publicly listed? Review section 9.8.
[C] :Where do you find net present values of projects publicly listed? Review section 9.8.
[D] :You are correct!
[E] :Where do you find net present values of projects publicly listed? Review section 9.8.
[A] :This statement implies the NPV would be negative. Review section 9.1.
[B] :You are correct!
[C] :If the NPV is zero, shouldn't the IRR be the same as the required rate of return? Review
section 9.5.
[D] :This statement ignores the initial investment. Review section 9.1.
[E] :This statement implies the NPV would be positive. Review section 9.1.
14) Which one of the following is an advantage of a capital budgeting rule?
15) Consider a project with an initial investment and positive future cash flows. As the discount
rate is increased the internal rate of return ________ while the net present value ____
[A] :You are partially correct. What happens to present values as the discount rate is increased?
Review section 9.1.
[B] :Why would the IRR change in this case? What happens to present values as the discount
rate is increased? Review sections 9.1 and 9.5.
[C] :You are correct!
[D] :Why would the IRR change in this case? What happens to present values as the discount
rate is increased?. Review sections 9.1 and 9.5.
[E] :Why would the IRR change in this case? Review section 9.5.
16) From a financial point of view, which one of the following is a correct statement?
[A] The internal rate of return is considered to be the best project analysis technique.
[B] The average accounting return is preferable to the profitability index method.
[C] Discounted payback analysis requires the use of a discount rate.
[D] Internal rate of return is the preferred method for comparing mutually exclusive investments.
[E] Regular payback analysis is preferable to discounted payback analysis.
[A] :Is it the IRR that all of the other decision rules are compared to? Review sections 9.1 and
9.5.
[B] :If the PI is closely related to NPV and if the NPV is considered best in principle, why is the
AAR better than the PI? Review sections 9.4 and 9.6.
[C] :You are correct!
[D] :The IRR should not be used for mutually exclusive investment decisions. Review section 9.5.
[E] :Since discounted payback incorporates the time value of money and regular payback does
not, discounted payback is preferable. Review sections 9.2 and 9.3.
17) Which one of the following decision rules is best for evaluating projects when distant cash
flows and the time value of money are to be ignored?
[A] payback
[B] net present value
[C] average accounting return
[D] profitability index
[E] internal rate of return
18) Which one of the following statements is true concerning discounted payback analysis for
projects which have conventional cash flows and for which the discount rate is positive?
[A] Discounted payback is better than simple payback because in simple payback analysis the
cutoff payback period is arbitrarily set by management.
[B] Any project that never pays back on a discounted basis must have a positive net present
value.
[C] When comparing two projects, the one with the shorter payback period on a discounted
basis will have the larger net present value.
[D] Discounted payback is much simpler to calculate than regular payback.
[E] The discounted payback period will be longer than the regular payback period.
[A] :An arbitrary cutoff point must be set for both discounted and simple payback. Review
sections 9.2 and 9.3.
[B] :This type of project would have to have a negative NPV. Review section 9.3.
[C] :Since the cash flows beyond the cutoff point are ignored by payback, you cannot draw any
conclusions regarding the relative NPVs. Review section 9.3.
[D] :The regular payback is easier to calculate since it doesn't require any discounting of cash
flows. Review section 9.2.
[E] :You are correct!
[A] :Correct, but there is at least one more correct option. Review section 9.2.
[B] :At least one of these is incorrect. Review section 9.2.
[C] :Correct, but there is at least one more correct option. Review section 9.2.
[D] :At least one of these is incorrect. Review section 9.2.
[E] :You are correct!
[A] True
[B] False
21) Which of the following questions are addressed in the capital budgeting process?
I. What products or services will we offer or sell?
II. In what markets will we compete?
III. What new products will we introduce?
[A] I only
[B] III only
[C] I and II only
[D] I and III only
[E] I, II, and III
[A] :Correct, but there is at least one more correct option. Review the introduction to chapter 9.
[B] :Correct, but there is at least one more correct option. Review the introduction to chapter 9.
[C] :Correct, but why isn't choice III correct as well? Review the introduction to chapter 9.
[D] :Correct, but why isn't choice II correct as well? Review the introduction to chapter 9.
[E] :You are correct!
22) Which of the following are problems associated with the internal rate of return?
I. omission of time value of money considerations
II. bias against long-term projects
III. inability to rank mutually exclusive or different sized projects
IV. multiple results if some future cash flows are negative
23) Which capital investment evaluation technique is described by the attributes below?
1. easy to understand and communicate
2. may result in multiple answers
3. may lead to incorrect decisions when applied to mutually exclusive investments
[A] :None of these apply to the NPV rule. Review section 9.1.
[B] :You are correct!
[C] :None of these apply to the AAR rule. Review section 9.4.
[D] :The payback rule neither results in multiple answers nor leads to incorrect decisions in
comparing mutually exclusive investments. Review section 9.2.
[E] :The discounted payback rule neither results in multiple answers nor leads to incorrect
decisions in comparing mutually exclusive investments. Review section 9.3.
