978-0133507676 chapter 8 Part 2

Unlock access to all the studying documents.

View Full Document

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

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

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

14) Consider the following two projects:

Projec

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

16) Consider the following two projects:

Projec

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

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

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

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

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

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

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