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T02 - Capital Budgeting
T02 - Capital Budgeting
BASIC CONCEPTS
Capital Budgeting Defined
1
. The capital budget is a(n)
a. Plan to insure that there are sufficient funds available for the operating needs of the company.
b. Exercise that sets the long-range goals of the company including the consideration of external influences.
c. Plan that coordinates and communicates a company’s plan for the coming year to all departments and divisions.
d. Plan that assesses the long-term needs of the company for plant and equipment purchases. CMA 0695 3-17
2
. In planning and controlling capital expenditures, the most logical sequence is to begin with
a. Analyzing capital addition proposals.
b. Making capital and expenditure decisions.
c. Analyzing and evaluating all promising alternatives.
d. Identifying capital addition projects and other capital needs. CMA 0696 3-11
21. Which of the following involves significant financial investments in projects to develop new products, expand production capacity,
or remodel current production facilities? (E)
a. Capital budgeting c. Master budgeting
b. Working capital d. Project-cost budgeting Horngren
*. The detailed plan for the acquisition and replacement of major portions of property, plant, and equipment is known as the
a. capital budget. c. commitments budget.
b. purchases budget. d. treasury budget. Barfield
2. _____________ decisions are concerned with the process of planning, setting goals and priorities, arranging financing, and
identifying criteria for making long-term investments.
a. Limited resources c. Capital investment
b. Sell now or process further d. Make or buy H&M
Uses
107.A capital budget is used by management to determine
Barfield a. b. c. d.
In what to invest No No Yes Yes
How much to invest No Yes No Yes
3
. Capital budgeting is concerned with
A. Decisions affecting only capital intensive industries.
B. Analysis of short-range decisions.
C. Analysis of long-range decisions.
D. Scheduling office personnel in office buildings. Gleim
4
. Capital budgeting is used for the decision analysis of
A. Adding product lines or facilities. C. Lease-or-buy decisions.
B. Multiple profitable alternatives. D. All of the answers are correct. Gleim
5
. Capital budgeting techniques are least likely to be used in evaluating the (E)
a. Acquisition of new aircraft by a cargo company.
b. Design and implementation of a major advertising program.
c. Trade for a star quarterback by a football team. CMA 0693 4-19
d. Adoption of a new method of allocating non-traceable costs to product lines.
Application
2. A company can replace the machinery currently used to manufacture its product with more efficient machinery. The new
machinery will reduce labor and also will reduce the percentage of spoiled units. It is expected to have a useful life of 5 years.
The most appropriate technique for determining whether or not the company should replace its machinery with the new, more
efficient machinery is:
A. cost-volume-profit analysis C. regression analysis
B. capital-budgeting analysis D. linear programming CIA adapted
Not-for-Profit Entities
10. Not-for-profit entities
a. Cannot use capital budgeting techniques because profitability is irrelevant to them.
b. Cannot use discounted cash flow techniques because the time value of money is irrelevant to them.
c. Might have serious problems in quantifying the benefits expected from an investment.
d. Should use the IRR method to make investment decisions. L&H
Stages
Identification Stage
23. The stage of the capital budgeting process which distinguishes which types of capital expenditure projects are necessary to
accomplish organization objectives is the (E)
a. identification stage. c. information-acquisition stage.
b. search stage. d. selection stage. Horngren
Information-Acquisition Stage
25. The stage of the capital budgeting process which considers the expected costs and the expected benefits of alternative capital
investments is the (E)
a. identification stage. c. information-acquisition stage.
b. search stage. d. selection stage. Horngren
Search Stage
24. The stage of the capital budgeting process which explores alternative capital investments that will achieve organization objectives
is the (E)
a. identification stage. c. information-acquisition stage.
b. search stage. d. selection stage. Horngren
Selection Stage
26. The stage of the capital budgeting process which chooses projects for implementation is the (E)
a. selection stage. c. identification stage.
b. search stage. d. management-control stage. Horngren
Appropriation Requests
8. Which of the following statements regarding appropriation requests is true?
A. Usually submitted by head office staff
B. Represents the first step in the capital budgeting process
C. Authorization tends to be reserved for senior management
D. None of the above B&M
Acquisition Considerations
6. Effective planning and control is important for the effective administration of a capital expenditure program because:
A. the long-term commitment increases financial risk
B. the magnitude of expenditures is substantial and the economic penalties for unwise decisions are usually severe
C. decisions made in this area provide the structure for operation of the firm
D. all of the above Carter & Usry
7. A company manual used for detailing policies and procedures required for administering the capital expenditure program should:
A. encourage people to work on and submit new ideas
B. focus attention on useful analytical tasks
C. facilitate rapid project development and expeditious review
D. all of the above Carter & Usry
8. A number of evaluations of a single capital expenditure proposal may be necessary because of:
A. circumstances that change during the time span from the origin of the project idea to its completion
B. alternative solutions of the problem for which the project is designed
C. assumptions that vary as to the amount and timing of cash flows
D. all of the above Carter & Usry
23. Which of the following events is most likely to increase the number of investments that meet a company’s acceptance criteria? (M)
a. Top management raises the target rate of return.
b. The interest rate on long-term debt rises.
c. The income tax rate rises.
d. The IRS allows companies to expense purchases of fixed assets, instead of depreciating them over their lives. L&H
Qualitative Factors
37. Qualitative issues could increase the acceptability of a project under which of the following conditions?
a. The IRR is less than the company’s cutoff rate.
b. The project has a negative NPV.
c. The payback period is longer than the company’s cutoff period.
d. All of the above. L&H
Ethical Consideration
4. Common problems related to ethical considerations in the capital budgeting include all of the following, except:
A. superiors and associates sometimes apply pressure to circumvent the approval process
B. pressure may exist to write-off or devalue assets below their true value to justify replacement
C. the economic benefit of capital projects may be exaggerated to increase the likelihood of approval
D. the accountant may mistakenly go to the individuals involved in the ethical conflict first, rather than first discussing it with the
accounting supervisor
E. all of the above are ethical problems related to capital budgeting AICPA adapted
Expansion Expenditures
10. In which of the following types of capital expenditure decisions does the basis for a decision most markedly shift from cost savings
to increased profits and cash flow?
A. replacement expenditures C. improvement expenditures
B. expansion expenditures D. allowance expenditures Carter & Usry
Improvement Expenditures
11. The capital expenditures in which the benefits are most difficult to quantify are:
A. replacement expenditures C. improvement expenditures
B. expansion expenditures D. allowance expenditures Carter & Usry
4. Which of the following capital expenditure may not appear in capital budget?
A. Investment in a new plant
B. Investment in a new machine
C. Investment in information technology
D. All of the above are included in capital budget B&M
5. Which of the following capital expenditures may not appear in capital budget?
A. Investment in a new building
B. Investment in a new machine
C. Investment in research and development
D. All of the above are included in capital budget B&M
Types of Projects
Independent Projects
1. ______________ are projects that when accepted or rejected will NOT affect the cash flows of another project.
a. Independent projects c. Dependent projects
b. Mutually exclusive projects d. Both b and c H&M
Inflation Element
*. The “inflation element” refers to the
a. Impact that future price increases will have on the original cost of a capital expenditure.
b. Fact that the real purchasing power of a monetary unit usually increases over time.
c. Future deterioration of the general purchasing power of the monetary unit.
d. Future increases in the general purchasing power of the monetary unit. RPCPA 0597
29. Which of the following are NOT included in the formal financial analysis of a capital budgeting program? (E)
a. Quality of the output c. Cash flow
b. Safety of employees d. Neither (a) nor (b) are included Horngren
32. The only future costs that are relevant to deciding whether to accept an investment are those that will
a. Be different if the project is accepted rather than rejected.
b. Be saved if the project is accepted rather than rejected.
c. Be deductible for tax purposes.
d. Affect net income in the period that they are incurred. L&H
7
. Which of the following rules are essential to successful cash flow estimates, and ultimately, to successful capital budgeting? (M)
a. The return on invested capital is the only relevant cash flow.
b. Only incremental cash flows are relevant to the accept/reject decision.
c. Total cash flows are relevant to capital budgeting analysis and the accept/reject decision.
d. Statements a and b are correct.
e. All of the statements above are correct. Brigham
Salvage Value
60. The relevant terminal disposal price of a machine equals (M)
a. the difference between the salvage value of the old machine and the ultimate salvage value of the new machine.
b. the total of the salvage values of the old machine and the new machine.
c. the salvage value of the old machine.
d. the salvage value of the new machine. Horngren
*. Karen Company is considering replacing an old machine with a new machine. Which of the following items is economically
relevant to Karen’s decisions? (M)
RPCPA 0598 a. b. c. d.
Carrying amount of old machine Yes Yes No No
Disposal value of new machine Yes No Yes No
*. You are the treasurer of the Hibang Corp. The company is considering a proposed project which has an expected economic life of
seven years. Net present value is the capital budgeting technique the president wants you to use. Salvage value of the project
would be (M)
a. Treated as cash inflow at estimated salvage value.
b. Treated as cash flow at its present value.
c. Irrelevant cash flow item.
d. Treated as cash inflow at the future value. RPCPA 1096
Working Capital
66. In the analysis of a capital budgeting proposal, for which of the following items are there no after-tax consequences? (E)
a. Cash flow from operations
b. Gain or loss on the disposal of the asset
c. Reduction of working capital balances at the end of the useful life of the capital asset
d. There are no after-tax consequences of any of the above. Horngren
11. A major difference between an investment in working capital and one in depreciable assets is that (M)
a. An investment in working capital is never returned, while most depreciable assets have some residual value.
b. An investment in working capital is returned in full at the end of the project’s life, while an investment in depreciable assets has
no residual value.
c. An investment in working capital is not tax-deductible when made, not taxable when returned, while an investment in
depreciable assets does allow tax deductions.
d. Because an investment in working capital is usually returned in full at the end of the project’s life, it is ignored in computing the
amount of the investment required for the project. L&H
*. Mahlin Movers, Inc. is planning to purchase equipment to make its operations more efficient. This equipment has an estimated
useful life of six years. As part of this acquisition, a P150,000 investment in working capital is required. In a discounted cash flow
analysis, this investment in working capital should be (E)
a. Amortized over the useful life of the equipment.
b. Disregarded because no cash is involved. RPCPA 1095
c. Treated as a recurring annual cash flow that is recovered at the end of six years.
d. Treated as an immediate cash outflow that is recovered at the end of six years.
8
. Fast Freight, Inc. is planning to purchase equipment to make its operations more efficient. This equipment has an estimated life of
6 years. As part of this acquisition, a $75,000 investment in working capital is anticipated. In a discounted cash flow analysis, the
investment in working capital (E)
a. Should be amortized over the useful life of the equipment.
b. Should be treated as a recurring cash outflow over the life of the equipment.
c. Should be treated as an immediate cash outflow. CMA 0691 4-20
d. Should be treated as an immediate cash outflow recovered at the end of 6 years.
32. In connection with a capital budgeting project, an investment in working capital is normally recovered
a. At the end of the project’s life. c. Evenly through the project’s life. L&H
b. In the first year of the project’s life. d. When the company goes out of business.
34. The cash inflow from the return on an investment in working capital is
a. Adjusted for taxes due.
b. Discounted to present value.
c. Ignored if any depreciable assets also involved in the project have no expected residual value.
d. Not real. L & H, RPCPA 1001
29. XYZ Co. is adopting just-in-time principles. When evaluating an investment project that would reduce inventory, how should XYZ
treat the reduction?
a. Ignore it.
b. Decrease the cost of the investment and decrease cash flows at the end of the project’s life.
c. Decrease the cost of the investment.
d. Decrease the cost of the investment and increase the cash flow at the end of the project’s life. L&H
Opportunity Costs
10. The value of a previously purchased machine expected to be used by a proposed project is an example of:
A. Sunk costs C. Fixed costs
B. Opportunity costs D. None of the above B&M
Cash Outflows
14. All of the following are common cash outflows from capital expenditure programs, except:
A. equipment installation D. increased working capital requirements
B. employee training E. salvage value at the end of the project
C. computer programming and fine tuning Carter & Usry
33. For investments that have only costs (no revenues or cost savings), an appropriate decision rule is to accept the project that has
the
a. Longest payback period.
b. Lower present value of cash outflows.
c. Higher present value of future cash outflows.
d. Lowest internal rate of return. L&H
Cash Inflows
15. As to a capital investment, net cash inflow is equal to the
a. cost savings resulting from the investment.
b. sum of all future revenues from the investment.
c. net increase in cash receipts over cash payments.
d. net increase in cash payments over cash receipts. Barfield
8. Which of the following describes the annual returns that are discounted in determining the NPV of an investment?
a. Net incomes expected to be earned by the project.
b. Pre-tax cash flows expected from the project.
c. After-tax cash flows expected from the project.
d. After-tax cash flows adjusted for the time value of money. L&H
57. Annual after-tax corporate net income can be converted to annual after-tax cash flow by (E)
a. adding back the depreciation amount.
b. deducting the depreciation amount. Barfield
c. adding back the quantity (t x depreciation deduction), where t is the corporate tax rate.
d. deducting the quantity [(1- t) x depreciation deduction], where t is the corporate tax rate.
59. Depreciation is usually not considered an operating cash flow in capital budgeting because (E)
a. depreciation is usually a constant amount each year over the life of the capital investment.
b. deducting depreciation from operating cash flows would be counting the lump-sum amount twice.
c. depreciation usually does not result in an increase in working capital.
d. depreciation usually has no effect on the disposal price of the machine. Horngren
25. Which of these could occur in practice where the capital expenditure relates to the production of an established product or service,
the demand for which is expected to vary in response to temporary changes in consumer taste?
A. perfectly correlated cash flows C. independent cash flows
B. negative cash flows D. mixed cash flows Carter & Usry
3. Which of the following is NOT relevant in calculating annual net cash flows for an investment?
a. Interest payments on funds borrowed to finance the project.
b. Depreciation on fixed assets purchased for the project.
c. The income tax rate.
d. Lost contribution margin if sales of the product invested in will reduce sales of other products. L&H
39. Which of the following is NOT relevant in calculating net cash flows for Project N?
a. Interest payments on funds that would be borrowed to finance Project N.
b. Depreciation on assets purchased for Project N.
c. The contribution margin the company would lose if sales of the product introduced by Project N will reduce sales of other
products.
d. The income tax rate applicable to the entity. L&H
13. All of the following are common cash inflows related to capital expenditure proposals, except:
A. additional revenues from increased sales
B. increased working capital requirements
C. reduction in inventory carrying costs
D. salvage value at the end of the project Carter & Usry
Irrelevant Costs
9. Money that a firm has already spent or committed to spend regardless of whether a project is taken is called:
A. Sunk costs C. Fixed costs
B. Opportunity costs D. None of the above B&M
*. In capital expenditures decisions, the following are relevant in estimating operating costs except (E)
a. Future costs. c. Differential costs.
b. Cash costs. d. Historical costs. RPCPA 1094
58. An example of a sunk cost in a capital budgeting decision for new equipment is (E)
a. increase in working capital required by a particular investment choice.
b. the book value of the old equipment.
c. the necessary transportation costs on the new equipment.
d. all of the above are examples of sunk costs. Horngren
7. The following cash flows should be treated as incremental flows when deciding whether to go ahead with an electric car except:
(M)
A. The consequent deduction in sales of the company's existing gasoline models
B. The expenditure on new plants and equipment
C. The value of tools that can be transferred from the company's existing plants
D. Interest payment on debt B&M
Comprehensive
9
. Which of the following statements is most correct? (E)
a. When evaluating corporate projects it is important to include all sunk costs in the estimated cash flows.
b. When evaluating corporate projects it is important to include all relevant externalities in the estimated cash flows.
c. Interest expenses should be included in project cash flows.
d. Statements a and b are correct. Brigham
10
. When evaluating potential projects, which of the following factors should be incorporated as part of a project’s estimated cash
flows? (E)
a. Any sunk costs that were incurred in the past prior to considering the proposed project.
b. Any opportunity costs that are incurred if the project is undertaken.
c. Any externalities (both positive and negative) that are incurred if the project is undertaken.
d. Statements b and c are correct. Brigham
11
. Which one of the following statements concerning cash flow determination for capital budgeting purposes is not correct?
a. Tax depreciation must be considered since it affects cash payments for taxes.
b. Book depreciation is relevant since it affects net income.
d. Net working capital changes should be included in cash flow forecasts.
c. Sunk costs are not incremental flows and should not be included. CMA 1295 4-11
12
. A company is considering a new project. The company’s CFO plans to calculate the project’s NPV by discounting the relevant
cash flows (which include the initial up-front costs, the operating cash flows, and the terminal cash flows) at the company’s cost of
capital (WACC). Which of the following factors should the CFO include when estimating the relevant cash flows? (E)
a. Any sunk costs associated with the project.
b. Any interest expenses associated with the project.
c. Any opportunity costs associated with the project.
d. Statements b and c are correct. Brigham
13
. Which of the following statements is correct? (M)
a. An asset that is sold for less than book value at the end of a project’s life will generate a loss for the firm and will cause an
actual cash outflow attributable to the project.
b. Only incremental cash flows are relevant in project analysis and the proper incremental cash flows are the reported
accounting profits because they form the true basis for investor and managerial decisions.
c. It is unrealistic to expect that increases in net operating working capital that are required at the start of an expansion project
are simply recovered at the project’s completion. Thus, these cash flows are included only at the start of a project.
d. Equipment sold for more than its book value at the end of a project’s life will increase income and, despite increasing taxes,
will generate a greater cash flow than if the same asset is sold at book value. Brigham
14
. Which of the following statements is most correct? (E)
a. The rate of depreciation will often affect operating cash flows, even though depreciation is not a cash expense.
b. Corporations should fully account for sunk costs when making investment decisions.
c. Corporations should fully account for opportunity costs when making investment decisions.
d. Statements a and c are correct. Brigham
. Which of the following is not a cash flow that results from the decision to accept a project? (E)
15
. Which of the following constitutes an example of a cost that is not incremental, and therefore, not relevant in an accept/reject
21
decision? (M)
a. A firm has a parcel of land that can be used for a new plant site, or alternatively, can be used to grow watermelons.
b. A firm can produce a new cleaning product that will generate new sales, but some of the new sales will be from customers
who switch from another product the company currently produces.
c. A firm orders and receives a piece of new equipment that is shipped across the country and requires $25,000 in installation
and set-up costs.
d. Statements a, b, and c are examples of incremental cash flows, and therefore, relevant cash flows. Brigham
. Which of the following is not considered a relevant concern in deter- mining incremental cash flows for a new product? (M)
22
a. The use of factory floor space that is currently unused but available for production of any product.
b. Revenues from the existing product that would be lost as a result of some customers switching to the new product.
c. Shipping and installation costs associated with preparing the machine to be used to produce the new product.
d. The cost of a product analysis completed in the previous tax year and specific to the new product. Brigham
Uncertainty
1. Which of the following best identifies the reason for using probabilities in capital budgeting decisions?
A. uncertainty C. time value of money
B. cost of capital D. projects with unequal lives AICPA adapted
*. Which of the following best identifies the reason for using probabilities in capital budgeting is (E)
a. Different life of projects. c. Uncertainty. RPCPA 0577, 0588, 1093
b. Cost of capital. d. Time value of money.