24) If a project has conventional cash flows, it may also have more than one IRR.
[A] True
[B] False
[A] :Projects with conventional cash flows have at most one IRR. Review section 9.5.
[B] :You are correct!
25) Which of the following consider the time value of money in their computation?
I. payback
II. average accounting return
III. profitability index
[A] I only
[B] II only
[C] III only
[D] I and III only
[E] II and III only
[A] :This does not consider the time value of money. Review the disadvantages of this rule in
section 9.2.
[B] :This does not consider the time value of money. Review the disadvantages of this rule in
section 9.4.
[C] :You are correct!
[D] :At least one of these choices is incorrect. Review sections 9.2 and 9.6.
[E] :At least one of these choices is incorrect. Review sections 9.4 and 9.6.
26) The essence of _____ is determining whether a proposed investment or project will generate
positive wealth for the owners of the firm once it is in place.
27) An investment's average net income divided by its average book value is called its:
[A] payback.
[B] discounted payback.
[C] net present value.
[D] internal rate of return.
[E] average accounting return.
[A] :This rule does not relate net income to book value. Review section 9.2.
[B] :This rule does not relate net income to book value. Review section 9.3.
[C] :This rule does not relate net income to book value. Review section 9.1.
[D] :This rule does not relate net income to book value. Review section 9.5.
[E] :You are correct!
28) Suppose you are evaluating two mutually exclusive projects, A and B. Project A costs $350
and has cash flows of $250 and $250 in the next 2 years, respectively. B costs $300 and
generates cash flows of $300 and $100. What is the crossover rate for these projects?
[A] the first cash flow of a project is negative and the remaining cash flows are positive.
[B] projects are independent of one another.
[C] a project has more than one NPV.
[D] projects are mutually exclusive.
[E] the profitability index is greater than one.
[A] :These cash flows are considered to be conventional. Doesn’t the conflict occur when cash
flows are not conventional? Review section 9.5.
[B] :If projects are dependent, not independent, then ranking problems may occur. Review
section 9.5.
[C] :A project cannot have more than one NPV if there is only one required rate of return. Review
section 9.1.
[D] :You are correct!
[E] :This will not create a ranking problem between the IRR and the NPV. Review section 9.6.
30) Which one of the following capital investment evaluation techniques uses readily available
information in an easy to compute manner?
[A] :The NPV is not easy to calculate and the required information normally has to be calculated.
Review section 9.1.
[B] :The IRR is not easy to calculate and the required information normally has to be calculated.
Review section 9.5.
[C] :You are correct!
[D] :While the payback computation is easy, the information required normally has to be
calculated. Review section 9.2.
[E] :The discounted payback is not easy to calculate and the required information normally has to
be calculated. Review section 9.3.
31) You undertake a project with an initial investment of $10,000. You expect to receive $3,500 a
year for the next 4 years. If the required return is 15 percent, what is the NPV?
[A] -$435.26
[B] -$32.48
[C] -$7.58
[D] $4.63
[E] $5.49
[A] I only
[B] II only
[C] III only
[D] I and II only
[E] I and III only
[A] :Correct, but there is another correct option also. Review sections 9.4 and 9.6.
[B] :Correct, but there is another correct option also. Review sections 9.5 and 9.6.
[C] :The inability to compare mutually exclusive investments is not a disadvantage of this
decision rule. Review section 9.4.
[D] :You are correct!
[E] :At least one of these is incorrect. Review sections 9.4 and 9.5.
33) A project that requires an initial cash outlay after which all remaining cash flows are inflows is
said to be:
[A] independent.
[B] conventional.
[C] mutually exclusive.
[D] value-creating.
[E] short term.
[A] :This sentence does not describe an independent project. Review section 9.5.
[B] :You are correct!
[C] :This sentence does not describe a mutually exclusive project. Review section 9.5.
[D] :This sentence does not describe a value-creating project. Review section 9.5.
[E] :This sentence does not describe a short-term project. Review section 9.5.
34) According to the 1999 capital budgeting survey cited in the text, most chief financial officers of
U.S. firms:
[A] :There are other methods that are used more heavily than payback. Review section 9.7.
[B] :The AAR is used as a primary method of evaluating projects by relatively few of these
companies. Review section 9.7.
[C] :You are correct!
[D] :The PI is the least used of the methods listed. Review section 9.7.
[E] :Both IRR and NPV, which are discounted cash flow methods, are preferred over payback.
Review section 9.7.
35) Which capital investment evaluation technique is described by the attributes below?
1. closely related to net present value
2. easy to understand and communicate
3. may lead to incorrect decisions in comparing mutually exclusive investments
4. may be useful when the available investment funds are limited
[A] :The discounted payback is useful for comparing mutually exclusive investments. Review
section 9.3.
[B] :The IRR does not have the advantage of being useful when investment funds are limited.
Review section 9.5.
[C] :The AAR does not fit these attributes. Review section 9.4.
