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10) Which of the following statements is FALSE?
A) In general, the diference between the cost of capital and the internal rate of return
(IRR) is the maximum amount of estimation error in the cost of capital estimate that can
exist without altering the original decision.
B) The internal rate of return (IRR) can provide information on how sensitive your analysis
is to errors in the estimate of your cost of capital.
C) If you are unsure of your cost of capital estimate, it is important to determine how
sensitive your analysis is to errors in this estimate.
D) If the cost of capital estimate is more than the internal rate of return (IRR), the net
present value (NPV) will be positive.
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
11) Consider a project with the following cash lows:
Year Cash Flow
0 -12,000
1 3000
2 3000
3 3000
4 3000
If the appropriate discount rate for this project is 13%, then the net present value (NPV) is
closest to ________.
A) $24,000
B) -$1846
C) -$3077
D) -$2154
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
11
12)
Year Cash Flow
0 -12,000
1 3000
2 3000
3 3000
4 3000
Given the cash lows in the table above, the point at which the NPV proile crosses the
vertical axis is ________.
A) $0
B) $12,000
C) 23%
D) 19%
AACSB Objective: Analytic Skills
Author: JP
Question Status: Revised
13) Consider the following two projects:
Projec
t
Year 0
Cash
Flow
Year 1
Cash
Flow
Year 2
Cash
Flow
Year 3
Cash
Flow
Year 4
Cash
Flow
Discount
Rate
A -100 40 50 60 N/A 0.11
B -73 30 30 30 30 0.11
The net present value (NPV) of project A is closest to ________.
A) 20.5
B) 22.5
C) 25.6
D) 51.2
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
12
14) Consider the following two projects:
Projec
t
Year 0
Cash
Flow
Year 1
Cash
Flow
Year 2
Cash
Flow
Year 3
Cash
Flow
Year 4
Cash
Flow
Discount
Rate
A -100 40 50 60 N/A 0.17
B -73 30 30 30 30 0.17
The net present value (NPV) of project B is closest to ________.
A) 9.3
B) 10.2
C) 11.6
D) 23.2
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
15) The Sisyphean Company is planning on investing in a new project. This will involve the
purchase of some new machinery costing $420,000. The Sisyphean Company expects cash
inlows from this project as detailed below:
Year 1 Year 2 Year 3 Year 4
$200,000 $225,000 $275,000 $200,000
The appropriate discount rate for this project is 16%.
The net present value (NPV) for this project is closest to ________.
A) $206,265
B) $144,385
C) $515,661
D) $216,578
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
13
16) Consider the following two projects:
Projec
t
Year 0
C/F
Year 1
C/F
Year 2
C/F
Year 3
C/F
Year 4
C/F
Year 5
C/F
Year 6
C/F
Year 7
C/F
Discount
Rate
Alpha -79 20 25 30 35 40 N/A N/A 12%
Beta -80 25 25 25 25 25 25 25 13%
The net present value (NPV) for project alpha is closest to ________.
A) $31.35
B) $25.08
C) $37.62
D) $21.32
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
17) Consider the following two projects:
Projec
t
Year 0
C/F
Year 1
C/F
Year 2
C/F
Year 3
C/F
Year 4
C/F
Year 5
C/F
Year 6
C/F
Year 7
C/F
Discount
Rate
Alpha -79 20 25 30 35 40 N/A N/A 16%
Beta -80 25 25 25 25 25 25 25 17%
The net present value (NPV) for project beta is closest to ________.
A) $21.67
B) $14.45
C) $18.06
D) $12.64
AACSB Objective: Analytic Skills
Author: JN
Question Status: Revised
14
18) How can you calculate the y-intercept of a net present value (NPV) proile without
using TVM concepts?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
19) What is the general shape of the net present value (NPV) proile?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
20) Under what situation can the net present value (NPV) proile be upward sloping?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Revised
8.3 Alternative Decision Rules
1) The payback rule is based on the idea that an opportunity that pays back its initial
investment quickly is a worthwhile opportunity.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
2) The internal rate of return (IRR) rule will agree with the Net Present Value rule even
when positive cash lows precede negative cash lows.
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Previous Edition
3) Which of the following situations can lead to IRR giving a diferent decision than NPV?
A) delayed investment
B) multiple IRRs
C) diferences in project scale
D) All of the above can lead to IRR giving a diferent decision than NPV.
AACSB Objective: Analytic Skills
Author: JP
Question Status: New
4) According to Graham and Harvey's 2001 survey (Figure 8.2 in the text), the most
popular decision rules for capital budgeting used by CFOs are ________.