26. In capital expenditure analysis, which of the following can be constructed to evaluate alternative levels of investment?
A. normal distribution D. pie chart
B. bar graph E. payoff table
C. nonnormal distribution Carter & Usry
28. The standard deviation of the expected net present value is determined by summing the discounted standard deviations for each
period over the life of the project when the cash flows in each of the periods are:
A. independent D. negative
B. positive E. perfectly correlated
C. mixed Carter & Usry
12. Cinzano Inc. wants to use discounted cash flow techniques when analyzing its capital investment projects. The company is aware
of the uncertainty involved in estimating future cash flows. A simple method some companies employ to adjust for the uncertainty
inherent in their estimates is to:
A. ignore salvage values
B. average the expectations of several different managers
C. use accelerated depreciation
D. adjust the minimum desired rate of return
E. increase the estimates of the cash flows CMA adapted
Tax Factor
In general
58. Income taxes are levied on
a. net cash flow.
b. income as measured by accounting rules.
c. net cash flow plus depreciation.
d. income as measured by tax rules. Barfield
*. In capital budgeting decisions, the following items are considered among others: (M)
1. Cash outflow for the investment.
2. Increase in working capital requirements.
3. Profit on sale of old asset
4. Loss on write-off of old asset.
For which of the above items would taxes be relevant? (D)
a. Items 1 and 3 only. c. All items.
b. Items 3 and 4 only. d. Items 1, 3 and 4 only. RPCPA 0594
61. Which of the following are tax deductible under U.S. tax law? (M)
a. interest payments to bondholders c. common stock dividends
b. preferred stock dividends d. all of the above Barfield
35. If a company is NOT subject to income tax, which of the following is true of a proposed investment?
a. The project’s IRR equals the entity’s cost of capital.
b. The project’s NPV is zero.
c. Depreciation on assets required for the project is irrelevant to the evaluation.
d. The expected annual increase in future cash flows equals the investment required to undertake the project. L & H
53. The pre-tax and after-tax cash flows would be the same for all of the following items except (D)
a. the liquidation of working capital at the end of a project's life.
b. the initial (outlay) cost of an investment.
c. the sale of an asset at its book value.
d. a cash payment for salaries and wages. Barfield
29. Which statement describes the relevance of depreciation in calculating cash flows?
a. Depreciation is relevant only when income taxes exist.
b. Depreciation is always relevant.
c. Depreciation is never relevant.
d. Depreciation is relevant only with discounted cash flow methods. L&H
56. Multiplying the depreciation deduction by the tax rate yields a measure of the depreciation tax (D)
a. shield. c. payable.
b. benefit. d. loss. Barfield
3. Depreciation is incorporated explicitly in the cash flow analysis of an investment proposal because it:
A. is a cost of operations that cannot be avoided
B. results in an annual cash outflow
C. is a cash inflow
D. reduces the cash outlay for income taxes
E. represents the initial cash outflow spread over the life of the investment CMA adapted
23
. A depreciation tax shield is
a. An after-tax cash outflow.
b. A reduction in income taxes.
c. The cash provided by recording depreciation.
d. The expense caused by depreciation. CMA 1293 4-14, RPCPA 0596
24
. The annual tax depreciation expense on an asset reduces income taxes by an amount equal to
a. The firm’s average tax rate times the depreciation amount.
b. One minus the firm’s average tax rate times the depreciation amount.
c. The firm’s marginal tax rate times the depreciation amount.
d. One minus the firm’s marginal tax rate times the depreciation amount. CMA 1293 4-20
Accelerated Method vs. Straight-line Method
25
. The use of an accelerated method instead of the straight-line method of depreciation in computing the net present value of a
project has the effect of
a. Raising the hurdle rate necessary to justify the project.
b. Lowering the net present value of the project.
c. Increasing the present value of the depreciation tax shield.
d. Increasing the cash outflows at the initial point of the project. CMA 0695 4-3
INVESTMENT OPTIONS
Abandonment option
29
. Which of the following statements best describes the likely impact that an abandonment option will have on a project’s expected
cash flow and risk? (E)
a. No impact on expected cash flow, but risk will increase.
b. Expected cash flow increases and risk decreases.
c. Expected cash flow increases and risk increases.
d. Expected cash flow decreases and risk decreases.
e. Expected cash flow decreases and risk increases. Brigham
Real options
31
. Which of the following is an example of a flexibility option? (E)
a. A company has the option to invest in a project today or to wait a year.
b. A company has the option to back out of a project that turns out to be unproductive.
c. A company pays a higher cost today in order to be able to reconfigure the project’s input or outputs at a later date.
d. A company invests in a project today that may lead to enhanced technological improvements that allow it to expand
into different markets at a later date.
e. All of the statements above are correct. Brigham
5. Which of the following will not increase the value of a real option? (M)
a. An increase in the time remaining until the real option must be exercised.
b. An increase in the volatility of the underlying source of risk.
c. An increase in the risk-free rate.
d. An increase in the cost of exercising the real option.
e. Statements b and d. Brigham
*. All of the following are methods that aid management in analyzing the expected results of capital budgeting decisions, except (E)
Horngren, RPCPA 1095, 1096
a. Accrual accounting rate of return. c. Future value cash flow.
b. Payback period. d. Discounted cash flow rate of return.
1. The following measures are used by firms when making capital budgeting decisions except:
A. Payback period C. Net present value
B. Internal rate of return D. P/E ratio B&M
9. Which of the following capital budgeting methods does NOT consider the time value of money?
a. IRR. c. Time-adjusted rate of return.
b. Book rate of return. d. NPV. L&H
33
. Which one of the following capital investment evaluation methods does not take the time value of money into consideration?
a. Net present value. c. Internal rate of return.
b. Discounted payback. d. Accounting rate of return. CMA 0696 4-26
57. All of the following are major categories of cash flows in capital investment decisions EXCEPT (E)
a. the initial investment in machines and working capital.
b. recurring operating cash flows.
c. the initial working capital investment
d. depreciation expense reported on the income statement. Horngren
8. The method of project selection that considers the time value of money in a capital budgeting decision computes the:
A. accounting rate of return on average investment
B. internal rate of return
C. payback period
D. return on investment
E. accounting rate of return on initial investment AICPA adapted
52. Which of the following methods consider the time value of money?
a. payback and accounting rate of return
b. payback and internal rate of return
c. internal rate of return and accounting rate of return
d. internal rate of return and net present value H&M
*. Which of the following capital investment rating procedures recognize(s) the time value of money? (E)
RPCPA 0590 a. b. c. d.
Profitability index Yes No Yes No
Discounted rate of return Yes Yes No No
1. Which of the following groups of capital budgeting techniques uses the time value of money? (E)
a. Book rate of return, payback, and profitability index.
b. IRR, payback, and NPV.
c. IRR, NPV, and profitability index.
d. IRR, book rate of return, and profitability index. L&H
30. Which of the following combinations of capital budgeting techniques includes only discounted cash flow techniques?
a. Book rate of return, payback, and profitability index.
b. NPV, IRR and profitability index.
c. IRR, payback, and NPV.
d. Profitability index, NPV, and payback. L&H
18. The net present value and internal rate of return methods of capital budgeting are superior to the payback method in that they: (M)
a. are easier to implement.
b. consider the time value of money.
c. require less input.
d. reflect the effects of depreciation and income taxes. AICPA adapted
31. The capital budgeting method that divides a project's annual incremental net income by the initial investment is the: (M)
a. internal rate of return method.
b. the simple ( or accounting) rate of return method.
c. the payback method.
d. the net present value method. CMA adapted
Characteristics
36
. The accounting rate of return
A. Is synonymous with the internal rate of return.
B. Focuses on income as opposed to cash flows.
C. Is inconsistent with the divisional performance measure known as return on investment.
D. Recognizes the time value of money. CMA 0691 4-18
11. Which of the following methods uses income instead of cash flows?
a. payback c. internal rate of return
b. accounting rate of return d. net present value H&M
37
. The capital budgeting technique known as accounting rate of return uses
a. b. c. d.
Revenue over life of project No No Yes Yes
Depreciation expense Yes No No Yes
99. The capital budgeting technique known as accounting rate of return uses (D)
Barfield a. b. c. d.
Salvage value No No Yes Yes
Time value of money No Yes Yes No
Formula
38
. The method that divides a project’s annual after-tax net income by the average investment cost to measure the estimated
performance of a capital investment is the
a. Internal rate of return method. c. Payback method. CMA 1294 4-24
b. Accounting rate of return method. d. Net present value (NPV) method.
100.In computing the accounting rate of return, the ______ level of investment should be used as the denominator.
a. Average c. Residual
b. Initial d. Cumulative Barfield
64. The approach to capital budgeting which divides an accounting measure of income by an accounting measure of investment is (E)
a. net present value. c. payback method. Horngren
b. internal rate of return. d. accrual accounting rate of return.
Limitation
*. The following statements refer to the accounting rate of return (ARR)
1. The ARR is based on the accrual basis, not cash basis.
2. The ARR does not consider the time value of money.
3. The profitability of the project is considered.
From the above statements, which are considered limitations of the ARR concept? (M)
a. Statements 2 and 3 only. c. All the 3 statements.
b. Statements 3 and 1 only. d. Statements 1 and 2 only. RPCPA 1094
65. For capital budgeting decisions, the use of the accrual accounting rate of return for evaluating performance is often a stumbling
block to the implementation of the (E)
a. net cash flow.
b. most effective goal-congruence choice.
c. discounted cash flow method for capital budgeting.
d. most effective tax strategy. Horngren
PAYBACK PERIOD
Definition
10. The payback period is the
a. length of time over which the investment will provide cash inflows.
b. length of time over which the initial investment is recovered.
c. shortest length of time over which an investment may be depreciated.
d. shortest length of time over which the net present value will be positive. Barfield
39
. The length of time required to recover the initial cash outlay of a capital project is determined by using the CMA 1294 4-20
a. Discounted cash flow method. c. Weighted net present value method.
b. Payback method. d. Net present value method.
*. An investment rating approach which measures the length of time required to recover the initial outlay for a particular investment
proposal is the (E)
a. Accounting rate of return c. Net present value
b. Payback period d. Present value index RPCPA 0590
40
. The technique that measures the number of years required for the after-tax cash flows to recover the initial investment in a project
is called the
A. Net present value method. C. Profitability index method. CMA 1290 4-17
B. Payback method. D. Accounting rate of return method.
*. The method that measures how quickly investment pesos may be recovered is the (E)
a. Payback method c. Simple rate of return method
b. Time adjusted rate of return d. Least squares methodRPCPA 1074, 10/77
61. The method that measures the time it will take to recoup, in the form of future cash inflows, the total dollars invested in a project is
called (E)
a. the accrued accounting rate-of-return method.
b. payback method.
c. internal rate-of-return method.
d. the book-value method. Horngren
63. The payback method of capital budgeting approach to the investment decision highlights (E)
a. cash flow over the life of the investment.
b. the liquidity of the investment.
c. the tax savings of the depreciation amounts.
d. having as lengthy payback time as possible. Horngren
Characteristics
19. The technique most concerned with liquidity is (M)
a. Payback. c. IRR.
b. NPV. d. Book rate of return. L&H
2. Which of the following capital budgeting techniques may potentially ignore part of a project's relevant cash flows? (M)
a. net present value c. payback period
b. internal rate of return d. profitability index Barfield
41
. A characteristic of the payback method (before taxes) is that it (E)
a. Incorporates the time value of money.
b. Neglects total project profitability.
c. Uses accrual accounting inflows in the numerator of the calculation. CMA 0694 4-17
d. Uses the estimated expected life of the asset in the denominator of the calculation.
4. Which of the following capital budgeting techniques does not routinely rely on the assumption that all cash flows occur at the end
of the period?
a. internal rate of return c. profitability index
b. net present value d. payback period Barfield
7. The payback method assumes that all cash inflows are reinvested to yield a return equal to
a. the discount rate. c. the internal rate of return.
b. the hurdle rate. d. zero. Barfield
39. Assuming that a project has already been evaluated using the following techniques, the evaluation under which technique is least
likely to be affected by an increase in the estimated residual value of the project?
a. Payback period. c. NPV.
b. IRR. d. PI. L&H
30. The evaluation of an investment having uneven cash flows using the payback method: (M)
a. cannot be done.
b. can be done only by matching cash inflows and investment outflows on a year-by-year basis.
c. will product essentially the same results as those obtained through the use of discounted cash flow techniques.
d. requires the use of a sophisticated calculator or computer software. G & N 9e
10. Which of the following investment rules may not use all possible cash flows in its calculations?
A. Payback period. C. IRR
B. NPV D. All of the above B&M
Advantage
*. An advantage of the payback method is (E)
a. Not based on cash flow data. c. Precise in estimate of profits.
b. Insensitive of the life of the project. d. Easy to apply. RPCPA 1093
*. An advantage of using the payback method of evaluating capital budgeting alternatives is that payback is
a. Insensitive to the life of the project considered.
b. Precise estimate of profitability.
c. Based on cash flow data.
d. Easy to apply. RPCPA 0577, 5/80, 5/98
Disadvantage
*. This technique is criticised because it fails to consider investment profitability (E)
a. Time adjusted ROI c. Average return on investment
b. Payback method d. Present value method RPCPA 1093
11. Which of the following capital budgeting techniques has been criticized because it fails to consider investment profitability? (E)
a. payback method c. net present value method
b. accounting rate of return d. internal rate of return Barfield
42
. Which one of the following statements about the payback method of investment analysis is correct? The payback method
a. Does not consider the time value of money.
b. Consider cash flows after the payback has been reached.
c. Uses discounted cash flow techniques. CMA 1295 4-1
d. Generally leads to the same decision as other methods for long-term projects.
34. Which of the following methods FAILS to distinguish between return of investment and return on investment.
a. NPV. c. Payback.
b. IRR. d. Book rate of return. L&H
14. Deficiencies associated with using the payback method to evaluate investment alternatives include all of the following, except that:
A. the present value of cash inflows is ignored
B. inflows of different time periods are treated equally
C. it may be used to select those investments yielding a quick return of cash
D. cash flows after the payback period are ignored CIA adapted
15. The following are disadvantages of using the payback rule except:
A. The payback rule ignores all cash flow after the cutoff date
B. The payback rule does not use the time value of money
C. The payback period is easy to calculate and use
D. The payback rule does not have the value additive property B&M
Formula
. The cash payback formula is:
a. Cost of Capital Investment / Net Income.
b. Average Investment / Net Annual Cash Inflow.
c. Cost of Capital Investment / Net Annual Cash Inflow.
d. Average Investment / Net Income. RPCPA 1001
5. Assume that a project consists of an initial cash outlay of $100,000 followed by equal annual cash inflows of $40,000 for 4 years.
In the formula X = $100,000/$40,000, X represents the (E)
a. payback period for the project. c. internal rate of return for the project.
b. profitability index of the project. d. project's discount rate. Barfield
Decision Criteria
9. The payback period rule accepts all projects for which the payback period is:
A. Greater than the cut-off value C. Is positive
B. Less than the cut-off value D. An integer B&M
Payback Reciprocal
43
. The payback reciprocal can be used to approximate a project’s
a. Profitability index
b. Net present value.
c. Accounting rate of return if the cash flow pattern is relatively stable.
d. Internal rate of return if the cash flow pattern is relatively stable. CMA 0693 4-27
Relevant Items
1. In order to calculate the payback period for a project, it is necessary to know the:
A. salvage value D. net present value
B. useful life E. annual cash flow
C. minimum desired rate of return Carter & Usry
1. Calculating the payback period for a capital project requires knowing which of the following?
a. Useful life of the project.
b. The company’s minimum required rate of return.
c. The project’s NPV.
d. The project’s annual cash flow. L&H
Irrelevant Items
*. As a capital budgeting technique, the payback period considers depreciation expenses (DE) and time value of money (TVM) as
follows: (M)
RPCPA 1095 a. b. c. d.
DE relevant irrelevant Irrelevant relevant
TVM relevant irrelevant Relevant irrelevant
44
. The capital budgeting technique known as payback period uses
a. b. c. d.