[D] :The payback period does not fit these attributes. Review section 9.2.
[E] :You are correct!
36) The following is a list of the primary disadvantages of which one of the following evaluation
methods as compared to the net present value method?
1. ignores cash flows beyond the cutoff date
2. requires an arbitrary cutoff point
3. biased against long-term projects
4. may reject positive NPV projects
[A] :None of these are considered to be disadvantages of the PI rule. Review section 9.6.
[B] :None of these are considered to be disadvantages of the IRR rule. Review section 9.5.
[C] :The only item in this list that is a disadvantage of the AAR is the requirement of an arbitrary
cutoff point. Review section 9.4.
[D] :One of the primary disadvantages of this rule is that it ignores the time value of money,
which is absent from this list. There is a better answer. Review section 9.2.
[E] :You are correct!
[A] True
[B] False
[A] :You are correct!
[B] :Payback is a measure of how long it takes to recover the initial investment. Isn't that easy to
understand? Review section 9.2.
38) A project costs $475 and has cash flows of $100 for the first three years and $75 in each of
the project's last five years. What is the payback period of the project?
[A] :Since the cash inflows over the life of the project total $675, it will pay back at some point.
Review section 9.2.
[B] :After 4.75 years, you have only recovered a total of $431.25. Review section 9.2.
[C] :After five years, you have only recovered a total of $450. Review section 9.2.
[D] :You are correct!
[E] :At the end of six years, the cash inflows total $525, so the project must pay back sometime
prior to the end of the sixth year. Review section 9.2.
39) The management of a firm wishes to accept projects with a high degree of liquidity, avoid the
higher forecasting error associated with distant cash flows, and avoid projects that require a large
amount of research and development. The firm would be justified in using the ________ rule to
evaluate its projects.
[A] :The IRR does not possess these attributes as advantages. Review section 9.5.
[B] :The NPV does not possess these attributes as advantages. Review section 9.1.
[C] :The AAR does not possess these attributes as advantages. Review section 9.4.
[D] :You are correct!
[E] :The PI does not possess these attributes as advantages. Review section 9.6.
40) A manager will prefer the internal rate of return rule over the net present value rule if the
manager:
41) According to the net present value (NPV) rule, a firm should accept a project if:
42) Which one of the following factors can cause a project to have multiple IRRs?
[A] :This will not lead to multiple IRRs. Review section 9.5.
[B] :You are correct!
[C] :This will not lead to multiple IRRs since the sign on the cash flows changes only once.
Review section 9.5.
[D] :This will not cause multiple IRRs. Review section 9.5.
[E] :This will not cause multiple IRRs. Review section 9.5.
43) Two projects that are mutually exclusive are said to be independent.
[A] True
[B] False
[A] :Mutually exclusive choices are not independent from one another. Review section 9.5.
[B] :You are correct!
44) Which of the following are problems associated with payback analysis?
I. omission of time value of money considerations
II. bias against long-term projects
III. inability to rank mutually exclusive projects
IV. multiple results when some future cash flows are negative
45) You need to borrow $2,000 quickly and Morry, the neighborhood loan shark, will give it to you
if you promise to repay him $200.92 a month for the next year. From your viewpoint, what is the
percentage cost of this transaction?
[A] :From your viewpoint, the initial investment is -$2,000 for a project that generates cash
outflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5.
[B] :From your viewpoint, the initial investment is -$2,000 for a project that generates cash
outflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5.
[C] :From your viewpoint, the initial investment is -$2,000 for a project that generates cash
outflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5.
[D] :From your viewpoint, the initial investment is -$2,000 for a project that generates cash
outflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5.
[E] :You are correct!
46) Which of the following methods can be used when choosing between mutually exclusive
projects?
I. AAR
II. PI
III. IRR
IV. NPV
[A] I only
[B] II and III only
[C] II and IV only
[D] I and IV only
[E] I and III only
[A] :Correct, but there is at least one more correct option. Review sections 9.1, 9.5 and 9.6.
[B] :Neither of these can be used for mutually exclusive investment decisions. Review sections
9.5 and 9.6.
[C] :At least one of these should not be used for mutually exclusive investment decisions. Review
sections 9.1 and 9.6.
[D] :You are correct!
[E] :At least one of these should not be used for mutually exclusive investment decisions. Review
section 9.1.
47) The _____ is equal to the present value of an investment's future cash flows divided by its
initial cost.
[A] payback
[B] profitability index
[C] net present value
[D] internal rate of return
[E] average accounting return
[A] :This rule ignores time value of money and therefore, does not relate the present value of the
project’s cash flows to the initial costs. Review section 9.2.
[B] :You are correct!
[C] :A NPV is reported in dollars, not as a ratio of benefits to cost. Review section 9.1.
[D] :An IRR is reported as a rate of return, not as a ratio of benefits to cost. Review section 9.5.
[E] :This rule does not relate project cash flows to the initial cost. Review section 9.4.
48) Which of the following are problems associated with the profitability index?