A) NPV, IRR, MIRR
B) MIRR, IRR, Payback period
C) IRR, NPV, Payback period
D) Proitability index, NPV, IRR
AACSB Objective: Analytic Skills
Author: JP
Question Status: Revised
5) Which of the following is NOT a limitation of the payback rule?
A) It does not consider the time value of money.
B) Lacks a decision criterion that is economically based.
C) It is diicult to calculate.
D) It does not consider cash lows occurring after the payback period.
AACSB Objective: Relective Thinking Skills
Author: DS
Question Status: Revised
16
6) A convenience store owner is contemplating putting a large neon sign over his store. It
would cost $50,000, but is expected to bring an additional $24,000 of proit to the store
every year for ive years. Would this project be worthwhile if evaluated using a payback
period of two years or less and if the cost of capital is 10%?
A) Yes, since it will pay back its initial investment in two years.
B) Yes, since the value of the cash lows into the store, in present dollars, are greater than
the initial investment.
C) Yes, since the cash lows after two years are greater than the initial investment.
D) No, since the value of the cash lows over the irst two years are less than the initial
investment.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
Use the information for the question(s) below.
Project A Project B
Time 0 -10,000 -10,000
Time 1 5,000 4,000
Time 2 4,000 3,000
Time 3 3,000 10,000
7) If WiseGuy Inc. uses payback period rule to choose projects, which of the projects
(Project A or Project B) will rank highest?
A) Project A
B) Project B
C) Project A and Project B have the same ranking.
D) Cannot calculate a payback period without a discount rate.
AACSB Objective: Analytic Skills
Author: JP
Question Status: Previous Edition
17
8) If WiseGuy Inc. uses IRR rule to choose projects, which of the projects (Project A or
Project B) will rank highest?
A) Project A
B) Project B
C) Project A and Project B have the same ranking.
D) Cannot calculate a payback period without a discount rate.
AACSB Objective: Analytic Skills
Author: JP
Question Status: Revised
9) A lorist is buying a number of motorcycles to expand its delivery service. These will cost
$78,000 but are expected to increase proits by $3000 per month over the next four years.
What is the payback period in this case?
A) 10.40 months
B) 15.60 months
C) 19.50 months
D) 26.00 months
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
18
10)
Investment A:
Year: 0 1 2 3 4 5
Cash low: -$14,000 $6000 $6000 $6000 $6000 $6000
Investment B:
Year: 0 1 2 3 4 5
Cash low: -$15,000 $7000 $7000 $7000 $7000 $7000
Investment C:
Year: 0 1 2 3 4 5
Cash low: -$18,000 $12,000 $2000 $2000 $2000 $2000
The cash lows for three projects are shown above. The cost of capital is 9.5%. If an
investor decided to take projects with a payback period two years or less, which of these
projects would he take?
A) Investment A
B) Investment B
C) Investment C
D) none of these investments
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
11) A lottery winner can take $6 million now or be paid $600,000 at the end of each of the
next 16 years. The winner calculates the internal rate of return (IRR) of taking the money
at the end of each year and, estimating that the discount rate across this period will be 4%,
decides to take the money at the end of each year. Was her decision correct?
A) Yes, because it agrees with the Net Present Value rule.
B) Yes, because it agrees with the payback rule.
C) Yes, because it agrees with both the Net Present Value rule and the payback rule.
D) Yes, because it disagrees with the Net Present Value rule.
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
19
12) Mary is in contract negotiations with a publishing house for her new novel. She has two
options. She may be paid $100,000 up front, and receive royalties that are expected to total
$26,000 at the end of each of the next ive years. Alternatively, she can receive $200,000 up
front and no royalties. Which of the following investment rules would indicate that she
should take the former deal, given a discount rate of 8%?
Rule I: The Net Present Value rule
Rule II: The Payback Rule with a payback period of two years
Rule III: The internal rate of return (IRR) Rule
A) Rule I only
B) Rule III only
C) Rule II and III
D) Rule I and II
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
13) A local government awards a landscaping company a contract worth $1.5 million per
year for ive years for maintaining public parks. The landscaping company will need to buy
some new machinery before they can take on the contract. If the cost of capital is 6%, what
is the most that this equipment could cost if the contract is to be worthwhile for the
landscaping company?
A) $5.69 million
B) $6.00 million
C) $6.32 million
D) $6.63 million
AACSB Objective: Analytic Skills
Author: DS
Question Status: Revised
20