Depreciation expense Yes Yes No No
Time value of money Yes No No Yes
BAILOUT PAYBACK
Definition
*. The bailout payback period is (E)
a. The payback period used by firms with government insured loans.
b. The length of time for payback using cash flows plus the salvage value to recover the original investment
c. (a) and (b)
d. None of the above. RPCPA 1090
45
. The bailout payback method (E)
A. Is used by firms with federally insured loans.
B. Calculates the payback period using the sum of the net cash flows and the salvage value.
C. Calculates the payback period using the difference between net cash inflow and the salvage value.
D. Estimates short-term profitability. Gleim
Use
46
. The bailout payback method
a. Incorporates the time value of money.
b. Equals the recovery period from normal operations.
c. Eliminates the disposal value from the payback calculation.
d. Measures the risk if a project is terminated. CMA 1292 4-11
DISCOUNTED CASH FLOW ANALYSIS
37. The consumption opportunity increases when an investment with positive NPV is available because:
A. The investment is better than what is available in the market
B. The project rate of return is less than market rate
C. The market is irrelevant to the investment criteria
D. All of the above are reasons for increase in consumption B&M
Factors
14. When using one of the discounted cash flow methods to evaluate the desirability of a capital budgeting project, which of the
following factors is generally not important? (E)
a. method of financing the project under consideration
b. timing of cash flows relating to the project
c. impact of the project on income taxes to be paid
d. amounts of cash flows relating to the project Barfield
Assumptions
52. In a typical (conservative assumptions) after-tax discounted cash flow analysis, depreciation expense is assumed to accrue at
a. the beginning of the period.
b. the middle of the period.
c. the end of the period.
d. irregular intervals over the life of the investment. Barfield
29. The line that connects the maximum that one can consume this year (now) and the maximum one can consume next year:
A. Has a slope of (1+r) C. Has a slope of r
B. Has a slope of -(1+r) D. Has a slope of 1/r B&M
*. The method of project selection which considers the time value of money in a capital budgeting decision is accomplished by
computing the (E)
a. Accounting rate of return on initial investment
b. Payback period.
c. Accounting rate of return on average investment.
d. Discounted cash flow. RPCPA 0598
2. The component of the capital investment decision that would most likely concern an accountant is the:
A. social responsibility factors D. imponderables
B. competition E. legal restrictions
C. time value of money Carter & Usry
*. The fact that an amount of money that is to be received in the future is not equivalent to the same amount of money to be received
now is referred to as: (E)
a. Present value of money. c. Future value of money.
b. Time value of money. d. Discounted value of money. RPCPA 0587
47
. What is the time value of money?
A. Interest. C. Future value.
B. Present value. D. Annuity. Gleim
12. The time value of money is explicitly recognized through the process of
a. interpolating. c. annuitizing.
b. discounting. d. budgeting. Barfield
13. The time value of money is considered in long-range investment decisions by (M)
a. assuming equal annual cash flow patterns.
b. investing only in short-term projects.
c. assigning greater value to more immediate cash flows.
d. ignoring depreciation and tax implications of the investment. Barfield
48
. Basic time value of money concepts concern
Gleim A. B. C. D.
Interest Factors Yes Yes No No
Risk Yes No Yes No
Cost of Capital No Yes No Yes
49
. The present value may be calculated for discounted cash
Gleim A. B. C. D.
Inflows Yes Yes No No
Outflows Yes No Yes No
Annuities Yes Yes No Yes
9. The net present value and the internal rate of return methods of decision making in capital budgeting are superior to the payback
method in that they:
A. consider the time value of money
B. are easier to implement
C. consider accrual-based accounting income
D. require less input
E. reflect the effects of depreciation and income taxes AICPA adapted
Application
11. A company is considering the purchase of a new conveyor belt system for carrying parts and subassemblies from building to
building within its plant complex. It is expected that the system will have a useful life of at least ten years and that it will
substantially reduce labor and waiting-time costs. If the company's average cost of capital is about 15% and if some evaluation
must be made of cost/benefit relationships (including the effects of interest) to determine the desirability of the purchase, the most
relevant quantitative technique for evaluating the investment is:
A. present value (or internal rate of return) analysis
B. Program Evaluation and Review Technique (PERT)
C. accounting rate of return analysis
D. cost-volume-profit analysis
E. payback analysis AICPA adapted
2. Discounted cash flow techniques for analyzing capital budgeting decisions are NOT normally applied to projects
a. Requiring no investment after the first year of life.
b. Having useful lives shorter than one year.
c. That are essential to the business.
d. Involving replacement of existing assets. L&H
*. The method of project selection which considers the value of money in a capital budgeting decision is accomplished by computing
the
a. Payback period.
b. Accounting rate of return on initial investment.
c. Accounting rate of return on average investment.
d. Discounted cash flow. RPCPA 0577, 10/79, 10/93
*. There are several evaluation techniques for determining the acceptability of an investment. The method that considers the time
value of money in an investment budgeting decision is accomplished by determining the (E)
a. Cash-flow payback method. c. Average rate of return.
b. Accounting rate of return. d. Discounted cash flow. RPCPA 1081
*. The method of project selection which considers the time value of money in a capital budgeting decision is accomplished by
computing the (E)
a. Accounting rate of return on initial investment.
b. Accounting rate of return on average investment.
c. Discounted cash flow.
d. Payback period. RPCPA 0580
*. The modern approach used by decision-makers in evaluating investment opportunities by comparing the original investment with
the cash generation for the entire life of the project to come up with the rate of return on investment is (E)
a. Discounted cash flow method d. Profitability index
b. Accounting rate of return approach e. Cash payoff method
c. Cash flow projections RPCPA 1077
50
. All of the following items are included in discounted cash flow analysis except
a. Future operating cash savings.
b. The disposal prices of the current assets
c. The future asset depreciation expense.
d. The tax effects of future asset depreciation. CMA 0694 4-18
51
. The capital budgeting model that is ordinarily considered the best model for long-range decision making is the CMA 1294 4-25
a. Payback model. c. Unadjusted rate of return model.
b. Accounting rate of return model. d. Discounted cash flow model.
*. When using one of the discounted-cash-flow methods to evaluate the feasibility of a capital budgeting project, which of the
following factors generally is not important? (M)
a. The method of financing the project under consideration.
b. The impact of the project on income taxes to be paid.
c. The timing of cash flows relating to the project.
d. The amount of cash flows relating to the project. RPCPA 0598
52
. Discounted cash flow concepts concern
Gleim a. b. c. d.
Interest Factors Yes Yes No No
Risk Yes No Yes No
53
. Depreciation is incorporated explicitly in the discounted cash flow analysis of an investment proposal because it
A. Is a cost of operations that cannot be avoided.
B. Is a cash inflow.
C. Reduces the cash outlay for income taxes.
D. Represents the initial cash outflow spread over the life of the investment. CMA 1277 5-14
31. Discounted cash flow methods for capital budgeting focus on (E)
a. cash inflows. c. cash outflows.
b. operating income. d. both (a) and (c). Horngren
Rate of Return
Discount Rate
18. The discount rate for safe projects is the:
A. Market rate of return C. Market risk premium
B. Risk-free rate D. None of the above B&M
19. The discount rate for a project with a risk the same as the market risk is the:
A. Market rate of return C. Market risk premium
B. Risk-free rate D. None of the above B&M
Cost of Capital
27. Hurdle rate for capital budgeting decisions is:
A. The cost of capital C. The cost of equity
B. The cost of debt D. All of the above B&M
*. In an investment in plant the return that should keep the market price of the firm stock unchanged is (M)RPCPA 0577, 1077, 0588,
1093
a. Payback c. Net present value
b. Discounted rate of return d. Cost of capital
25. For a project such as plant investment, the return that should leave the market price of the firm's stock unchanged is known as the
a. cost of capital. c. payback rate.
b. net present value. d. internal rate of return. Barfield
16. A company with cost of capital of 15% plans to finance an investment with debt that bears 10% interest. The rate it should use to
discount the cash flows is
a. 10%. c. 25%.
b. 15%. d. Some other rate. L&H
Comprehensive
. All of the following refer to the discount rate used by a firm in capital budgeting except (M)
a. Hurdle rate. c. Opportunity cost.
b. Required rate of return. d. Opportunity cost of capital. RPCPA 1096
97. Which of the following indicates that the first cash flow is at the end of a period? (M)
Barfield a. b. c. d.
Ordinary annuity Yes Yes No No
Annuity due No Yes Yes No
98. Assume that X represents a sum of money that Bill has available to invest in a project that will yield a return of r. In the formula Y =
X(1 + r), Y represents the
a. future value of X in one period.
b. future value interest factor associated with r.
c. present value of X.
d. present value interest factor associated with r. Barfield
2. Which of the following investment rules does not use the time value of the money concept?
A. The payback period
B. Internal rate of return
C. Net present value
D. All of the above use the time value concept B&M
BREAKEVEN TIME
14. Which of the following statements regarding the discounted payback period rule is true?
A. The discounted payback rule uses the time value of money concept.
B. The discounted payback rule is better than the NPV rule
C. The discounted payback rule considers all cash flows
D. The discounted payback rule exhibits the value additive property B&M
57
. When evaluating projects, breakeven time is best described as (M)
a. Annual fixed costs monthly contribution margin.
b. Project investment annual net cash inflows.
c. The point at which cumulative cash inflows on a project equal total cash outflows.
d. The point at which discounted cumulative cash inflows on a project equal discounted total cash outflows. CMA 0693 4-28
PROFITABILITY INDEX
Definition
3. The profitability index
a. Does not use present values of cash flows.
b. Is generally preferable to any other approach for evaluating mutually exclusive investment alternatives.
c. Produces the same ranking of investment alternatives as does the IRR criterion.
d. Is a discounted cash flow method. L&H
*. Which of the following capital budgeting techniques is computed by dividing present value of future inflows by the initial
investment? (M)
a. Accounting rate of return c. Payback reciprocal
b. Time-adjusted rate of return d. Profitability index RPCPA 0589
Assumption
42. Which method of evaluating capital projects assumes that cash inflows can be reinvested at the discount rate?
a. internal rate of return c. profitability index
b. payback period d. accounting rate of return Barfield
Formula
33. Profitability index is the ratio of:
A. Present value of cash flow to initial investment
B. Net present value cash flow to initial investment
C. Net present value of cash flow to IRR
D. Present value of cash flow to IRR B&M
22. Probabilistic estimates are most frequently used with which of the following methods of capital expenditure evaluation?
A. payback C. internal rate of return
B. present value D. accounting rate of return Carter & Usry
34. The capital budgeting method which calculates the expected monetary gain or loss from a project by discounting all expected
future cash inflows and outflows to the present point in time using the required rate of return is the (E)
a. payback method.
b. accrual accounting rate-of-return method.
c. sensitivity method.
d. net present value method. Horngren
70. A capital budgeting tool management can use to summarize the difference in the future net cash inflows from an intangible asset at
two different points in time is referred to as (E)
a. the accrual accounting rate-of-return method.
b. the net present value method.
c. sensitivity analysis
d. the payback method. Horngren
Underlying Theory
*. The excess present value method is anchored on the theory that the future returns, expressed in terms of present value, must at
least be (E)
a. Equal to the amount of investment c. More than the amount of investment
b. Less than the amount of investment RPCPA 1074
62
. If a firm identifies (or creates) an investment opportunity with a present value <List A> its cost, the value of the firm and the price of
its common stock will <List B> (M)
CIA 1195 IV-44 a. b. c. d.
List A Greater than Greater than Equal to Equal to
List B Increase Decrease Increase Decrease
Characteristics
35. The net present value method of evaluating proposed investments
a. measures a project's internal rate of return.
b. ignores cash flows beyond the payback period.
c. applies only to mutually exclusive investment proposals.
d. discounts cash flows at a minimum desired rate of return. Barfield
63
. In evaluating a capital budget project, the use of the net present value (NPV) model is ordinarily not affected by the (E)
a. Method of funding the project.
b. Initial cost of the project.
c. Amount of added working capital needed for operations during the term of the project.
d. Project’s salvage value. CMA 1294 4-21
e. Amount of the project’s associated depreciation tax allowance.
64
. The capital budgeting technique known as net present value uses
AICPA 1180 T-48 a. b. c. d.
Cash flow over life of project No No Yes Yes
Time value of money Yes No No Yes
16. Which of the following capital budgeting methods has the value additive property?
A. NPV C. Payback period
B. IRR D. Discounted payback period B&M
Assumption
33. If an analyst desires a conservative net present value estimate, he/she will assume that all cash inflows occur at (M)
a. mid year. c. year end.
b. the beginning of the year. d. irregular intervals. Barfield
*. The common assumption in capital budgeting analysis is that cash inflows occur in lump sums at the end of individual years during
the life of an investment project when in fact they flow more or less continuously during those years (M)
a. Results in understated estimates of NPV.
b. Is done because present value tables for continuous flows cannot be constructed.
c. Will result in inconsistent errors being made on estimating NPVs such that project cannot be evaluated reliably.
d. Results in higher estimate for the IRR on the investment. RPCPA 1095
65
. The accountant of Ronier, Inc. has prepared an analysis of a proposed capital project using discounted cash flow techniques. One
manager has questioned the accuracy of the results because the discount factors employed in the analysis have assumed the
cash flows occurred at the end of the year when the cash flows actually occurred uniformly throughout each year. The net present
value calculated by the accountant will
A. Not be in error.
B. Be slightly overstated.
C. Be unusable for actual decision making.
D. Be slightly understated but usable. CMA 1278 5-10
21. The net present value method assumes that all cash inflows can be immediately reinvested at the
a. cost of capital. c. internal rate of return. Barfield
b. discount rate. d. rate on the corporation's short-term debt.
21. The net present value method of capital budgeting assumes that cash flows are reinvested at: (E)
a. the internal rate of return on the project.
b. the rate of return on the company's debt.
c. the discount rate used in the analysis.
d. a zero rate of return. CMA adapted
66
. The net present value (NPV) method of investment project analysis assumes that the project’s cash flows are reinvested at the
CMA 0692 4-16, RPCPA 0596
a. Computed internal rate of return. c. Discount rate used in the NPV calculation.
b. Risk-free interest rate. d. Firm’s accounting rate of return.
67
. The net present value method of capital budgeting assumes that cash flows are reinvested at
a. The risk-free rate. c. The internal rate of return of the project.
b. The cost of debt. d. The discount rate used in the analysis.
CMA 1295 4-9
36. Which of the following statements is true regarding capital budgeting methods? (D)
a. The Fisher rate can never exceed a company's cost of capital.
b. The internal rate of return measure used for capital project evaluation has more conservative assumptions than the net
present value method, especially for projects that generate a positive net present value.
c. The net present value method of project evaluation will always provide the same ranking of projects as the profitability index
method.
d. The net present value method assumes that all cash inflows can be reinvested at the project's cost of capital. Barfield
10. The advantage of the Net Present Value method over the Internal Rate of Return method for screening investment projects is that
it:
a. does not consider the time value of money
b. implicitly assumes that the company is able to reinvest cash flows from the project at the company’s discount rate
c. implicitly assumes that the company is able to reinvest cash flows from the project at the internal rate of return
d. fails to consider the timing of cash flows Pol Bobadilla
16. The capital budgeting method that assumes that funds are reinvested at the company's cost of capital is:
A. accounting rate of return D. return on investment
B. net present value E. payback
C. internal rate of return AICPA adapted
Advantage
68
. An advantage of the net present value method over the internal rate of return model in discounted cash flow analysis is that the net
present value method
a. Computes a desired rate of return for capital projects. CMA 0695 4-1
b. Can be used when there is no constant rate of return required for each year of the project.
c. Uses a discount rate that equates the discounted cash inflows with the outflows.
d. Uses discounted cash flows whereas the internal rate of return model does not.
28. The net present value capital budgeting technique can be used when cash flows from period to period are:
AICPA adapted A. B. C. D.
Uniform No No Yes Yes
Uneven Yes No No Yes
53. In situations where the required rate of return is not constant for each year of the project, it is advantageous to use (E)
a. the adjusted rate-of-return method. c. the net present value method.
b. the internal rate-of-return method. d. sensitivity analysis. Horngren
Disadvantage
69
. A disadvantage of the net present value method of capital expenditure evaluations is that it (M)
a. Is calculated using sensitivity analysis.
b. Computes the true interest rate.
c. Does not provide the true rate of return on investment.
d. Is difficult to apply because it uses a trial-and-error approach.CMA 1295 4-16 RPCPA 0597
Application
35. NPV is appropriate to use to analyze which decision relating to a joint-products company?
a. Whether or not to sell facilities now used for additional processing of one of the joint products.
b. Whether or not to acquire facilities needed for additional processing of one of the joint products.
c. Whether or not to sell facilities now used to operate the joint process.
d. All of the above. L&H
Variables
Required Rate of Return
32. Net present value is calculated using (E)
a. the internal rate of return.
b. the required rate of return.
c. the rate of return required by the investment bankers.
d. none of the above. Horngren
39. Which of the following is NOT an appropriate term for the required rate of return? (E)
a. Discount rate c. Cost of capital Horngren
b. Hurdle rate d. All of the above are appropriate terms
18. The interest rate used to find the present value of a future cash flow is the
a. prime rate. c. cutoff rate.
b. discount rate. d. internal rate of return. Barfield
54. By using the required rate of return of an equivalent security traded in the financial markets as a discount rate in the NPV
calculations, we are:
A. Discounting for time C. A and B above
B. Discounting for risk D. None of the above B&M
52. The discount rate is used for calculating the NPV is:
A. Determined by the financial market
B. Found by the government
C. Found by the CEO
D. None of the above B&M
70
. The discount rate ordinarily used in present value calculation is the
a. Federal Reserve rate.
b. Treasury bill rate.
c. Minimum desired rate of return set by the firm.
d. Prime rate. Gleim
20. In capital budgeting, a firm's cost of capital is frequently used as the (M)
a. internal rate of return. c. discount rate.
b. accounting rate of return. d. profitability index. Barfield
71
. When using the net present value method for capital budgeting analysis, the required rate of return is called all of the following
except the
A. Risk-free rate. C. Discount rate.
B. Cost of capital. D. Cutoff rate. CMA 1292 4-16
72
. All of the following are the rates used in net present value analysis except for the
a. Cost of capital. c. Discount rate.
b. Hurdle rate. d. Accounting rate of return. CMA 0694 4-15
Net Investment
73
. A project’s net present value, ignoring income tax considerations, is normally affected by the
a. Proceeds from the sale of the asset to be replaced.
b. Carrying amount of the asset to be replaced by the project.
c. Amount of annual depreciation on the asset to be replaced. AICPA 0593 T-47
d. Amount of annual depreciation on fixed assets used directly on the project.