I. omission of time value of money considerations
VI. bias against long-term projects
III. inability to rank mutually exclusive projects
IV. multiple results if some future cash flows are negative
[A] I only
[B] II only
[C] III only
[D] IV only
[E] III and IV only
[A] :This is not a problem associated with the profitability index. Review section 9.6.
[B] :This is not a problem associated with the profitability index. Review section 9.6.
[C] :You are correct!
[D] :This is not a problem associated with the profitability index. Review section 9.6.
[E] :At least one of these is incorrect. Review section 9.6.
49) You need to borrow $2,000 quickly and Morry, the neighborhood loan shark, will give it to you
if you promise to repay him $200.92 a month for the next year. Suppose that Morry has more
customers than funds. Which capital budgeting technique would allow him to rank his potential
customers in order to maximize his current wealth?
50) A financial manager who consistently underestimates the ________ will tend to incorrectly
reject projects that would actually create wealth for the stockholders.
[A] :Underestimating this would actually lead managers to accept, not reject more projects.
Review section 9.1.
[B] :Underestimating this would actually lead managers to accept, not reject more projects.
Review section 9.1.
[C] :Underestimating this would actually lead managers to accept, not reject more projects.
Review section 9.1.
[D] :Underestimating this would actually lead managers to accept, not reject more projects.
Review section 9.1.
[E] :You are correct!
51) Your firm needs to generate income from some unused equipment which the company owns.
The president presents you with two options. First, you can sell the equipment or second, you can
rent out the equipment. This is an example of a decision involving:
[A] :Can you simultaneously both rent and sell the equipment? Review section 9.5.
[B] :This decision relates to fixed assets, not net working capital. Review section 9.5.
[C] :The projects may have positive NPVs, but that is not the issue here. There is a better
answer. Review section 9.5.
[D] :Taxes are not the primary issue in this question. There is a better answer. Review section
9.5.
[E] :You are correct!
52) Which one of the following is computed using only accounting numbers?
[A] payback period
[B] profitability index
[C] net present value
[D] internal rate of return
[E] average accounting return
[A] :This requires the use of cash flows, not accounting numbers. Review section 9.2.
[B] :This requires the use of cash flows, not accounting numbers. Review section 9.6.
[C] :This requires the use of cash flows, not accounting numbers. Review section 9.1.
[D] :This requires the use of cash flows, not accounting numbers. Review section 9.5.
[E] :You are correct!
53) The _____ is the length of time required for an investment's discounted cash flows to equal
its initial cost.
[A] payback
[B] discounted payback
[C] net present value
[D] internal rate of return
[E] average accounting return
[A] :This rule ignores the time value of money. Review section 9.2.
[B] :You are correct!
[C] :The NPV rule considers all project cash flows, not just the ones it takes to recover the initial
investment in discounted terms. Review section 9.1.
[D] :This is reported as a return in percentage points, not as a length of time. Review section 9.5.
[E] :This rule does not relate cash flows to project cost. Review section 9.4.
54) Which one of the following decision rules has the advantage that the information needed for
the computation is usually readily available?
[A] :In this case the cash flows must be computed. Review section 9.1.
[B] :In this case the cash flows must be computed. Review section 9.5.
[C] :You are correct!
[D] :In this case the cash flows must be computed. Review section 9.2.
[E] :In this case the cash flows must be computed. Review section 9.3.
55) An investment is acceptable if the internal rate of return (IRR) exceeds the required return.
[A] True
[B] False
[A] True
[B] False
57) One of the risks a firm takes when it uses the ________ as the investment criterion for
proposed projects is that it may reject some profitable projects because of the timing of their cash
flows.
[A] :This rule is not based on cash flows. Review section 9.4.
[B] :This rule requires all of a project's cash flows be considered. Review section 9.1.
[C] :This rule requires all of a project's cash flows be considered. Review section 9.5.
[D] :This rule requires all of a project's cash flows be considered. Review section 9.6.
[E] :You are correct!
[A] :If the NPV is zero, you are indifferent about the project and should accept it absent other
more desirable investment opportunities. Review section 9.1.
[B] :Remember, the PI is the present value of the cash flows divided by the initial investment. If
the NPV is zero, what must be true about the PI ratio? Review section 9.6.
[C] :You are correct!
[D] :If the NPV is zero, the discounted payback is equal to the life of the project. Review section
9.3.
[E] :What is the net present value when the IRR equals the required return? Review section 9.5.
59) If a project with conventional cash flows has a profitability index (PI) that is less than one,
then the:
[A] :If the IRR exceeds the required return, isn't the PI greater than 1? Review sections 9.5 and
9.6.
[B] :You are correct!
[C] :The AAR is not related to the PI and the required return. Review section 9.4.
[D] :The payback period is not related to the profitability index. Review section 9.2.
[E] :You need to review how to interpret the profitability index in section 9.6.
60) If the net present value (NPV) is greater than zero for a project with conventional cash flows,
then the:
[A] internal rate of return (IRR) is equal to the firm's required rate of return.
[B] profitability index is greater than 1.
[C] payback period is shorter than required by the firm.
[D] average accounting return exceeds the internal rate of return.
[E] the project does not pay back on a discounted basis.
[A] :What is the NPV when the IRR is equal to the required return? Review section 9.5.
[B] :You are correct!
[C] :The payback period does not relate directly to the NPV. Review section 9.2.
[D] :The AAR does not relate directly to the IRR. Review sections 9.4 and 9.5.
[E] :If a project’s NPV is greater than zero, the project must pay back on a discounted basis at
some point during its’ life. Review section 9.3.
61) A steep net present value (NPV) profile indicates that a project's NPV is very sensitive to
changes in the cost of capital.
[A] True
[B] False
62) The length of time required for an investment's undiscounted cash flows to equal its initial
cost is called the:
[A] payback.
[B] discounted payback.
[C] average accounting return.
[D] profitability index.
[E] net present value.
63) When multiple IRR's exist, a project must have a negative NPV at the highest IRR.
[A] True
[B] False
[A] :By definition, what is the NPV at the IRR? Review section 9.5.
[B] :You are correct!
64) If the required return is zero and a project has conventional cash flows, then:
[A] :The two payback periods would be identical in this case. Review sections 9.2 and 9.3.
[B] :You are correct!
[C] :If the NPV is negative at a required return of zero, then the NPV cannot be zero at any
discount rate greater than zero. Review section 9.1.
[D] :Even though the discount rate is zero, you can't draw any conclusions regarding the PI.
Review section 9.6.
[E] :The AAR does not relate to the cash flows and required return of a project. Review section
9.4.
65) Rank the following decision rules from worst to best in terms of their overall usefulness in
capital budgeting analysis.
I. NPV
II. Payback
III. IRR
[A] :How does acquiring a truck preclude you from acquiring more warehouse space? Review
section 9.5.
[B] :This response is not descriptive of this type of investment choice. Review section 9.5.
[C] :Are these mutually exclusive projects? Review section 9.5.
[D] :You are correct!
[E] :Why can you not apply the net present value rule to this situation? Review section 9.1.
67) Which one of the following is based on net income rather than on cash flows?
68) What is the maximum number of internal rates of return (IRRs) that may exist for the following
project? Yr0 = -$50,000; Yr1 = -$5,000; Yr2 = $50,000; Yr3 = $50,000; and Yr4 = -$25,000?
[A] 0
[B] 1
[C] 2
[D] 3
[E] 4
[A] :Since the signs on the cash flows change twice, negative to positive then positive back to
negative, there can be at most 2 IRRs. Review section 9.5.
[B] :Since the signs on the cash flows change twice, negative to positive then positive back to
negative, there can be at most 2 IRRs. Review section 9.5.
[C] :You are correct!
[D] :Since the signs on the cash flows change twice, negative to positive then positive back to
negative, there can be at most 2 IRRs. Review section 9.5.
[E] :Since the signs on the cash flows change twice, negative to positive then positive back to
negative, there can be at most 2 IRRs. Review section 9.5.
69) If financial managers invest only in projects that have a profitability index greater than one
then ________ should increase.
I. the value of the firm
II. shareholder wealth
III. share price
[A] I only
[B] II only
[C] III only
[D] I and III only
[E] I, II, and III
[A] :Correct, but there is at least one other correct option also. Review section 9.6.
[B] :Correct, but there is at least one other correct option also. Review section 9.6.
[C] :Correct, but there is at least one other correct option also. Review section 9.6.
[D] :If the share price increases, why doesn’t shareholder wealth also increase? Review section
9.6.
[E] :You are correct!
70) Suppose a firm invests $600 in a project. The initial cost is depreciated straight-line to zero
over 3 years. Net income from the project is $100, $125, and $140 in each of the three years of
the project's life. What is the average accounting return?
[A] :To answer this, you must find the average net income and the average book value. Did you
find the average book value to be $300? Review section 9.4.
[B] :To answer this, you must find the average net income and the average book value. Did you
find the average book value to be $300? Review section 9.4.
[C] :To answer this, you must find the average net income and the average book value. Did you
find the average book value to be $300? Review section 9.4.
[D] :You are correct!
[E] :To answer this, you must find the average net income and the average book value. Did you
find the average book value to be $300? Review section 9.4.
71) Suppose you are considering a project that costs $300 and has expected cash flows of $110,
$121 and $133.10 over the next three years, respectively. If the appropriate discount rate is 10
percent, what is the net present value of this project?
[A] -$19.79
[B] $0.00
[C] $0.71
[D] $19.79
[E] $64.10
[A] :You need to review this calculation in section 9.1.
[B] :You are correct!
[C] :You need to review this calculation in section 9.1.
[D] :You need to review this calculation in section 9.1.
[E] :You need to review this calculation in section 9.1.
72) The _____ is the difference between an investment's present value and its cost.