Working Capital
22. Some investment projects require that a company expand its working capital to service the greater volume of business that will be
generated. Under the net present value method, the investment of working capital should be treated as: (M)
a. an initial cash outflow for which no discounting is necessary.
b. a future cash inflow for which discounting is necessary.
c. both an initial cash outflow for which no discounting is necessary and a future cash inflow for which discounting is necessary.
d. irrelevant to the net present value analysis. G & N 9e
Salvage Value
31. A proposed project has an expected economic life of eight years. In the calculation of the net present value (NPV) of the project,
salvage value would be:
A. excluded from the calculation of the NPV
B. included as a cash inflow at the estimated salvage value AICPA adapted
C. included as a cash inflow at the future amount of the estimated salvage value
D. included as a cash inflow at the present value of the estimated salvage value
Comprehensive
19. How are the following used in the calculation of the net present value of a proposed project? Ignore income tax considerations. (M)
AICPA adapted A. B. C. D.
Depreciation expense Include Include Exclude Exclude
Salvage value Include Exclude Include Exclude
20. The net present value method takes into account: (M)
AICPA adapted A. B. C. D.
Cash Flow Over Life of Project No No Yes Yes
Time Value of Money Yes No No Yes
Formula
50. The present value formula for one period cash flow is:
A. PV = C1(1 + r) C. PV = C1/(1 + r)
B. PV = C1/r D. None of the above B&M
51. The net present value formula for one period is:
A. NPV = PV cash flows - initial investment C. NPV = C0/[C1(1 + r)]
B. NPV = C0/C1 D. None of the above B&M
Decision Criteria
43. The managers of a firm can maximize stockholder wealth by:
A. Taking all projects with positive NPVs
B. Taking all projects with NPVs greater than the cost of investment
C. Taking all projects with NPVs greater than present value of cash flow
D. All of the above B&M
43. If the net present value for a project is zero or positive, this means (E)
a. the project should be accepted.
b. the project should not be accepted.
c. the expected rate of return is below the required rate of return.
d. both (a) and (c). Horngren
32. According to the net present value rule, an investment in a project should be made if the:
A. Net present value is greater than the cost of investment
B. Net present value is greater than the present value of cash flows
C. Net present value is positive
D. Net present value is negative B&M
35. Which of the following statements regarding the net present value rule and the rate of return rule is true?
A. Accept a project if the rate of return is positive
B. Accept a project the rate of return on a risky project exceeds the risk-free rate
C. Accept a project if the net present value is positive
D. None of the above statements are true B&M
38. In using the net present value method, only projects with a zero or positive net present value are acceptable because (E)
a. the return from these projects equals or exceeds the cost of capital.
b. a positive net present value on a particular project guarantees company profitability.
c. the company will be able to pay the necessary payments on any loans secured to finance the project.
d. of both (a) and (b). Horngren
33. Which of the following statements regarding the net present value rule and the rate of return rule is not true?
A. Accept a project if NPV > cost of investment
B. Accept a project if NPV is positive
C. Accept a project if return on investment exceeds the rate of return on an equivalent investment in the financial market
D. All of the above statements are true B&M
17. The following statements regarding the NPV rule and the rate of return rule are true except:
A. Accept a project if its NPV > 0
B. Reject a project if its NPV < 0
C. Accept a project if its rate of return > 0
D. Accept a project if its rate of return > opportunity cost of capital B&M
34. According to the rate of return rule an investment in a risky project should be made if:
A. The return on investment exceeds the risk-free rate
B. The return on investment is positive
C. The return on investments exceeds the rate of return on an equivalent investment in the financial market
D. None of the above statements are true B&M
20. The NPV value obtained by discounting nominal cash flows using the nominal discount rate is:
A. The same as the NPV value obtained by discounting real cash flows using the real discount rate
B. The same as the NPV value obtained by discounting real cash flows using the nominal discount rate
C. The same as the NPV value obtained by discounting nominal cash flows using the real discount rate
D. None of the above B&M
46. The rate of interest that produces a zero net present value when a project's discounted cash operating advantage is netted against
its discounted net investment is the
a. cost of capital. c. cutoff rate.
b. discount rate. d. internal rate of return. Barfield
77
. The internal rate of return for a project can be determined
A. If the internal rate of return is greater than the firm's cost of capital.
B. Only if the project cash flows are constant. CMA 1293 4-12
C. By finding the discount rate that yields a net present value of zero for the project.
D. By subtracting the firm's cost of capital from the project's profitability index.
78
. The internal rate of return is
a. The discount rate at which the NPV of the cash flows is zero.
b. The breakeven borrowing rate for the project in question.
c. The yield rate/effective rate of interest quoted on long-term debt and other instruments.
d. All of the answers are correct. AICPA 1181 I-39
79
. The internal rate of return is
A. The breakeven borrowing rate for the project in question.
B. The yield rate/effective rate of interest quoted on long-term debt and other instruments.
C. Favorable when it exceeds the hurdle rate.
D. All of the answers are correct. Gleim
17. When a project has uneven projected cash inflows over its life, an analyst may be forced to use _______________ to find the
project's internal rate of return.
a. a screening decision c. a post investment audit
b. a trial-and-error approach d. a time line Barfield
47. The capital budgeting method that calculates the discount rate at which the present value of expected cash inflows from a project
equals the present value of expected cash outflows is the (E)
a. net present value method.
b. accrual accounting rate-of-return method.
c. payback method.
d. internal rate of return. Horngren
Variables
*. The capital budgeting technique known as internal rate of return uses (E)
RPCPA 0598 a. b. c. d.
Cash flow over entire life of project No Yes Yes No
Time value of money Yes Yes No No
80
. How are the following used in the calculation of the internal rate of return of a proposed project? Ignore income tax considerations.
a. b. c. d.
Residual sales value of project Exclude Include Exclude Include
Depreciation expense Include Include Exclude Exclude
38. If Co. X wants to use IRR to evaluate long-term decisions and to establish a cutoff rate of return, X must be sure the cutoff rate is
(E)
a. At least equal to its cost of capital.
b. At least equal to the rate used by similar companies.
c. Greater than the IRR on projects accepted in the past.
d. Greater than the current book rate of return. L&H
Assumption/Disadvantage
48. Which of the following capital expenditure planning and control techniques has been criticized because it might mistakenly imply
that earnings are reinvested at the rate of return earned by the investment? (M)
a. payback method c. net present value method
b. accounting rate of return d. internal rate of return Barfield
81
. The net present value (NPV) method and the internal rate of return (IRR) method are used to analyze capital expenditures. The
IRR method, as contrasted with the NPV method,
A. Is considered inferior because it fails to calculate compounded interest rates.
B. Incorporates the time value of money whereas the NPV method does not.
C. Assumes that the rate of return on the reinvestment of the cash proceeds is at the indicated rate of return of the project
analyzed rather than at the discount rate used.
D. Is preferred in practice because it is able to handle multiple desired hurdle rates, which is impossible with the NPV method.
CMA 1291 4-7
82
. A weakness of the internal rate of return (IRR) approach for determining the acceptability of investments is that it (E)
a. Does not consider the time value of money.
b. Is not a straightforward decision criterion.
c. Implicitly assumes that the firm is able to reinvest project cash flows at the firm’s cost of capital.
d. Implicitly assumes that the firm is able to reinvest project cash flows at the project’s internal rate of return. CMA 1292 4-13
25. A weakness of the internal rate of return method for screening investment projects is that it: (M)
a. does not consider the time value of money.
b. implicitly assumes that the company is able to reinvest cash flows from the project at the company's discount rate.
c. implicitly assumes that the company is able to reinvest cash flows from the project at the internal rate of return.
d. does not take into account all of the cash flows from a project. CMA adapted
10. Which of the following capital expenditure planning and control techniques has been criticized because it might mistakenly imply
that earnings are reinvested at the rate of return earned by the investment?
A. internal rate of return method
B. accounting rate of return on initial investment method
C. payback method
D. average return on investment method
E. present value method AICPA adapted
25. The following are some of the shortcomings of the IRR method except: (E)
A. IRR is conceptually easy to communicate
B. Projects can have multiple IRRs B&M
C. IRR method cannot distinguish between a borrowing project and a lending project
D. It is very cumbersome to evaluate mutually exclusive projects using the IRR method
Advantage
83
. Which of the following characteristics represent an advantage of the internal rate of return techniques over the accounting rate of
return technique in evaluating a project? (M)
I Recognition of the project’s salvage value.
II Emphasis on cash flows.
III Recognition of the time value of money.
a. I only. c. II and III.
b. I and II. d. I, II, and III. AICPA 1192 T-49
Decision Criteria
48. In capital budgeting, a project is accepted only if the internal rate of return (E)
a. equals or exceeds the required rate of return.
b. equals or is less than the required rate of return.
c. equals or exceeds the net present value.
d. equals or exceeds the accrual accounting rate of return. Horngren
Comprehensive
23. Your company is comparing internal rate of return to net present value computations as alternative criteria for evaluating potential
capital investments. Which of the following best describes these computations?
A. The internal rate of return method ignores the initial cost of the investment in its computations.
B. The net present value method ignores the company's cost of capital.
C. The net present value method is more appropriate to use during periods of inflation.
D. The two methods will give the same rankings because they both consider the time value of money. CIA adapted
E. The internal rate of return method assumes that the positive cash flows generated each year are reinvested at the computed
rate of return for the investment being evaluated.
11. A company is considering the purchase of a new conveyor belt system for carrying parts and subassemblies from building to
building within its plant complex. It is expected that the system will have a useful life of at least ten years and that it will
substantially reduce labor and waiting-time costs. If the company's average cost of capital is about 15% and if some evaluation
must be made of cost/benefit relationships (including the effects of interest) to determine the desirability of the purchase, the most
relevant quantitative technique for evaluating the investment is:
A. present value (or internal rate of return) analysis
B. Program Evaluation and Review Technique (PERT)
C. accounting rate of return analysis
D. cost-volume-profit analysis
E. payback analysis AICPA adapted
*. Statement 1 The internal rate of return is the discount rate that equals the amount invested at a given date with the present value
of the expected cash inflows from the investment.
Statement 2 If the minimum desired rate of return exceeds the internal rate of return expected from a project, the project should
be rejected.
Statement 3 The internal rate of return can be more easily applied to situations with uneven periodic cash flows than can the net
present value. (M)
RPCPA 0592 a. b. c. d.
Statement 1 True False True False
Statement 2 True False True False
Statement 3 True False False True
PI and NPV
31. An investment whose profitability index is 1.00
a. Has an IRR equal tot eh prevailing interest rate.
b. Returns to the company only the cash outlay for the investment.
c. Has a payback period equal to its useful life.
d. Has an NPV of zero. L&H
38. If a project generates a net present value of zero, the profitability index for the project will
a. equal zero. c. equal -1.
b. equal 1. d. be undefined. Barfield
39. If the profitability index for a project exceeds 1, then the project's
a. net present value is positive.
b. internal rate of return is less than the project's discount rate.
c. payback period is less than 5 years.
d. accounting rate of return is greater than the project's internal rate of return. Barfield
PI & IRR
21. If the profitability index is less than one,
a. The IRR is less than cost of capital. c. The IRR is greater than cost of capital.
b. The IRR is the same as cost of capital. d. None of the above is true. L&H
48. A project has an IRR less than the cost of capital. The profitability index for this project would be
a. Less than zero.
b. Between zero and one.
c. Greater than one.
d. Cannot be determined without more information. L&H
47. A project has an IRR in excess of the cost of capital. The profitability index for this project would be (M)
a. Less than zero.
b. Between zero and one.
c. Greater than one.
d. Cannot be determined without more information. L&H
49. If the discount rate that is used to evaluate a project is equal to the project's internal rate of return, the project's _________ is zero.
a. profitability index c. present value of the investment
b. internal rate of return d. net present value Barfield
22. If an investment project (normal project) has an IRR equal to the cost of capital, the NPV for that project is: (E)
A. Positive C. Zero
B. Negative D. Unable to be determined B&M
26. If the net present value of a project is zero based on a discount rate of sixteen percent, then the time-adjusted rate of return: (M)
a. is equal to sixteen percent.
b. is less than sixteen percent.
c. is greater than sixteen percent.
d. cannot be determined from the information given. G & N 9e
4. If the present value of the future cash flows for an investment equals the required investment, the IRR is (D)
a. Equal to the cutoff rate.
b. Equal to the cost of borrowed capital.
c. Equal to zero.
d. Lower than the company’s cutoff rate of return. L&H
87
. If a prospective investment has a positive net present value at a company's cost of capital of 15%, it can be concluded that
A. The accounting rate of return of the project is greater than 15%.
B. The internal rate of return of the project is equal to the accounting rate of return.
C. The payback period of the associated asset is shorter than its life.
D. The internal rate of return of the project is greater than 15%. CIA 0R98 IV-37
*. Lenders Inc. is considering an investment that has a positive net present value based on its 16% hurdle rate. The internal rate of
return would be (M)
a. More than 16%. c. 16%.
b. Less than 16%. d. Zero. RPCPA 1095
88
. Neu Co. is considering the purchase of an investment that has a positive net present value based on Neu’s 12% hurdle rate. The
internal rate of return would be
a. 0%. c. >12%
b. 12%. d. < 12%
18. An investment has a positive NPV discounting the cash flows at a 14% cost of capital. Which statement is true?
a. The IRR is lower than 14%. c. The payback period is less than 14 years.
b. The IRR is higher than 14%. d. The book rate of return is 14%. L&H
89
. The net present value of a proposed investment is negative; therefore, the discount rate used must be
A. Greater than the project's internal rate of return.
B. Less than the project's internal rate of return.
C. Greater than the firm's cost of equity.
D. Less than the risk-free rate. CMA 1295 4-14, RPCPA 0596
25. At a company's cost of capital of 15%, a prospective investment has a negative net present value. Based on this information, it can
be concluded that:
A. the internal rate of return is greater than 15%
B. the payback period is shorter than the life of the asset
C. the accounting rate of return is less than 15%
D. the accounting rate of return is greater than 15%
E. the internal rate of return is less than 15% CIA adapted
90
. Which of the following statements is most correct? (E)
a. If a project’s internal rate of return (IRR) exceeds the cost of capital, then the project’s net present value (NPV) must be
positive.
b. If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.
c. The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the cost of capital.
d. Statements a and c are correct. Brigham
91
. Which of the following statements is most correct? (M)
a. If a project with normal cash flows has an IRR which exceeds the cost of capital, then the project must have a positive NPV.
b. If the IRR of Project A exceeds the IRR of Project B, then Project A must also have a higher NPV.
c. The modified internal rate of return (MIRR) can never exceed the IRR.
d. Statements a and c are correct. Brigham
92
. Project A has an internal rate of return (IRR) of 15 percent. Project B has an IRR of 14 percent. Both projects have a cost of
capital of 12 percent. Which of the following statements is most correct? (E)
a. Both projects have a positive net present value (NPV).
b. Project A must have a higher NPV than Project B.
c. If the cost of capital were less than 12 percent, Project B would have a higher IRR than Project A.
d. Statements a and c are correct.
e. All of the statements above are correct. Brigham
93
. Project A has an IRR of 15 percent. Project B has an IRR of 18 percent. Both projects have the same risk. Which of the following
statements is most correct? (E)
a. If the WACC is 10 percent, both projects will have a positive NPV, and the NPV of Project B will exceed the NPV of Project A.
b. If the WACC is 15 percent, the NPV of Project B will exceed the NPV of Project A.
c. If the WACC is less than 18 percent, Project B will always have a shorter payback than Project A.
d. If the WACC is greater than 18 percent, Project B will always have a shorter payback than Project A.
e. If the WACC increases, the IRR of both projects will decline. Brigham
94
. Project J has the same internal rate of return as Project K. Which of the following statements is most correct? (M)
a. If the projects have the same size (scale) they will have the same NPV, even if the two projects have different levels of risk.
b. If the two projects have the same risk they will have the same NPV, even if the two projects are of different size.
c. If the two projects have the same size (scale) they will have the same discounted payback, even if the two projects have
different levels of risk.
d. All of the statements above are correct.
e. None of the statements above is correct. Brigham
a. Assuming a project has normal cash flows, the NPV will be positive if the IRR is less than the cost of capital.
b. If the multiple IRR problem does not exist, any independent project acceptable by the NPV method will also be acceptable by
the IRR method.
c. If IRR = k (the cost of capital), then NPV = 0.
d. NPV can be negative if the IRR is positive.
e. The NPV method is not affected by the multiple IRR problem. Brigham
97
. A project has an up-front cost of $100,000. The project’s WACC is 12 percent and its net present value is $10,000. Which of the
following statements is most correct? (E)
a. The project should be rejected since its return is less than the WACC.
b. The project’s internal rate of return is greater than 12 percent.
c. The project’s modified internal rate of return is less than 12 percent.
d. All of the statements above are correct. Brigham
Depreciation
23. (Ignore income taxes in this problem.) How is depreciation handled by the following capital budgeting techniques? (M)
CMA adapted A. B. C. D.
Internal Rate of Return Excluded Included Excluded Included
Simple Rate of Return Included Excluded Excluded Included
Payback Excluded Included Excluded
19. If income tax considerations are ignored, how is depreciation expense used in the following capital budgeting techniques?