[A] payback
[B] profitability index
[C] net present value
[D] internal rate of return
[E] average accounting return
[A] :Payback measures time not differences in dollar values. Review section 9.2.
[B] :The profitability index is reported as a benefit to cost ratio, not as a dollar amount. Review
section 9.6.
[C] :You are correct!
[D] :The IRR is reported as a rate of return, not as a dollar value. Review section 9.5.
[E] :This rule does not compare market values and costs. Review section 9.4.
[A] I only
[B] III only
[C] I and II only
[D] I and III only
[E] I, II, and III
[A] :Correct, but there is at least one more correct option. Review sections 9.3 and 9.4.
[B] :Correct, but there is at least one more correct option. Review sections 9.2 and 9.4.
[C] :At least one of these choices is incorrect. Review sections 9.2 and 9.4.
[D] :You are correct!
[E] :At least one of these choices is incorrect. Review sections 9.2, 9.3 and 9.4.
74) You are comparing two projects using a net present value profile. At the point where the net
present values (NPV) of the two projects are equal, the:
[A] :Note that the problem states the NPVs will be equal, not necessarily zero. Review section
9.5.
[B] :Note that the problem states the NPVs will be equal, not necessarily zero. Review section
9.5.
[C] :You are correct!
[D] :The NPVs can be equal and still be greater than or less than zero. Review section 9.5.
[E] :The AAR is not related to the NPV. Review section 9.4.
75) The profitability index is computed using accounting income and accounting book values.
[A] True
[B] False
[A] :This describes the average accounting return, not the profitability index. Review sections 9.4
and 9.6.
[B] :You are correct!
[A] :How does this relate to the required rate of return? Review section 9.5.
[B] :By definition, the NPV is zero at the IRR. Review section 9.5.
[C] :How does this relate to the required rate of return? Review section 9.5.
[D] :The IRR decision rule does not depend on a firm's bank borrowing rate. Review section 9.5.
[E] :You are correct!
77) You run a small bagel shop and are considering replacing your four sales clerks with
automated machines that allow customers to buy their bagels without any human interaction. Of
the following, the most difficult task you face in computing the net present value of this project is
estimating the:
[A] :This would be relatively easy since you already know what you are paying the four
employees you would replace. Review section 9.1.
[B] :This would be relatively easy to identify once you determine the cost of the new machines.
Review section 9.1.
[C] :You could get this information simply by calling an equipment dealer. Review section 9.1.
[D] :You could get this information simply by getting a price quote from a contractor. Review
section 9.1.
[E] :You are correct!
78) You are going to choose one of two mutually exclusive investments. Investment A pays
$35,000 a year for 4 years and has an initial cost of $80,000. Investment B pays $60,000 a year
for 5 years and has an initial cost of $170,000. If your required return is 13 percent, which
investment should you choose and why?
[A] :Project A does cost less, but what about the NPVs? Review section 9.1.
[B] :In fact, both projects have IRRs that exceed 13 percent. Can you use the IRR rule to rank
mutually exclusive investments? Review section 9.5.
[C] :Can you use the IRR rule to rank mutually exclusive investments? Review section 9.5.
[D] :In fact, both projects have IRRs that exceed 13 percent. Can you use the IRR rule to rank
mutually exclusive investments? Review section 9.5.
[E] :You are correct!
79) You need to borrow $2,000 quickly and Morry, the neighborhood loan shark, will give it to you
if you promise to repay him $200.92 a month for the next year. Suppose that Morry's cost of
funds is 1 percent per month. From Morry’s point of view, what is the net present value of this
deal?
[A] $44.11
[B] $111.01
[C] $226.17
[D] $261.37
[E] $292.01
[A] :Did you compute the net present value at a discount rate of 1 percent? Review section 9.5.
[B] :Did you compute the net present value at a discount rate of 1 percent? Review section 9.5.
[C] :Did you compute the net present value at a discount rate of 1 percent? Review section 9.5.
[D] :You are correct!
[E] :Did you compute the net present value at a discount rate of 1 percent? Review section 9.5.
80) As a financial manager, rank the following decision rules in order of preference from best to
worst in terms of usefulness in making capital budgeting decisions.
I. NPV
II. discounted payback
III. payback
81) If an investment has a ________ of 1.2 it can be said the investment generates $1.20 in
present value benefits for each dollar invested.
82) The profitability index, net present value, and internal rate of return are all closely related to
one another.
[A] True
[B] False
83) For all projects, the AAR will be less than the IRR.
[A] True
[B] False
[A] :There is no prescribed relationship between the AAR and the IRR. Review sections 9.4 and
9.5.
[B] :You are correct!
[A] :You should review the disadvantages of this rule in section 9.5.
[B] :You should review the disadvantages of this rule in section 9.2.
[C] :You should review the disadvantages of this rule in section 9.4.
[D] :You are correct!
[E] :You should review the disadvantages of this rule in section 9.6.
85) If investment funds are limited and the projects under consideration are independent from one
another, then the accounting rate of return should be used to rank projects to determine which
ones should be accepted.
[A] True
[B] False
[A] :Since these are independent investments, the profitability index should be used to rank the
projects. Review section 9.6.
[B] :You are correct!
86) In which of the following cases is it possible that the NPV and IRR rules will lead to different
decisions?
I. project cash flows are conventional
II. the IRR is negative
III. an investment decision involves mutually exclusive choices
[A] I only
[B] III only
[C] I and II only
[D] I and III only
[E] II and III only
[A] :If project cash flows are conventional there will only be one IRR and both the NPV and IRR
will lead to the same decision. Review section 9.5.
[B] :You are correct!
[C] :If project cash flows are conventional there will only be one IRR and both the NPV and IRR
will lead to the same decision. The fact that the IRR is negative will not lead to differing decisions.
Review section 9.5.
[D] :At least one of these choices is incorrect. Review section 9.5.
[E] :At least one of these choices is incorrect. Review section 9.5.
87) Would you accept a project which is expected to pay $10,000 a year for 7 years if the initial
investment is $40,000 and your required return is 15 percent?
88) A project that has a discounted payback period longer than its life also has a positive NPV.
[A] True
[B] False
[A] :If the project doesn't ever pay back on a discounted basis, how can it have a positive NPV?
Review section 9.3.
[B] :You are correct!
89) What is the IRR, to the nearest whole percent, of an investment that costs $77,000 and pays
$27,500 a year for 4 years?
[A] 16 percent
[B] 18 percent
[C] 20 percent
[D] 22 percent
[E] 24 percent
90) Which of the following are correct statements concerning capital budgeting decision rules?
I. If a project has a profitability index greater than one, the project should be accepted.
II. If a firm's target average accounting return is lower than that computed for a given project, the
project should be accepted.
III. If the cost of capital is greater than the internal rate of return, the project should be accepted.
IV. If a project has a payback period that is less than what the company requires, the project
should be accepted.
[A] :Correct, but there is at least one more correct option. Review section 9.2.
[B] :This decision rule is stated correctly. Review section 9.4.
[C] :At least one of these options is incorrect. Review sections 9.2, 9.5 and 9.6.
[D] :You are correct!
[E] :At least one of these options is incorrect. Review sections 9.2, 9.4 and 9.5.
91) Compute the NPV, to the nearest whole dollar, for a project with an initial investment of
$40,000 and cash inflows of $11,000 a year for 5 years given a required return of 11.649 percent.
[A] -$1,205
[B] -$1,103
[C] $0
[D] $567
[E] $1,218
92) Suppose a project costs $300 and produces cash flows of $100 over each of the following six
years. What is the IRR of the project?
[A] 0 percent
[B] 10.0 percent
[C] 24.3 percent
[D] 34.9 percent
[E] 38.1 percent
[A] :This choice is irrational since the total cash inflows for the project are $600, making the NPV
$300 at a discount rate of 0 percent. Review section 9.5.
[B] :If you check, you should find the NPV is positive, not zero, at this rate of interest. Review
section 9.5.
[C] :You are correct!
[D] :If you check, you should find the NPV is negative, not zero, at this rate of interest. Review
section 9.5.
[E] :If you check, you should find the NPV is negative, not zero, at this rate of interest. Review
section 9.5.
93) What is the net present value, rounded to the nearest whole dollar, of the following set of
cash flows if the required return is 14 percent? Yr0 = -$50,000; Yr1 = -$5,000; Yr2 = $50,000; Yr3
= $50,000; and Yr4 = -$25,000?
[A] -$500
[B] $3,034
[C] $9,525
[D] $10,376
[E] $41,410
94) Which capital investment evaluation technique is described by the attributes below?
1. easy to understand
2. biased towards liquidity
3. requires an arbitrary cutoff point
4. ignores the time value of money
[A] :None of these apply to the NPV rule. Review section 9.1.
[B] :Except for the first statement, none of the rest apply to the IRR rule. Review section 9.5.
[C] :Except for the first statement, none of the rest apply to the PI rule. Review section 9.6.
[D] :You are correct!
[E] :The first three statements do apply to the discounted payback, but this rule does not ignore
the time value of money. Review section 9.3.
95) You need to borrow $2,000 quickly, and Morry, the neighborhood loan shark, will give it to
you if you promise to repay him $200.92 a month for the next year. From Morry's viewpoint, what
is the IRR of this transaction?
[A] :From Morry's viewpoint, the initial investment is $2,000 for a project that generates cash
inflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5.
[B] :From Morry's viewpoint, the initial investment is $2,000 for a project that generates cash
inflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5.
[C] :From Morry's viewpoint, the initial investment is $2,000 for a project that generates cash
inflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5.
[D] :From Morry's viewpoint, the initial investment is $2,000 for a project that generates cash
inflows of $200.92 per month for twelve months. Review how to compute IRRs in section 9.5.
[E] :You are correct!
96) Which of the following are problems associated with net present value?