AICPA adapted A. B. C. D.
Internal Rate of Return Excluded Included Included Excluded
Payback Included Excluded Included Excluded
*. If income tax considerations are ignored, how is depreciation used in the following capital budgeting techniques? (E)
RPCPA 0595 a. b. c. d.
Internal rate of return Included Excluded Excluded Included
Accounting rate of return Excluded Included Excluded Included
30. If income tax considerations are ignored, how is depreciation expense used in the following capital budgeting techniques?
AICPA adapted A. B. C. D.
Internal Rate of Return Excluded Excluded Included Included
Net Present Value Excluded Included Excluded Included
100
. If income tax considerations are ignored, how is depreciation handled by the following budgeting technique?
CMA 1293 4-17 a. b. c. d.
Internal Rate of Return Excluded Included Excluded Included
Accounting Rate of Return Included Excluded Excluded Included
Payback Excluded Included Included Included
Cash Flow
24. Which of the following capital budgeting techniques consider(s) cash flow over the entire life of the project? (E)
AICPA adapted A. B. C. D.
Internal Rate of Return Yes Yes No No
Payback Yes No Yes No
23. On a graph with common stock returns on the Y axis and market returns on the X-axis, the slope of the regression line represents
the:
A. Alpha C. R-squared
B. Beta D. Adjusted beta B&M
15. The historical returns data for the past three years for Company A's stock is -6.0%, 15%, 15% and that of the market portfolio is
10%, 10% and 16%. According to the SML, the Stock A is:
A. over priced C. Correctly priced
B. Under priced D. Need more information B&M
22. The historical returns data for the past three years for Stock B and the stock market portfolio are: Stock B:- 24%, 0%, 24%, Market
Portfolios:- 10%, 12%, 20%. According to the SML the stock B is:
A. Overpriced C. Correctly priced
B. Underpriced B&M
Single Project
101
. The profitability index approach to investment analysis (M)
A. Fails to consider the timing of project cash flows.
B. Considers only the project's contribution to net income and does not consider cash flow effects.
C. Always yields the same accept/reject decisions for independent projects as the net present value method.
D. Always yields the same accept/reject decisions for mutually exclusive projects as the net present value method. CMA
1292 4-14, RPCPA 0596
14. The NPV and IRR methods give
a. The same decision (accept or reject) for any single investment.
b. The same choice from among mutually exclusive investments.
c. Different rankings of projects with unequal lives.
d. The same rankings of projects with different required investments. L&H
29. Which of the following is always true of the net present value (NPV) approach?
A. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the internal rate of return
(IRR) approach.
B. The NPV and the IRR approaches will always rank projects in the same order.
C. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the payback approach.
CIA adapted
D. The NPV and the payback approaches will always rank projects in the same order.
Questions 140 and 141 are based on the following information. CIA 0594 IV-45 & 46
The financial management team of a company is assessing an investment proposal involving a $100,000 outlay today. Manager one
expects the project to provide cash inflows of $20,000 at the end of each year for 6 years. She considers the project to be of low risk,
requiring only a 10% rate of return. Manager two expects the project to provide cash inflows of $5,000 at the end of the first year,
followed by $23,000 at the end of each year in years two through six. He considers the project to be of medium risk, requiring a 14%
rate of return. Manager three expects the project to be of high risk, providing one large cash inflow of $135,000 at the end of the sixth
year. She proposes a 15% rate of return for the project.
Additional Information:
Number Discount Present Value of $1 Due at Annuity of $1 per Period
of Years Rate (%) the End of n Periods (PVIF) for n Periods (PVIFA)
1 10 .9091 .9091
1 14 .8772 .8772
1 15 .8696 .8696
5 10 .6209 3.7908
5 14 .5194 3.4331
5 15 .4972 3.3522
6 10 .5645 4.3553
6 14 .4556 3.8887
6 15 .4323 3.7845
102
. According to the net present value criterion, which of the following is true?
A. Manager one will recommend that the project be accepted.
B. Manager two will recommend that the project be accepted.
C. All three managers will recommend acceptance of the project.
D. All three managers will recommend rejection of the project.
103
. Which manager will assess the project as having the shortest payback period?
A. Manager one.
B. Manager two.
C. Manager three.
D. All three managers will agree on the payback period.
Group Project
6. You are given a job to make a decision on project X, which is composed of three projects A, B, and C which have NPVs of +$50, -
$20 and +$100, respectively. How would you go about making the decision about whether to accept or reject the project? (M)
A. Accept the firm's joint project as it has a positive NPV
B. Reject the joint project
C. Break up the project into its components: accept A and C and reject B
D. None of the above B&M
Unlimited Capital
104
. A company has unlimited capital funds to invest. The decision rule for the company to follow in order to maximize shareholders'
wealth is to invest in all projects having a(n)
A. Present value greater than zero.
B. Net present value greater than zero.
C. Internal rate of return greater than zero. CMA 1293 4-15
D. Accounting rate of return greater than the hurdle rate used in capital budgeting analyses.
105
. Future, Inc. is in the enviable situation of having unlimited capital funds. The best decision rule, in an economic sense, for it to
follow would be to invest in all projects in which the
A. Accounting rate of return is greater than the earnings as a percent of sales.
B. Payback reciprocal is greater than the internal rate of return.
C. Internal rate of return is greater than zero.
D. Net present value is greater than zero. CMA 1278 5-12
106
. Barker Inc. has no capital rationing constraint and is analyzing many independent investment alternatives. Barker should accept
all investment proposals
a. If debt financing is available for them.
b. That have positive cash flows.
c. That provide returns greater than the after-tax cost of debt.
d. That have a positive net present value. CMA 1295 4-2
Independent Projects
107
. An organization is using capital budgeting techniques to compare two independent projects. It could accept one, both, or neither
of the projects. Which of the following statements is true about the use of net-present-value (NPV) and internal-rate-of-return (IRR)
methods for evaluating these two projects?
a. NPV and IRR criteria will always lead to the same accept or reject decision for two independent projects.
b. If the first project’s IRR is higher than the organization’s cost of capital, the first project will be accepted but the second project
will not.
c. If the NPV criterion leads to accepting or rejecting the first project, one cannot predict whether the IRR criterion will lead to
accepting or rejecting the first project.
d. If the NPV criterion leads to accepting the first project, the IRR criterion will never lead to accepting the first project. CIA
0597 IV-43
108
. Which of the following is always true with regard to the net present value (NPV) approach?
A. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the internal rate of return
(IRR) approach.
B. The NPV and the IRR approaches will always rank projects in the same order.
C. If a project is found to be acceptable under the NPV approach, it would also be acceptable under the payback approach.
CIA 0586 IV-29
D. The NPV and payback approaches will always rank projects in the same order.
57. Which of the following capital investment models would be preferred when choosing among mutually exclusive alternatives? (M)
a. payback period c. IRR
b. accounting rate of return d. NPV H&M
Profitability Index
109
. When ranking two mutually exclusive investments with different initial amounts, management should give first priority to the project
A. That generates cash flows for the longer period of time.
B. Whose net after-tax flows equal the initial investment.
C. That has the greater accounting rate of return.
D. That has the greater profitability index. CMA 1291 4-6
50. Why do the NPV method and the IRR method sometimes produce different rankings of mutually exclusive investment projects?
A. The NPV method does not assume reinvestment of cash flows while the IRR method assumes the cash flows will be
reinvested at the internal rate of return.
B. The NPV method assumes a reinvestment rate equal to the discount rate while the IRR method assumes a reinvestment rate
equal to the internal rate of return.
C. The IRR method does not assume reinvestment of the cash flows while the NPV assumes the reinvestment rate is equal to
the discount rate.
D. The NPV method assumes a reinvestment rate equal to the bank loan interest rate while the IRR rate method assumes a
reinvestment rate equal to the discount rate. Pol Bobadilla
Ranking Decision
112
. Which mutually exclusive project would you select, if both are priced at $1,000 and your discount rate is 15%; Project A with three
annual cash flows of $1,000, or Project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually?
A. Project A.
B. Project B.
C. The IRRs are equal, hence you are indifferent.
D. The NPVs are equal, hence you are indifferent. Gleim
Independent Projects
Definition
*. The kind of investment project which has no direct relationship with other projects and can therefore be implemented or rejected
independently of others (E)
a. Independent investment project
b. Complimentary investment project
c. None of these RPCPA 0588
Examples
60. Below are pairs of projects. Which pair best represents independent projects?
a. buy computer; buy software package
b. buy computer #1; buy computer #2
c. buy computer; buy computer security system
d. buy computer; repave parking lot Barfield
Profitability Index
35. Profitability index is useful under: (E)
A. Capital rationing C. Non-normal projects
B. Mutually exclusive projects D. None of the above B&M
40. The profitability index can be used for ranking projects under: (E)
A. Soft capital rationing C. Capital rationing at t = 0
B. Hard capital rationing D. Both A and B B&M
113
. The recommended technique for evaluating projects when capital is rationed and there are no mutually exclusive projects from
which to choose is to rank the projects by
A. Accounting rate of return. C. Internal rate of return.
B. Payback. D. Profitability index. CMA 0692 4-15
114
. The technique used to evaluate all possible capital projects of different dollar amounts and then rank them according to their
desirability is the (M)
a. Profitability index method. c. Payback method. CMA 1294 4-26
b. Net present value method. d. Discounted cash flow method.
Ranking Decision
37. A company is evaluating three possible investments. Information relating to the company and the investments follow:
Fisher rate for the three projects 7%
Cost of capital 8%
Based on this information, we know that (D)
a. all three projects are acceptable.
b. none of the projects are acceptable.
c. the capital budgeting evaluation techniques profitability index, net present value, and internal rate of return will provide a
consistent ranking of the projects.
d. the net present value method will provide a ranking of the projects that is superior to the ranking obtained using the internal
rate of return method. Barfield
*. Several proposed capital projects which are economically acceptable may have to be ranked due to constraints in financial
resources. In ranking these projects, the least pertinent is this statement. (M)
a. If the internal rate of return method is used in the capital rationing problem, the higher the rate, the better the project.
b. In selecting the required rate of return, one may either calculate the organization’s cost of capital or use a rate generally
acceptable in the industry.
c. A ranking procedure on the basis of quantitative criteria may be established by specifying a minimum desired rate of return,
which rate is used in calculating the net present value of each project.
d. If the net present value method is used, the profitability index is calculated to rank the projects. The lower the index, the better
the project. RPCPA 1094
Profitability Index
115
. Capital budgeting methods are often divided into two classifications: project screening and project ranking. Which one of the
following is considered a ranking method rather than a screening method?
A. Net present value. C. Profitability index.
B. Time-adjusted rate of return. D. Accounting rate of return. CMA 0691 4-17
IRR
116
. A company has analyzed seven new projects, each of which has its own internal rate of return. It should consider each project
whose internal rate of return is _____ its marginal cost of capital and accept those projects in _____ order of their internal rate of
return.
A. Below; decreasing. C. Above; increasing.
B. Above; decreasing. D. Below; increasing. CIA 0593 IV-55
RISK ANALYSIS
Risk
Risk-free Rate
117
. The proper discount rate to use in calculating certainty equivalent net present value is the (E)
a. Risk-adjusted discount rate. d. Cost of equity capital.
b. Cost of capital. c. Risk-free rate. CMA 1292 4-19
118
. The following data are related to the cash flows of a risky capital-budgeting alternative:
Col. 1 Col. 2 Col. 3
Period Expected Cash Flows Certainty Equivalent Factors
1 1,000 .85
2 1,000 .75
3 1,000 .70
The discount rates available for this analysis are: risk-free rate = 5%, cost of capital = 10%, and risk-adjusted discount rate = 15%.
How should these cash flows be discounted using the certainty-equivalent method (CE) and the risk-adjusted discount rate method
(RADR)?
CE RADR
A. (Col.2xCol.3) at 10% (Col.2xCol.3) at 5%
B. (Col.2xCol.3) at 5% (Col.2xCol.3) at 10%
C. (Col.2xCol.3) at 10% Col.2 at 15%
D. (Col.2xCol.3) at 5% Col.2 at 15%
CIA 0586 IV-32
119
. A firm has negotiated a contract with the government and has locked in the payment it will receive in each of the future years from
this project. However, the firm's costs for this project are uncertain. How should the certainty-equivalent (CE) approach be applied
in this situation?
A. Discount cash inflows using cost of capital and CE values of cost using cost of capital.
B. Discount cash inflows using cost of capital and CE values of cost using risk-free rate.
C. Determine net cash inflows using CE values of cost and discount using cost of capital.
D. Determine net cash inflows using CE values of cost and discount using risk-free rate.
CIA 0586 IV-34
Uncertainties
120
. Carco, Inc. wants to use discounted cash flow techniques when analyzing its capital investment projects. The company is aware of
the uncertainty involved in estimating future cash flows. A simple method some companies employ to adjust for the uncertainty
inherent in their estimates is to
A. Prepare a direct analysis of the probability of outcomes.
B. Use accelerated depreciation.
C. Adjust the minimum desired rate of return.
D. Increase the estimates of the cash flows. CMA 1278 5-8
23. To reflect greater uncertainty (greater risk) about a future cash inflow, an analyst could
a. increase the discount rate for the cash flow.
b. decrease the discounting period for the cash flow.
c. increase the expected value of the future cash flow before it is discounted.
d. extend the acceptable length for the payback period. Barfield
Risk Factor
121
. For capital budgeting purposes, management would select a high hurdle rate of return for certain projects because management
a. Wants to use equity funding exclusively.
b. Believes too many proposals are being rejected.
c. Believes bank loans are riskier than capital investments.
d Wants to factor risk into its consideration of projects. CMA 1294 4-22
16. In a discounted cash flow analysis, which of the following would not be consistent with adjusting a project's cash flows to account
for higher-than-normal risk?
a. increasing the expected amount for cash outflows
b. increasing the discounting period for expected cash inflows
c. increasing the discount rate for cash outflows
d. decreasing the amount for expected cash inflows Barfield
. If a typical U. S. company uses the same discount rate to evaluate all projects, the firm will most likely become (M)
a. Riskier over time, and its value will decline.
b. Riskier over time, and its value will rise.
c. Less risky over time, and its value will rise.
d. Less risky over time, and its value will decline.
e. There is no reason to expect its risk position or value to change over time as a result of its use of a single discount rate.
Brigham
124
. A company estimates that an average-risk project has a WACC of 10 percent, a below-average risk project has a WACC of 8
percent, and an above-average risk project has a WACC of 12 percent. Which of the following independent projects should the
company accept? (E)
a. Project A has average risk and an IRR = 9 percent.
b. Project B has below-average risk and an IRR = 8.5 percent.
c. Project C has above-average risk and an IRR = 11 percent.
d. All of the projects above should be accepted.
e. None of the projects above should be accepted. Brigham
125
. A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for
assessing risk. In evaluating this asset, the decision maker should(E)
a. Increase the IRR of the asset to reflect the greater risk.
b. Increase the NPV of the asset to reflect the greater risk.
c. Reject the asset, since its acceptance would increase the risk of the firm.
d. Ignore the risk differential if the asset to be accepted would comprise only a small fraction of the total assets of the firm.
e. Increase the cost of capital used to evaluate the project to reflect the higher risk of the project. Brigham
126
. Downingtown Industries has an overall (composite) WACC of 10 percent. This cost of capital reflects the cost of capital for a
Downingtown project with average risk; however, there are large differences among the projects. The company estimates that low-
risk projects have a cost of capital of 8 percent and high-risk projects have a cost of capital of 12 percent. The company is
considering the following projects:
Project Expected Return Risk
A 15% High
B 12 Average
C 11 High
D 9 Low
E 6 Low
Which of the projects will the company select? (E)
a. A and B. d. A, B, C, and D.
b. A, B, and C. e. A, B, C, D, and E.
c. A, B, and D. Brigham
127
. Mega Inc., a large conglomerate with operating divisions in many industries, uses risk-adjusted discount rates in evaluating capital
investment decisions. Consider the following statements concerning Mega's use of risk-adjusted discount rates.
I. Mega may accept some investments with internal rates of return less than Mega's overall average cost of capital.
II. Discount rates vary depending on the type of investment.
III. Mega may reject some investments with internal rates of return greater than the cost of capital.
IV. Discount rates may vary depending on the division.
Which of the above statements are correct?
A. I and III only. C. II, III, and IV only.
B. II and IV only. D. I, II, III, and IV. CMA Samp Q4-5
128
. Kemp Consolidated has two divisions of equal size: a computer division and a restaurant division. Stand-alone restaurant
companies typically have a cost of capital of 8 percent, while stand-alone computer companies typically have a 12 percent cost of
capital. Kemp’s restaurant division has the same risk as a typical restaurant company, and its computer division has the same risk
as a typical computer company. Consequently, Kemp estimates that its composite corporate cost of capital is 10 percent. The
company’s consultant has suggested that they use an 8 percent hurdle rate for the restaurant division and a 12 percent hurdle rate
for the computer division. However, Kemp has chosen to ignore its consultant, and instead, chooses to assign a 10 percent cost of
capital to all projects in both divisions. Which of the following statements is most correct? (M)
a. While Kemp’s decision to not risk adjust its cost of capital will lead it to accept more projects in its computer division and fewer
projects in its restaurant division, this should not affect the overall value of the company.
b. Kemp’s decision to not risk adjust means that it is effectively subsidizing its restaurant division, which means that its restaurant
division is likely to become a larger part of the overall company over time.
c. Kemp’s decision to not risk adjust means that the company will accept too many projects in the computer business and too
few projects in the restaurant business. This will lead to a reduction in the overall value of the company.
d. Statements a and b are correct. Brigham
129
. The Barabas Company has an equal amount of low-risk projects, average-risk projects, and high-risk projects. Barabas estimates
that the overall company’s WACC is 12 percent. This is also the correct cost of capital for the company’s average-risk projects.