I. omission of time value of money considerations
II. bias against long-term projects
III. inability to rank mutually exclusive projects
IV. multiple results if some future cash flows are negative
[A] I only
[B] II only
[C] III only
[D] IV only
[E] None of these are problems that apply to NPV.
[A] :This is not a problem associated with NPV. Review section 9.1.
[B] :This is not a problem associated with NPV. Review section 9.1.
[C] :This is not a problem associated with NPV. Review section 9.1.
[D] :This is not a problem associated with NPV. Review section 9.1.
[E] :You are correct!
97) You are considering the following independent projects but you have limited funds to invest
and can't take them all. Using the profitability index, rank the projects in the order in which you
would accept them. That is, rank them from best to worst.
I. Project I requires an initial investment of $100,000 and has a NPV of $30,000.
II. Project II requires an initial investment of $80,000 and has a NPV of $25,000.
III. Project III requires an initial investment of $40,000 and has a NPV of $17,000.
[A] :Did you get a PI of 1.3 for project I? That is computed as ($100,000 + $30,000) / $100,000 =
1.3. Review section 9.6.
[B] :If you didn't get a profitability index of 1.3, 1.3125, and 1.425 for I, II and III, respectively, you
have done something wrong. If you did get these numbers, you have not ranked them correctly.
Review section 9.6.
[C] :If you didn't get a profitability index of 1.3, 1.3125, and 1.425 for I, II and III, respectively, you
have done something wrong. If you did get these numbers, you have not ranked them correctly.
Review section 9.6.
[D] :You are correct!
[E] :If you didn't get a profitability index of 1.3, 1.3125, and 1.425 for I, II and III, respectively, you
have done something wrong. If you did get these numbers, you have not ranked them correctly.
Review section 9.6.
98) Which one of the following is considered to be an advantage of the average accounting return
method of analysis?
[A] :The time value of money is ignored in this computation. Review the disadvantages of this
rule in section 9.4.
[B] :The cutoff must be arbitrarily determined for this rule. Review the disadvantages of this rule
in section 9.4.
[C] :This is considered to be a disadvantage, not an advantage of this rule. Review the
disadvantages of this rule in section 9.4.
[D] :This is considered to be a disadvantage, not an advantage of this rule. Review the
disadvantages of this rule in section 9.4.
[E] :You are correct!
99) What is the payback period of a $40,000 investment with the following cash flows? Yr1 =
20,000; Yr2 = 25,000; Yr3 = 10,000; Yr4 = 10,000; Yr5 = 5,000.
[A] :At the end of one year you have only recovered half of the initial investment. Review section
9.2.
[B] :You are correct!
[C] :At the end of two years you have recovered more than the initial investment, meaning the
payback must be something less than two years. Review section 9.2.
[D] :At the end of two years you have recovered more than the initial investment, meaning the
payback must be something less than two years. Review section 9.2.
[E] :At the end of two years you have recovered more than the initial investment, meaning the
payback must be something less than two years. Review section 9.2.
100) A firm that only accepts projects for which the IRR is equal to the firm's required return will,
on average, neither create nor destroy wealth for its shareholders.
[A] True
[B] False
[A] :If only the initial investments are considered, all NPVs would be negative. Review section
9.1.
[B] :You are correct!
[C] :If the IRR exceeds the discount rate, would the project really have a NPV of zero? Review
section 9.5.
[D] :Cash flows are not easy to estimate. Review section 9.1.
[E] :The NPV rule does not require an arbitrary cutoff. What is the decision rule? Review section
9.1.
102) Compute the NPV of the following project using a discount rate of 12 percent: Yr0 -$500;
Yr1 -$50; Yr2 $50; Yr3 $200; Yr4 $400; Yr5 $400.
[A] $0.00
[B] $61.22
[C] $118.75
[D] $208.00
[E] $269.21
103) The average accounting return (AAR) decision rule states that a project should be accepted
whenever the AAR:
[A] is positive.
[B] exceeds the internal rate of return (IRR).
[C] indicates that a project has more than recaptured its initial cost in terms of net income.
[D] exceeds the target AAR.
[E] is less than the IRR.
[A] :With the AAR, you need to somehow establish a hurdle rate. This cutoff will almost always
be set at something greater than zero. Review section 9.4.
[B] :While a hurdle rate must be set for the AAR rule, it is not likely to be set relative to the IRR.
Review section 9.4.
[C] :The AAR does not relate net income to the initial cost. Review section 9.4.
[D] :You are correct!
[E] :While a hurdle rate must be set for the AAR rule, it is not likely to be set relative to the IRR.
Review section 9.4.
[A] :The NPV of project A is positive so the PI must exceed one. Review section 9.6.
[B] :The NPV of project B is positive so the PI must exceed one. Review section 9.6.
[C] :You are correct!
[D] :The NPV of project A and project B are both positive so the PI's must exceed one. Review
section 9.6.
[E] :This statement is not always true. Review section 9.6.
105) An advantage of the average accounting return is that the information needed to compute it
will usually be available.
[A] True
[B] False