The company’s CFO argues that, even though the company’s projects have different risks, the cost of capital for each project
should be the same because the company obtains its capital from the same sources. If the company follows the CFO’s advice,
what is likely to happen over time? (M)
a. The company will take on too many low-risk projects and reject too many high-risk projects.
b. The company will take on too many high-risk projects and reject too many low-risk projects.
c. Things will generally even out over time, and therefore, the risk of the firm should remain constant over time.
d. Statements a and c are correct. Brigham
130
. The Oneonta Chemical Company is evaluating two mutually exclusive pollution control systems. Since the company’s revenue
stream will not be affected by the choice of control systems, the projects are being evaluated by finding the PV of each set of
costs. The firm’s required rate of return is 13 percent, and it adds or subtracts 3 percentage points to adjust for project risk
differences. System A is judged to be a high-risk project (it might end up costing much more to operate than is expected). System
A’s risk-adjusted cost of capital is(M)
a. 10 percent; this might seem illogical at first, but it correctly adjusts for risk where outflows, rather than inflows, are being
discounted.
b. 13 percent; the firm’s cost of capital should not be adjusted when evaluating outflow only projects.
c. 16 percent; since A is more risky, its cash flows should be discounted at a higher rate, because this correctly penalizes the
project for its high risk.
d. Somewhere between 10 percent and 16 percent, with the answer depending on the riskiness of the relevant inflows.
e. Indeterminate, or, more accurately, irrelevant, because for such projects we would simply select the process that meets the
requirements with the lowest required investment. Brigham
Simulation Analysis
134
. A firm is evaluating a large project. It desires to develop not only the best guess of the outcome of the project, but also a list (or
distribution) of outcomes that might occur. This firm would best achieve its objective by using
A. The net-present-value (NPV) approach for capital budgeting.
B. The profitability-index approach for capital budgeting.
C. Simulation as applied to capital budgeting.
D. The internal-rate-of-return (IRR) approach for capital budgeting. CIA 0589 IV-51
135
. A statistical technique used to evaluate possible rates of return for a capital budgeting project is
A. Regression analysis. C. Markov chain analysis.
B. Simulation analysis. D. Gantt charting. CMA 0689 5-15
136
. Which of the following statements is most correct? (E)
a. Sensitivity analysis is a good way to measure market risk because it explicitly takes into account the effects of diversification.
b. One advantage of sensitivity analysis relative to scenario analysis is it explicitly takes into account the probability of certain
effects occurring, whereas scenario analysis does not take into account probabilities.
c. Simulation analysis is a computerized version of scenario analysis that uses continuous probability distributions of the input
variables.
d. Statements a and b are correct.
e. All of the statements above are correct. Brigham
Sensitivity Analysis
137
. Sensitivity analysis, if used with capital projects (M)
a. Is used extensively when cash flows are known with certainty.
b. Measures the change in the discounted cash flows when using the discounted payback method rather than the net present
value method.
c. Is a “what-if” technique that asks how a given outcome will change if the original estimates of the capital budgeting model are
changed.
d. Is a technique used to rank capital expenditure requests. CMA 0695 4-2, RPCPA 0596
138
. A manager wants to know the effect of a possible change in cash flows on the net present value of a project. The technique used
for this purpose is
A. Sensitivity analysis. C. Cost behavior analysis. CMA 1286 5-4
B. Risk analysis. D. Return on investment analysis.
62. Sensitivity analysis is
a. an appropriate response to uncertainty in cash flow projections.
b. useful in measuring the variance of the Fisher rate.
c. typically conducted in the post investment audit.
d. useful to compare projects requiring vastly different levels of initial investment. Barfield
139
. Sensitivity analysis is used in capital budgeting to
A. Estimate a project's internal rate of return.
B. Determine the amount that a variable can change without generating unacceptable results.
C. Simulate probabilistic customer reactions to a new product.
D. Identify the required market share to make a new product viable and produce acceptable results. CMA 1293 4-16
17. Which of the following makes investments more desirable than they had been?
a. An increase in income tax rate.
b. An increase in interest rates.
c. An increase in the number of years over which assets must be depreciated.
d. None of the above. L&H
28. Which statement could express the results of a sensitivity analysis of an investment decision?
a. The NPV of the project is $50,000.
b. A 5% decline in volume will make the project unprofitable.
c. This project ranks third out of the five available.
d. This project does not meet the cutoff rate of return. L&H
36. If X Co. expects to get a one-year bank loan to help cover the initial financing of capital project Q, the analysis of Q should (D)
a. Offset the loan against any investment in inventory or receivables required by the project.
b. Show the loan as an increase in the investment.
c. Show the loan as a cash outflow in the second year of the project’s life.
d. Ignore the loan. L&H
54. A "what-if" technique that examines how a result will change if the original predicted data are not achieved or if an underlying
assumption changes is called (E)
a. sensitivity analysis. c. internal rate-of-return analysis. Horngren
b. net present value analysis. d. adjusted rate-of-return analysis.
Net Investment
64. All other factors equal, which of the following would affect a project's internal rate of return, net present value, and payback period?
(M)
a. an increase in the discount rate c. an increase in the initial cost of the project
b. a decrease in the life of the project d. all of the above Barfield
47. For a profitable company, an increase in the rate of depreciation on a specific project could
a. increase the project's profitability index.
b. increase the project's payback period.
c. decrease the project's net present value.
d. increase the project's internal rate of return. Barfield
50. As the marginal tax rate goes up, the benefit from the depreciation tax shield
a. decreases.
b. increases.
c. stays the same. Barfield
d. can move up or down depending on whether the firm's cost of capital is high or low.
Payback Period
In general
6. All other factors equal, a large number is preferred to a smaller number for all capital project evaluation measures except (E)
a. net present value. c. internal rate of return.
b. payback period. d. profitability index. Barfield
3. In comparing two projects, the _______ is often used to evaluate the relative riskiness of the projects. (D)
a. payback period c. internal rate of return
b. net present value d. discount rate Barfield
Relative Profitability
24. Investment A has a payback period of 5.4 years, investment B one of 6.7 years. From this information we can conclude
a. That investment A has a higher NPV than B.
b. That investment A has a higher IRR than B.
c. That investment A’s book rate of return is higher than B’s.
d. None of the above. L&H
9. If investment A has a payback period of three years and investment B has a payback period of four years, then
a. A is more profitable than B.
b. A is less profitable than B.
c. A and B are equally profitable. Barfield
d. the relative profitability of A and B cannot be determined from the information given.
Accounting Rate of Return
25. Investment A has a book rate of return of 26%, investment B one of 18%. From this information we can conclude
a. That investment A has a higher NPV than B.
b. That investment A has a higher IRR than B.
c. That investment A has a shorter payback period than B.
d. None of the above. L&H
Discount Rate
Effect of Change in Acceptability of Projects
10. All other things being equal, as cost of capital increases
a. More capital projects will probably be acceptable.
b. Fewer capital projects will probably be acceptable.
c. The number of capital projects that are acceptable will change, but the direction of the change is not determinable just by
knowing the direction of the change in cost of capital.
d. The company will probably want to borrow money rather than issue stock. L&H
96. All other things being equal, as the time period for receiving an annuity lengthens,
a. the related present value factors increase.
b. the related present value factors decrease.
c. the related present value factors remain constant. Barfield
d. it is impossible to tell what happens to present value factors from the information given.
17. Which of the following events will increase the NPV of an investment involving a new product?
a. An increase in the income tax rate.
b. An increase in the expected per-unit variable cost of the product.
c. An increase in the expected annual unit volume of the product.
d. A decrease in the expected salvage value of equipment. L&H
55. A project's after-tax net present value is increased by all of the following except
a. revenue accruals. c. depreciation deductions.
b. cash inflows. d. expense accruals. Barfield
22. Which of the following changes would not decrease the present value of the future depreciation deductions on a specific
depreciable asset? (D)
a. a decrease in the marginal tax rate
b. a decrease in the discount rate
c. a decrease in the rate of depreciation
d. an increase in the life expectancy of the depreciable asset Barfield
17. Suppose an investment has cash inflows of R dollars at the end of each year for two years. The present value of these cash
inflows using a 12% discount rate will be: (M)
a. greater than under a 10% discount rate.
b. less than under a 10% discount rate.
c. equal to that under a 10% discount rate. G & N 9e
d. sometimes greater than under a 10% discount rate and sometimes less; it depends on R.
24. A firm is evaluating a project that has a net present value of $0 when a discount rate of 8% is used. A discount rate of 10% will
result in
a. a negative net present value
b. a positive net present value
c. a net present value of $0
d. The question cannot be answered based upon the information provided. H&M
27. A firm is evaluating a project that has a net present value of $0 when a discount rate of 8% is used. A discount rate of 6% will
result in
a. a negative net present value
b. a positive net present value
c. a net present value of $0
d. The question cannot be answered based upon the information provided. H&M
12. Which of the following would decrease the net present value of a project?
A. A decrease in the income tax rate.
B. A decrease in the initial investment.
C. An increase in the useful life of the project.
D. An increase in the discount rate. Pol Bobadilla
142
. Other things held constant, which of the following would increase the NPV of a project being considered? (E)
a. A shift from MACRS to straight-line depreciation.
b. Making the initial investment in the first year rather than spreading it over the first three years.
c. A decrease in the discount rate associated with the project.
d. An increase in required net operating working capital.
e. All of the statements above will increase the project’s NPV. Brigham
*. You have determined the profitability of a planned project by finding the present value of all the cash flows from that project.
Which of the following would cause the project to look less appealing, that is, have a lower present value? (M)
a. The discount rate increases.
b. The cash flows are extended over a longer period of time.
c. The investment cost decreases without affecting the expected income and life of the project. RPCPA 0595
d. The cash flows are accelerated and the project life is correspondingly shortened.
*. Velasquez & Co. is considering an investment proposal for P10 million yielding a net present value of P450,000. The project has a
life of 7 years with salvage value of P200,000. The company uses a discount rate of 12%. Which of the following would decrease
the net present value? (M)
a. Extend the project life and associated cash inflows.
b. Increase discount rate to 15%.
c. Decrease the initial investment amount to P9.0 million.
d. Increase the salvage value. RPCPA 0597
Effect of Salvage Value
34. The salvage value of an old lathe is zero. If instead, the salvage value of the old lathe was $20,000, what would be the impact on
the net present value of the proposal to purchase a new lathe? (M)
a. It would increase the net present value of the proposal.
b. It would decrease the net present value of the proposal.
c. It would not affect the net present value of the proposal.
d. Potentially it could increase or decrease the net present value of the new lathe. Barfield
Expected Returns
143
. Stock C has a beta of 1.2, while Stock D has a beta of 1.6. Assume that the stock market is efficient. Which of the following
statements is most correct? (E)
a. The required rates of return of the two stocks should be the same.
b. The expected rates of return of the two stocks should be the same.
c. Each stock should have a required rate of return equal to zero.
d. The NPV of each stock should equal its expected return.
e. The NPV of each stock should equal zero. Brigham
NPV profiles
144
. If the net present value profiles for two mutually exclusive capital projects are shaped as in the graph below, which of the following
statements is true?
$
NPV Profile
for Project 2 Cost of
Capital %
43 Projects A and B have the same expected lives and initial cash outflows. However, one project’s cash flows are larger in the early
years, while the other project has larger cash flows in the later years. The two NPV profiles are given below:
5. Projects L and S each have an initial cost of $10,000, followed by a series of positive cash inflows. Project L has total,
undiscounted cash inflows of $16,000, while S has total undiscounted inflows of $15,000. Further, at a discount rate of 10 percent,
the two projects have identical NPVs. Which project’s NPV will be more sensitive to changes in the discount rate? (Hint: Projects
with steeper NPV profiles are more sensitive to discount rate changes.) (M)
a. Project S.
b. Project L.
c. Both projects are equally sensitive to changes in the discount rate since their NPVs are equal at all costs of capital.
d. Neither project is sensitive to changes in the discount rate, since both have NPV profiles which are horizontal.
e. The solution cannot be determined unless the timing of the cash flows is known. Brigham
6. Two mutually exclusive projects each have a cost of $10,000. The total, undiscounted cash flows from Project L are $15,000, while
the undiscounted cash flows from Project S total $13,000. Their NPV profiles cross at a discount rate of 10 percent. Which of the
following statements best describes this situation? (M)
a. The NPV and IRR methods will select the same project if the cost of capital is greater than 10 percent; for example, 18
percent.
b. The NPV and IRR methods will select the same project if the cost of capital is less than 10 percent; for example, 8 percent.
c. To determine if a ranking conflict will occur between the two projects the cost of capital is needed as well as an additional
piece of information.
d. Project L should be selected at any cost of capital, because it has a higher IRR.
e. Project S should be selected at any cost of capital, because it has a higher IRR. Brigham
147
. A company is comparing two mutually exclusive projects with normal cash flows. Project P has an IRR of 15 percent, while Project
Q has an IRR of 20 percent. If the WACC is 10 percent, the two projects have the same NPV. Which of the following statements
is most correct? (M)
a. If the WACC is 12 percent, both projects would have a positive NPV.
b. If the WACC is 12 percent, Project Q would have a higher NPV than Project P.
c. If the WACC is 8 percent, Project Q would have a lower NPV than Project P.
d. All of the statements above are correct. Brigham
148
. Project C and Project D are two mutually exclusive projects with normal cash flows and the same risk. If the WACC were equal to
10 percent, the two projects would have the same positive NPV. However, if the WACC < 10%, Project C has a higher NPV,
whereas if the WACC > 10%, Project D has a higher NPV. On the basis of this information, which of the following statements is
most correct? (M)
a. Project D has a higher IRR, regardless of the cost of capital.
b. If the WACC < 10%, Project C has a higher IRR.
c. If the WACC < 10%, Project D’s MIRR is less than its IRR.
d. Statements a and c are correct. Brigham
7. Your assistant has just completed an analysis of two mutually exclusive projects. You must now take her report to a board of
directors meeting and present the alternatives for the board’s consideration. To help you with your presentation, your assistant also
constructed a graph with NPV profiles for the two projects. However, she forgot to label the profiles, so you do not know which line
applies to which project. Of the following statements regarding the profiles, which one is most reasonable? (D)
a. If the two projects have the same investment cost, and if their NPV profiles cross once in the upper right quadrant, at a
discount rate of 40 percent, this suggests that a NPV versus IRR conflict is not likely to exist.
b. If the two projects’ NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will
probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical
sense (that is, a conflict which will affect the actual investment decision).
c. If one of the projects has a NPV profile which crosses the X-axis twice, hence the project appears to have two IRRs, your
assistant must have made a mistake.
d. Whenever a conflict between NPV and IRR exist, then, if the two projects have the same initial cost, the one with the steeper
NPV profile probably has less rapid cash flows. However, if they have identical cash flow patterns, then the one with the
steeper profile probably has the lower initial cost. Brigham
e. If the two projects both have a single outlay at t = 0, followed by a series of positive cash inflows, and if their NPV profiles
cross in the lower left quadrant, then one of the projects should be accepted, and both would be accepted if they were not
mutually exclusive.
Profitability Index
*. What is the effect of changes in cash inflows, investment cost and cash outflows on profitability (present value) index (PI) (M)
a. PI will increase with an increase in cash inflows, a decrease in investment cost, or a decrease in cash outflows.
b. PI will increase with an increase in cash inflows, an increase in investment cost, or an increase in cash outflows.
c. PI will decrease with an increase in cash inflows, a decrease in investment cost, or a decrease in cash outflows.
d. PI will decrease with an increase in cash outflows, an increase in investment cost, or an increase in cash inflows. RPCPA
0594
153
. The economic value of the firm will rise following an increase in
A. Net cash flow. C. Unsystematic risk.
B. Systematic risk. D. The discount rate. CIA 0591 IV-47
Comprehensive
33. Which of the following is true of an investment?
a. The lower the cost of capital, the higher the NPV.
b. The lower the cost of capital, the higher the IRR.
c. The longer the project’s life, the shorted its payback period.
d. The higher the project’s NPV, the shorter its life. L&H
154
. Lieber Technologies is considering two potential projects, Project X and Project Y. In assessing the projects’ risk, the company has
estimated the beta of each project and has also conducted a simulation analysis. Their efforts have produced the following
numbers:
Project X Project Y
Expected NPV $350,000 $350,000
Standard deviation (NPV) $100,000 $150,000
Estimated project beta 1.4 0.8
Estimated correlation of Cash flows are not highly Cash flows are highly
project’s cash flows with the correlated with the cash correlated with the cash
cash flows of the Company’s flows of the existing flows of the existing
existing projects. projects. projects.
3. If a firm uses the same company cost of capital for evaluating all projects, which of the following is likely?
A. Accepting poor low risk projects. C. Both A and B
B. Rejecting good high risk projects D. Neither A nor B B&M
Project Analysis
1. Project analysis includes the following procedures:
A. Sensitivity analysis C. Monte Carlo simulation
B. Break-even analysis D. All of the above B&M
Break-even Analysis
16. Firms often calculate a project's break-even sales using book earnings. Generally, break-even sales based on NPV is:
A. Higher than the one calculated using book earnings
B. Lower than the one calculated using book earnings
C. Equal to the one calculated using book earnings
D. None of the above B&M
Decision Tree
32. Which of the following statements applied to decision trees?
A. They are simple to construct and analyze
B. They should include all possible future events and decisions
C. They help the financial manager to assess the value of options to abandon or expand the project
D. All of the above B&M
Simulation Models
2. Simulation models are useful:
A. To understand the project better C. To assess the project risk
B. To forecast expected cash flows D. All of the above B&M
23. Generally, the simulation models for projects are developed using a:
A. Computer C. Pair of dice
B. Roulette wheel D. Pack of cards B&M
20. Which of the following simulation outputs is likely to be most useful and easy to interpret? The output shows the distribution(s) of
the project:
A. Earnings C. Cash flows
B. Internal rate of return D. Profits B&M
21. The following statements about simulation models are true except:
A. Simulation models enable the financial manager to analyze risky projects without estimating the approximate cost of capital
B. Simulation models are complex and expensive to develop
C. Simulation models are specific to the project and every project requires a new simulation model
D. Simulation models usually ignore opportunities to expand or abandon the project B & M
22. The following statements about simulation models are true except:
A. Simulation models enable the financial manager to analyze what would happen if the uncertainty about any of the variables
were reduced
B. Simulation models take into account the interdependencies between different time periods
C. Simulation models are easy to understand and communicate
D. Simulation models enable the financial manager to visualize how outcomes may be affected if the project is modified B & M
26. There are three steps involved in Monte Carlo simulations. One of the following is not one of them:
A. Modeling the project C. Modeling the strategy
B. Specifying probabilities D. Simulating the cash flows B&M
27. The following is not among the steps involved in the Monte Carlo method:
A. Modeling the project
B. Specifying the numbers on the roulette wheel
C. Specifying probabilities
D. Simulating the cash flows B&M
29. The pharmaceutical companies have used the following method to analyze investments in R&D (research and development) of
new drugs:
A. Monte Carlo Simulation C. Sensitivity analysis
B. Decision trees D. None of the above B&M
30. The pharmaceutical companies face three types of uncertainty. They are the following except:
A. Scientific and clinical C. Bureaucratic
B. Production and distribution D. Market success B&M
31. According to the simulation model used by Merck and Company, the following types of variables are used in their model except:
A. Research and development
B. Manufacturing variables
C. Marketing variables
D. FDA (Food and Drug Administration) variables B&M
Ranking methods
159
. Which of the following statements is correct? (M)
a. Because discounted payback takes account of the cost of capital, a project’s discounted payback is normally shorter than its
regular payback.
b. The NPV and IRR methods use the same basic equation, but in the NPV method the discount rate is specified and the
equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found.
c. If the cost of capital is less than the crossover rate for two mutually exclusive projects’ NPV profiles, a NPV/IRR conflict will not
occur.
d. If you are choosing between two projects which have the same life, and if their NPV profiles cross, then the smaller project will
probably be the one with the steeper NPV profile.
e. If the cost of capital is relatively high, this will favor larger, longer-term projects over smaller, shorter-term alternatives because
it is good to earn high rates on larger amounts over longer periods. Brigham
160
. In comparing two mutually exclusive projects of equal size and equal life, which of the following statements is most correct? (M)
a. The project with the higher NPV may not always be the project with the higher IRR.
b. The project with the higher NPV may not always be the project with the higher MIRR.
c. The project with the higher IRR may not always be the project with the higher MIRR.
d. Statements a and c are correct.
e. All of the statements above are correct. Brigham
Ranking conflicts
26 Which of the following statements is most correct? (E)
a. The NPV method assumes that cash flows will be reinvested at the cost of capital while the IRR method assumes
reinvestment at the IRR.
b. The NPV method assumes that cash flows will be reinvested at the risk-free rate while the IRR method assumes reinvestment
at the IRR.
c. The NPV method assumes that cash flows will be reinvested at the cost of capital while the IRR method assumes
reinvestment at the risk-free rate.
d. The NPV method does not consider the inflation premium.
e. The IRR method does not consider all relevant cash flows, and particularly cash flows beyond the payback period. Brigham
Comprehensive
18 Which of the following statements is most correct? (D)
a. When dealing with independent projects, discounted payback (using a payback requirement of 3 or less years), NPV, IRR,
and modified IRR always lead to the same accept/reject decisions for a given project.
b. When dealing with mutually exclusive projects, the NPV and modified IRR methods always rank projects the same, but those
rankings can conflict with rankings produced by the discounted payback and the regular IRR methods.
c. Multiple rates of return are possible with the regular IRR method but not with the modified IRR method, and this fact is one
reason given by the textbook for favoring MIRR (or modified IRR) over IRR.
d. Statements a and c are correct.
e. None of the statements above is correct. Brigham
Decision-Making
161
. Which of the following statements is correct? (D)
a. There can never be a conflict between NPV and IRR decisions if the decision is related to a normal, independent project, that
is, NPV will never indicate acceptance if IRR indicates rejection.
b. To find the MIRR, we first compound CFs at the regular IRR to find the TV, and then we discount the TV at the cost of capital
to find the PV.
c. The NPV and IRR methods both assume that cash flows are reinvested at the cost of capital. However, the MIRR method
assumes reinvestment at the MIRR itself.
d. If you are choosing between two projects which have the same cost, and if their NPV profiles cross, then the project with the
higher IRR probably has more of its cash flows coming in the later years. Brigham
e. A change in the cost of capital would normally change both a project’s NPV and its IRR.
162
. In an operational audit of the finance department, the auditor observed that the department always used proper quantitative
techniques based on sound economic assumptions to evaluate proposed alternative capital investments. However, management
did not always choose the investment option with the most favorable quantitative assessment. In fact, sometimes management
opted for what appeared to be the third or fourth most favorable investment. The chief financial officer indicated that management
ultimately makes a subjective decision as to which investment is best regardless of which investment option looks best according
to the quantitative analysis. Which of the following statements is most accurate?
A. The approach is justifiable if the economic results of capital investments are highly uncertain.
B. The approach is an irrational, intuitive decision process.
C. The approach results in the organization not maximizing its profits.
D. The approach is an example of the bounded rationality model of decision making whereby managers simplify problems.
CIA 1195 II-4
COMPREHENSIVE
*. In capital budgeting decision, the following are relevant statements except: (E)
a. Since resources are scarce, all capital expenditures must be ranked according to priority.
b. The company must be able to define what falls under this category, whether they are for expansion, for replacements, or for
improvements in operations.
c. Capital investments are short-term commitments of resources, and they are decided in the same process as operating
expenses/
d. A careful analysis of the economic and non-economic reasons or justifications for these investments must be made to arrive at
the appropriate decision. RPCPA 0593
ACRS
15. The system for recovering the cost of capital expenditures through federal income tax deductions that was required for tangible,
depreciable property placed in service after 1980 is known as:
A. MACRS C. ACRS
B. 200% declining balance D. 150% declining balance Carter & Usry
MACRS
16. Under the Tax Reform Act of 1986, the system that increased the number of property classes and lengthened the recovery periods
of most kinds of depreciable property is known as:
A. MACRS C. ACRS
B. 200% declining balance D. 150% declining balance Carter & Usry
21. When computing depreciation deductions under the MACRS system, taxpayers must: (M)
a. use the half-year convention under which taxpayers are allowed to take only a half year's depreciation in the first year of an
asset's life.
b. use the half-year convention under which taxpayers are allowed to take only a half year's depreciation in the last year of an
asset's life.
c. use the half-year convention under which taxpayers are allowed to take only a half year's depreciation in the first and last
years of an asset's life.
d. calculate depreciation for partial periods using the exact number of days if the asset is acquired at some time other than the
beginning or end of the fiscal year. G & N 9e
20. Under MACRS, the depreciation on tangible personal property is computed as if the property were placed into service at the:
A. beginning of the year C. midpoint of the year
B. end of the year D. midpoint of the month Carter & Usry
21. Under MACRS, the depreciation on real property is computed as if the property were placed into service at the:
A. beginning of the year C. midpoint of the year
B. end of the year D. midpoint of the month Carter & Usry
20. With respect to income taxes, the principal advantage of MACRS over straight-line depreciation is that
a. Total taxes will be lower under MACRS.
b. Taxes will be constant from year to year under MACRS.
c. Taxes will be lower in the earlier years under MACRS.
d. Taxes will decline in future years under MACRS. L&H
4. Companies using MACRS for tax purposes and straight-line depreciation for financial reporting purposes usually find that the
relationship between the tax basis and book value of their assets is
a. The tax basis is lower than book value.
b. The tax basis is higher than book value.
c. The tax basis is the same as book value.
d. None of the above. L&H
38. A company evaluates a project using straight-line depreciation over its 10-year estimated useful life and then reevaluates it using a
7-year MACRS class life. The second analysis will show
a. A lower IRR for the project.
b. The same NPV and IRR for the project.
c. A higher NPV for the project.
d. Lower total cash flows over the 10 years. L&H
13. If a company uses a five-year MACRS period to depreciate assets instead of a 10-year life with straight-line depreciation,
a. The NPV of the investment is higher.
b. The IRR of the investment is lower.
c. There is no difference in either NPV or IRR.
d. Total cash flows over the useful life would be lower. L&H
167
. Flex Corporation is studying a capital acquisition proposal in which newly acquired assets will be depreciated using the straight-line
method. Which one of the following statements about the proposal would be incorrect if a switch is made to the Modified
Accelerated Cost Recovery System (MACRS)? CMA 0693 4-29
A. The net present value will increase. C. The payback period will be shortened.
B. The internal rate of return will increase. D. The profitability index will decrease.
. Which of the following statement completions is incorrect? For a profitable firm, when MACRS accelerated depreciation is
168
Questions 74 and 75 are based on the following information. CMA 0694 4-13 & 14
The tax impact of equipment depreciation affects capital budgeting decisions. Currently, the Modified Accelerated Cost Recovery
System (MACRS) is used as the depreciation method for most assets for tax purposes.
169
. The MACRS method of depreciation for assets with 3, 5, 7, and 10-year recovery periods is most similar to which one of the
following depreciation methods used for financial reporting purposes?
A. Straight-line. C. Sum-of-the-years'-digits.
B. Units-of-production. D. 200% declining-balance.
170
. When employing the MACRS method of depreciation in a capital budgeting decision, the use of MACRS as compared with the
straight-line method of depreciation will result in
A. Equal total depreciation for both methods.
B. MACRS producing less total depreciation than straight line.
C. Equal total tax payments, after discounting for the time value of money.
D. MACRS producing more total depreciation than straight line.
19. The use of the MACRS tables instead of the optional straight-line method of depreciation has the effect of: (M)
a. raising the hurdle rate necessary to justify the project.
b. decreasing the net present value of the project.
c. increasing the present value of the depreciation tax shield.
d. increasing the cash outflows at the beginning of the project. CMA adapted
Risk-adjusted NPV
185
. Virus Stopper Inc., a supplier of computer safeguard systems, uses a cost of capital of 12 percent to evaluate average-risk
projects, and it adds or subtracts 2 percentage points to evaluate projects of more or less risk. Currently, two mutually exclusive
projects are under consideration. Both have a cost of $200,000 and will last 4 years. Project A, a riskier-than-average project, will
produce annual end-of-year cash flows of $71,104. Project B, a less-than-average-risk project, will produce cash flows of $146,411
at the end of Years 3 and 4 only. Virus Stopper should accept(M)
a. B with a NPV of $10,001.
b. Both A and B because both have NPVs greater than zero.
c. B with a NPV of $8,042.
d. A with a NPV of $7,177.
e. A with a NPV of $15,968. Brigham
186
. An all-equity firm is analyzing a potential project that will require an initial, after-tax cash outlay of $50,000 and after-tax cash
inflows of $6,000 per year for 10 years. In addition, this project will have an after-tax salvage value of $10,000 at the end of Year
10. If the risk-free rate is 6 percent, the return on an average stock is 10 percent, and the beta of this project is 1.50, what is the
project’s NPV? (M)
a. $13,210 d. -$ 6,158
b. $ 4,905 e. -$12,879
c. $ 7,121 Brigham
187
. Real Time Systems Inc. is considering the development of one of two mutually exclusive new computer models. Each will require a
net investment of $5,000. The cash flows for each project are shown below:
Year Project A Project B
1 $2,000 $3,000
2 2,500 2,600
3 2,250 2,900
Model B, which will use a new type of laser disk drive, is considered a high-risk project, while Model A is an average-risk project.
Real Time adds 2 percentage points to arrive at a risk-adjusted cost of capital when evaluating high-risk projects. The cost of
capital used for average-risk projects is 12 percent. Which of the following statements regarding the NPVs for Models A and B is
most correct? (M)
a. NPVA = $380; NPVB = $1,815 c. NPVA = $380; NPVB = $1,590
b. NPVA = $197; NPVB = $1,590 d. NPVA = $5,380; NPVB = $6,590 Brigham
Risky projects
190
. Cochran Corporation has a weighted average cost of capital of 11 percent for projects of average risk. Projects of below-average
risk have a cost of capital of 9 percent, while projects of above-average risk have a cost of capital equal to 13 percent. Projects A
and B are mutually exclusive, whereas all other projects are independent. None of the projects will be repeated. The following table
summarizes the cash flows, internal rate of return (IRR), and risk of each of the projects.
Year Project A Project B Project C Project D Project E
0 -$200,000 -$100,000 -$100,000 -$100,000 -$100,000
1 66,000 30,000 30,000 30,000 40,000
2 66,000 30,000 30,000 30,000 25,000
3 66,000 40,000 30,000 40,000 30,000
4 66,000 40,000 40,000 50,000 35,000
Scenario analysis
191
. Klott Company encounters significant uncertainty with its sales volume and price in its primary product. The firm uses scenario
analysis in order to determine an expected NPV, which it then uses in its budget. The base-case, best-case, and worst-case
scenarios and probabilities are provided in the table below. What is Klott’s expected NPV, standard deviation of NPV, and
coefficient of variation of NPV? (M)
Probability of Unit Sales Sales Price NPV
Outcome Volume (In Thousands)
Worst case 0.30 6,000 $3,600 -$6,000
Base case 0.50 10,000 4,200 +13,000
Best case 0.20 13,000 4,400 +28,000
a. Expected NPV = $35,000; σNPV = 17,500; CVNPV = 2.00
b. Expected NPV = $35,000; σNPV = 11,667; CVNPV = 0.33
c. Expected NPV = $10,300; σNPV = 12,083; CVNPV = 1.17
d. Expected NPV = $13,900; σNPV = 8,476; CVNPV = 0.61
e. Expected NPV = $10,300; σNPV = 13,900; CVNPV = 1.35 Brigham
ANSWER EXPLANATIONS
1
.Answer (D) is correct. Capital budgeting is the process of planning expenditures for long-lived assets. It involves
choosing among investment proposals using a ranking procedure. Evaluations are based on various measures involving
rate of return on investment.
Answer (A) is incorrect because capital budgeting involves long-term investment needs, not immediate operating needs.
Answer (B) is incorrect because strategic planning establishes long-term goals in the context of relevant factors in the
firm's environment. Answer (C) is incorrect because cash budgeting determines operating cash flows. Capital budgeting
evaluates the rate of return on specific investment alternatives.
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Sunk costs are never included in project cash flows, so statement a is false.
Externalities are always included, so statement b is true. Since the weighted
average cost of capital includes the cost of debt, and this is the discount
rate used to evaluate project cash flows, interest expense should not be
included in project cash flows. Therefore, statement c is false.
NPV
$
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Sunk costs should be ignored, but externalities and opportunity costs should
be included in the project evaluation. Therefore, the correct choice is
statement d.
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Statement a is a sunk cost and sunk costs are never included in the capital
budgeting analysis. Therefore, statement a is not included. Statement b is an
opportunity cost and should be included in the capital budgeting analysis.
Statement c is the cannibalization of existing products, which will cause the
company to forgo cash flows and profits in another division. Therefore, it is
included in the capital budgeting analysis. Therefore, the correct answer is
statement d.
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Therefore, John would only choose Project 1, because it is the only project whose IRR exceeds its cost of capital.
Consequently, the firm’s capital budget (based on John’s WACC) is only $400 million.
Becky would choose projects 1, 2, 3, and 4 because all of these projects have an IRR that exceeds the Division’s 9.5
percent cost of capital. Based on Becky’s WACC, the firm’s capital budget would be $1,270 million ($400 + $300 + $250
+ $320). Therefore, the firm’s capital budget based on Becky’s WACC is $870 million ($1,270 - $400) larger than the one
based on John’s WACC.
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
$
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Answer: c Diff: E N
You have to find out what the required rate of return on each project is. Projects that are of high risk must have a
higher required rate of return than projects that are of low risk. The following table shows the required return for
each project on the basis of its risk level.
The company will accept all projects whose expected return exceeds its required return. Therefore, it will accept
Projects A, B, and D.
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Answer: c Diff: E N
Statement a is false; sensitivity analysis measures a project’s stand-alone risk. Statement b is false; sensitivity
analysis doesn’t take into account probabilities, while scenario analysis does. Statement c is correct.
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
NPV
($)
NPV
$
A
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B B
A
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
k
0 10% IRRB IRRA
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
Draw the NPV profiles using the information given in the problem. It is clear that Project A will have a higher NPV when
the cost of capital is 12 percent. Therefore, statement a is false. At a 17 percent cost of capital, Project B will have a
higher NPV than Project A. Therefore, statement b is true. If the cost of capital were 0, then the NPV of the projects
would be the simple sum of all the cash flows. In order for statement c to be correct, B’s NPV at a 0 cost of capital would
have to be higher than A’s. From the diagram we see that this is clearly incorrect. So, statement c is false.
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
Answer: d Diff: M N
NPV
$
k
10% 15% 20% %
The diagram above can be drawn from the statements in this question. From the diagram drawn, statements a, b, and c
are correct; therefore, statement d is the correct choice.
NPV ($)
NPV
C
A
D
10% k k
0 7% 12% 15%
NPV
$
B n
Sigma CF t
k t=1
0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k
10% 15% 20% %
.
NPV ($)
10% k
First, draw the NPV profiles as shown above. Make sure the profiles cross at 10 percent because the projects have the
same NPV at a cost of capital of 10 percent. When WACC is less than 10 percent, C has a higher NPV, so C’s NPV
profile is above D’s NPV profile to the left of the crossover point (10%).
Statement a is true. IRR is always independent of the cost of capital, and from the diagram above, we can see that
D’s IRR is to the right of C’s where the two lines cross the X-axis. Statement b is false. IRR is independent of the
cost of capital, and from the diagram C’s IRR is always lower than D’s. Statement c is true. D’s MIRR will be
somewhere between the cost of capital and the IRR. Therefore, the correct choice is statement d.
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
.
NPV
k
0 7% 12% 15%
Since both projects have an IRR greater than the cost of capital, both will have a positive NPV. Therefore, statement a is
true. At 6 percent, the cost of capital is less than the crossover rate and Project A has a higher NPV than B. Therefore,
statement b is false. If the cost of capital is 13 percent, then the cost of capital is greater than the crossover rate and B
would have a higher NPV than A. Therefore, statement c is true. Since statements a and c are both true, the correct
choice is statement e.
NPV
$
B n
Sigma CF t
k t=1
0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV
k
0 7% 12% 15%
.
NPV
$
k
0 7% 12% 14%
Statement a is correct, because at any point to the right of the crossover point B will have a higher NPV than A.
Statement b is correct for the same reason that statement a is true; at any point to the right of the crossover point, B will
have a higher NPV than A. Statement c is correct. If B’s cost of capital is 9 percent, when MIRR is calculated the cash
flows are being reinvested at 9 percent. When IRR is used, the IRR calculation assumes that cash flows are being
reinvested at the IRR (which is higher than the cost of capital.) Statement e is the correct choice.
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K)
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
(1 + K)t
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
.Answer (A)
is correct. Investments with present values in excess of their costs (positive NPVs) that can be identified or created by
the capital budgeting activities of the firm will have a positive impact on firm value and on the price of the common
shares of the firm. Accordingly, the more effective capital budgeting is, the higher the share price.
Answer (B) is incorrect because positive NPV investments will increase, not decrease, firm value and share price.
Answer (C) is incorrect because investments with present values equal to their costs have a zero NPV and neither
increase nor decrease firm value and share price. Answer (D) is incorrect because investments with present values
equal to their costs have a zero NPV and neither increase nor decrease firm value and share price.
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
(1 + K)t
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
.Answer (A)
is correct. The value of the firm is the present value of the expected cash flows, which is given by the following
expression:
n
Sigma CF t
t=1
(1 + K)t
If CF is net cash flow, K is the discount rate (cost of capital), and t is time, value will rise as CF increases.
Answer (B) is incorrect because an increase in systematic (market or undiversifiable) risk will increase the overall cost of
capital and thereby increase K, the discount rate. As a result, the value of the firm will fall. Answer (C) is incorrect
because an increase in unsystematic (or firm-specific) risk will have no effect on the value of the firm. The total risk is
the sum of systematic and unsystematic risk. By definition, the latter is the risk that can be eliminated by diversification.
Answer (D) is incorrect because an increase in the discount rate will reduce the value of the firm.
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
Statement a is false. Stand-alone risk is measured by standard deviation. Therefore, since Y’s standard deviation is
higher than X’s, Y has higher stand-alone risk than X. Statement b is false. Corporate risk is measured by the
correlation of project cash flows with other company cash flows. Therefore, since Y’s cash flows are highly
correlated with the cash flows of existing projects, while X’s are not, Y has higher corporate risk than X. Market
risk is measured by beta. Therefore, since X’s beta is greater than Y’s, statement c is true.
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
n
Sigma CF t
t=1
(1 + K)t .Statement a is correct. The IRR’s of both exceed the cost of capital. Statement b is incorrect. We
cannot determine this without knowing the NPV’s of the projects. Statement c is correct. To see why draw the NPV
profiles. Statement d is incorrect. Therefore, statement e is the correct answer.
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
n
Sigma CF t
t=1
(1 + K)t .This is the only project with either a positive NPV or an IRR which exceeds the cost of capital.
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
n
Sigma CF t
t=1
(1 + K)t .Draw out the NPV profiles of these two projects. As B’s NPV declines more rapidly with an increase in
discount rates, this implies that more of the cash flows are coming later on. Therefore, Project A has a faster payback
than Project B.
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
n
Sigma CF t
t=1
(1 + K)t .
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
If IRRX is greater than MIRRX, then its IRR must be higher than the cost of capital. (Remember that the MIRR will be
somewhere between the cost of capital and the IRR). Therefore, statement a must be true. Similarly, if IRR Y is less than
MIRRY, then its IRR must be lower than the cost of capital. Therefore, statement b must be true. At a cost of capital of 10
percent they have the same NPV, so this is the crossover rate. From statements a and b we know that IRR X must be
greater than IRRY, so to the right of the crossover rate NPV X will be larger than NPVY. Consequently, to the left of the
crossover rate NPVX must be smaller than NPVY. Therefore, statement c is also true. Since statements a, b, and c are all
true, the correct choice is statement d.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .This statement reflects exactly the difference
between the NPV and IRR methods.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Both statements a and c are correct;
therefore, statement d is the correct choice. Due to reinvestment rate assumptions, NPV and IRR can lead to conflicts;
however, there will be no conflict between NPV and MIRR if the projects are equal in size (which is one of the
assumptions in this question).
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Statement a is true. To see this, sketch out a
NPV profile for a normal, independent project, which means that only one NPV profile will appear on the graph. If WACC
< IRR, then IRR says accept. But in that case, NPV > 0, so NPV will also say accept. Statement d is false. Here is the
reasoning:
1. For the NPV profiles to cross, then one project must have a higher NPV at k = 0 than the other project, that is, their
vertical axis intercepts will be different.
2. A second condition for NPV profiles to cross is that one have a higher IRR than the other.
3. The third condition necessary for profiles to cross is that the project with the higher NPV at k = 0 will have the lower
IRR.
One can sketch out two NPV profiles on a graph to see that these three conditions are indeed required.
4. The project with the higher NPV at k = 0 must have more cash inflows, because it has the higher NPV when cash
flows are not discounted, which is the situation if k = 0.
5. If the project with more total cash inflows also had its cash flows come in earlier, it would dominate the other
project--its NPV would be higher at all discount rates, and its IRR would also be higher, so the profiles would not
cross. The only way the profiles can cross is for the project with more total cash inflows to get a relatively high
percentage of those inflows in distant years, so that their PVs are low when discounted at high rates. Most students
either grasp this intuitively or else just guess at the question!
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Answer (A) is correct. If the economic results
of alternative capital investments were known with certainty or with minimal risk, the quantitative analyses would reveal
the absolute best investment options. However, if the economic results are highly uncertain, using a decision-making
process that combines rational analysis with intuition is appropriate. Moreover, nonquantifiable variables may be
involved.
Answer (B) is incorrect because the decision-making process described combines rational quantitative analysis with
intuition. In addition, research has shown that intuition can improve decision making. Answer (C) is incorrect because
knowing with certainty which investment is the most profitable is not possible. Answer (D) is incorrect because the term
bounded rationality refers to the inability to perceive all aspects of a situation and the tendency to simplify, not to intuitive
decision making.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Statement e is correct; the other statements
are false. IRR can lead to conflicting decisions with NPV even with normal cash flows if the projects are mutually
exclusive. Cash outflows are discounted at the cost of capital with the MIRR method, while cash inflows are
compounded at the cost of capital. Conflicts between NPV and IRR arise when the cost of capital is below the
crossover point. The discounted payback method does correct the problem of ignoring the time value of money, but it
still does not account for cash flows beyond the payback period.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Statements a and c are correct; therefore,
statement d is the correct choice. The discounted payback method still ignores cash flows after the payback period.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Statement a is correct; the other statements
are false. Multiple IRRs can occur only for projects with nonnormal cash flows. Mutually exclusive projects imply that
only one project should be chosen. The project with the highest NPV should be chosen.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Statement a is correct; the other statements
are false. Sketch the profiles. From the information given, D has the higher IRR. The project’s scale cannot be
determined from the information given. As C’s NPV declines more rapidly with an increase in rates, this implies that
more of the cash flows are coming later on. So C would have a slower payback than D.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Answer (D) is correct. MACRS is an
accelerated method of depreciation under which depreciation expense will be greater during the early years of an
asset's life. Thus, the outflows for income taxes will be less in the early years, but greater in the later years, and the NPV
(present value of net cash inflows - investment) will be increased. The profitability index (present value of net cash
inflows ÷ the investment) must increase if the NPV increases.
Answer (A) is incorrect because the NPV will increase. The present value of the net inflows will increase with no change
in the investment. Answer (B) is incorrect because the IRR will increase. Deferring expenses to later years increases the
discount rate needed to reduce the NPV to $0. Answer (C) is incorrect because the payback period will be shortened.
Switching to MACRS defers expenses and increases cash flows early in the project's life.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
12A-. Depreciation cash flows Answer: c Diff: M
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Answer (D) is correct. MACRS for assets with
lives of 10 years or less is based on the 200% declining-balance method of depreciation. Thus, an asset with a 3-year
life would have a straight-line rate of 33-1/3%, or a double-declining-balance rate of 66-2/3%.
Answer (A) is incorrect because the straight-line method uses the same percentage each year during an asset's life, but
MACRS uses various percentages. Answer (B) is incorrect because MACRS is unrelated to the units-of-production
method. Answer (C) is incorrect because MACRS is unrelated to SYD depreciation.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Answer (A) is correct. For tax purposes,
straight-line depreciation is an alternative to the MACRS method. Both methods will result in the same total depreciation
over the life of the asset; however, MACRS will result in greater depreciation in the early years of the asset's life
because it is an accelerated method. Given that MACRS results in larger depreciation deductions in the early years,
taxes will be lower in the early years and higher in the later years. Because the incremental benefits will be discounted
over a shorter period than the incremental depreciation costs, MACRS is preferable to the straight-line method.
Answer (B) is incorrect because both methods will produce the same total depreciation over the life of the asset. Answer
(C) is incorrect because both methods will produce the same total tax payments (assuming rates do not change).
However, given that the tax payments will be lower in the early years under MACRS, discounting for the time value of
money makes the straight-line alternative less advantageous. Answer (D) is incorrect because both methods will
produce the same total depreciation over the life of the asset.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K) .Taxes on gain on saleAnswer: b Diff:
E N
When the machine is sold the total accumulated depreciation on it is: (0.2 + 0.32 + 0.19) $1,000,000 = $710,000.
The book value of the equipment is: $1,000,000 - $710,000 = $290,000. The machine is sold for $400,000, so the
gain is $400,000 - $290,000 = $110,000. Taxes are calculated as $110,000 0.4 = $44,000.
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
Tabular solution:
Solve for the NPV of Project A, which is also the NPV of Project B at some k
= ?
NPVA = -$15,000 + $4,000(PVIFA12%,6) + $5,000(PVIF12%,6)
= -$15,000 + $4,000(4.1114) + $5,000(0.5066) = $3,978.60.
Solve for kB
NPVB = $3,978.60 = -$14,815 + $5,100(PVIFAk,6)
$18,793.60 = $5,100(PVIFAk,6)
PVIFAk,6 = 3.68502.
Look across the row for 6 years in the PVIFA table. The factor for 16 percent
is 3.6847; therefore, the risk-adjusted rate for Project B is approximately
16 percent.
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Tabular solution:
NPVA = -$25,000 + $13,000(PVIFA12%,3) + $18,000(PVIF12%,4)
= -$25,000 + $13,000(2.4018) + $18,000(0.6355) = $17,662.40.
NPVB = $17,662.40 = -$25,000 + $15,247(PVIFAk,4)
$42,662.40 = $15,247(PVIFAk,4)
(PVIFAk,4) = 2.79808
k 16%.
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Tabular solution:
NPV = -$3,000 + $1,728(PVIF18%,1) + $1,920(PVIF18%,2) + $1,152(PVIF18%,3)
= -$3,000 + $1,728(0.8475) + $1,920(0.7182) + $1,152(0.6086) = $544.53.
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Tabular solution:
NPV = -$45,000 + $7,800(PVIF12%,1) + $10,680(PVIF12%,2) + $7,560(PVIF12%,3)
+ $5,880(PVIF12%,4) - $1,920(PVIF12%,5)
= -$45,000 + $7,800(0.8929) + $10,680(0.7972) + $7,560(0.7118)
+ $5,880(0.6355) - $1,920(0.5674) = -$21,492.74 -$21,493.
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Tabular solution:
NPV = -$40,000 + $9,800(PVIF9%,1) + $11,720(PVIF9%,2) + $9,640(PVIF9%,3)
+ $8,520(PVIF9%,4) + $15,320(PVIF9%,5)
= -$40,000 + $9,800(0.9174) + $11,720(0.8417) + $9,640(0.7722)
+ $8,520(0.7084) + $15,320(0.6499) = $2,291.29 $2,292.
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Project B:
0 k = ? 1 2 6 Years
CFsB -14,815 5,100 5,100 5,100
Time lines:
Project A:
0 1 2 3 4 Years
k = 12%
Project B:
0 1 2 3 4 Years
k = ?
Time line:
0 1 2 3 4 5 Years
k = 12%
Time line:
0 k = 9% 1 2 3 4 5 Years
0 1 2 3
Equipment purchase -$600,000
NOWC -50,000
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Year 0 1 2 3 4
Project cost -5,000,000
NOWC* -300,000
*An increase in inventories is a use of funds for the company, and an increase in accounts payable is a source of
funds for the company. Thus, the change in net operating working capital will be $200,000 - $500,000 = -$300,000
at time 0.
Time lines:
Project A:
0 k = 14% 1 2 3 4 Years
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B
k k
0 7% 12% 15% 0 7% 12% 14%
NPV
$
X
Crossover
n
Sigma CF t k
t=1
10% IRRY 12% IRRX
t
(1 + K)
0 k = 12% 1 2 3 4 5 6
Project B:
0 k = ? 1 2 6 Years
CFsB -14,815 5,100 5,100 5,100
Time lines:
Project A:
0 1 2 3 4 Years
k = 12%
Project B:
0 1 2 3 4 Years
k = ?
Time line:
0 1 2 3 4 5 Years
k = 12%
Time line:
0 k = 9% 1 2 3 4 5 Years
0 1 2 3 4
Project cost ($500,000)
NOWC (40,000)
Time lines:
Project A:
0 k = 14% 1 2 3 4 Years
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Time lines:
Project A:
0 k = 14% 1 2 3 4 Years
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Now, enter these CFs along with the cost of the equipment to find the pre-
salvage NPV (note that the salvage value is not yet accounted for in these
CFs). The appropriate discount rate for these CFs is 11 percent. This yields
a pre-salvage NPV of $16,498.72.
Finally, the salvage value must be discounted. The PV of the salvage value
is: N = 4; I = 12; PMT = 0; FV = -10,000; and PV = $6,355.18. Adding the PV
of the salvage amount to the pre-salvage NPV yields the project NPV of
$22,853.90.
Time lines:
Project A:
0 k = 14% 1 2 3 4 Years
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Enter the cash flows and solve for the NPV = $38,839.56.
Time lines:
Project A:
0 k = 14% 1 2 3 4 Years
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Enter the cash flows into the cash flow register and solve for the NPV using
the WACC of 10%. NPV = $54,676.59.
Time lines:
Project A:
0 k = 14% 1 2 3 4 Years
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Project B:
0 k = 10% 1 2 3 4 Years
Tabular solution:
NPVA = $71,104(PVIFA14%,4) - $200,000
= $71,104(2.9137) - $200,000 = $7,175.72.
NPVB = $146,411(PVIF10%,3) + $146,411(PVIF10%,4) - $200,000
= $146,411(0.7513) + $146,411(0.6830) - $200,000 = $9,997.30.
Project B has the higher NPV. Since they are mutually exclusive, select
Project B.
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Tabular solution:
NPV = -$50,000 + $6,000(PVIFA12%,10) + $10,000(PVIF12%,10)
= -$50,000 + $6,000(5.6502) + $10,000(0.3220)
= -$12,878.80 -$12,879.
Time lines:
Project A:
0 k = 12% 1 2 3 Periods
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Project B:
0 k = 14% 1 2 3 Periods
Tabular solution:
NPVA = $2,000(PVIF12%,1) + $2,500(PVIF12%,2) + $2,250(PVIF12%,3) - $5,000
= $2,000(0.8929) + $2,500(0.7972) + $2,250(0.7118) - $5,000
= $380.35 $380.
NPVB = $3,000(PVIF14%,1) + $2,600(PVIF14%,2) + $2,900(PVIF14%,3) - $5,000
= $3,000(0.8772) + $2,600(0.7695) + $2,900(0.6750) - $5,000
= $1,589.80 $1,590.
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
0 1 2 3 4 5
Initial invest. outlay -$30.0
Sales $20.0 $20.0 $20.0 $20.0 $20.0
Oper. cost 12.0 12.0 12.0 12.0 12.0
Deprec. 10.0 10.0 10.0 0.0 0.0
EBIT -$ 2.0 -$ 2.0 -$ 2.0 $ 8.0 $ 8.0
Less: Taxes -0.8 -0.8 -0.8 3.2 3.2
EBIT(1 - T) -$ 1.2 -$ 1.2 -$ 1.2 $ 4.8 $ 4.8
Add back: Deprec. 10.0 10.0 10.0 0.0 0.0
NCF -$30.0 $ 8.8 $ 8.8 $ 8.8 $ 4.8 $ 4.8
0 1 2 3 4
| | | | |
CFsNew Tech -1,500 -315 -315 -315 -315 x x x
Time line:
0 1 2 3 Years
k = 14%
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Time line:
0 1 2 3 Years
k = 14%
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
Time line:
0 1 2 3 Years
k = 14%
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6
B
A
NPV
($)
NPV
$
NPV ($)
P
C
k 10% k
10% 15% 20% %
NPV NPV
$
A A
B
B n
Sigma CF t
k k t=1
0 7% 12% 15% 0 7% 12% 14%
(1 + K)t
NPV
$
X
Crossover
k
10% IRRY 12% IRRX
0 k = 12% 1 2 3 4 5 6