978-0133507676 chapter 8 Part 3

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14) A mining company plans to mine a beach for rutile. To do so will cost $14 million up

front and then produce cash lows of $7 million per year for ive years. At the end of the

sixth year the company will incur shut-down and clean-up costs of $6 million. If the cost of

capital is 13.0%, then what is the MIRR for this project?

A) -60.97%

B) -78.39%

C) -87.10%

D) -95.81%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

15) An investor is considering a project that will generate $900,000 per year for four years.

In addition to upfront costs, at the completion of the project at the end of the ifth year

there will be shut-down costs of $400,000. If the cost of capital is 4.4%, based on the MIRR,

at what upfront costs does this project cease to be worthwhile?

A) $2.62 million

B) $2.91 million

C) $3.21 million

D) $3.50 million

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

16) Which of the following is NOT a valid method of modifying cash lows to produce a

MIRR?

A) Discount all of the negative cash lows to time 0 and leave the positive cash lows alone.

B) Leave the initial cash low alone and compound all of the remaining cash lows to the

inal period of the project.

C) Discount all of the negative cash lows to the present and compound all of the positive

cash lows to the end of the project.

D) Turn multiple negative cash lows into a single negative cash low by summing all

negative cash lows over the project’s lifetime.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

17) Which of the following statements is FALSE?

A) The payback investment rule is based on the notion that an opportunity that pays back

its initial investments quickly is a good idea.

B) An internal rate of return (IRR) will always exist for an investment opportunity.

C) A net present value (NPV) will always exist for an investment opportunity.

D) In general, there can be as many internal rates of return (IRRs) as the number of times

the project’s cash lows change sign over time.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

18) Which of the following statements is FALSE?

A) The payback rule is useful in cases where the cost of making an incorrect decision might

not be large enough to justify the time required for calculating the net present value (NPV).

B) The payback rule is reliable because it considers the time value of money and depends

on the cost of capital.

C) For most investment opportunities, expenses occur initially and cash is received later.

D) Fifty percent of irms surveyed reported using the payback rule for making decisions.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

19) Consider a project with the following cash lows:

Year Cash Flow

0 -12,000

1 5000

2 5000

3 5000

4 5000

Assume the appropriate discount rate for this project is 13%. The payback period for this

project is closest to ________.

A) 2.88 years

B) 2.40 years

C) 1.92 years

D) 3.60 years

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

20) 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 80 N/A 0.12

B -73 30 30 30 30 0.12

The payback period for project A is closest to ________.

A) 1.9 years

B) 2.3 years

C) 2.6 years

D) 2.1 years

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

21) 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 0.10

B -73 25 25 25 25 0.10

The payback period for project B is closest to ________.

A) 3.2 years

B) 2.3 years

C) 2.6 years

D) 2.9 years

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

22) The Sisyphean Company is planning on investing in a new project. This will involve the

purchase of some new machinery costing $400,000. The Sisyphean Company expects cash

inlows from this project as

detailed below:

Year 1 Year 2 Year 3 Year 4

$157,452.975$157,452.975 $157,452.975 $157,452.975

The appropriate discount rate for this project is 15%. The internal rate of return (IRR) for

this project is closest to ________.

A) 13%

B) 16%

C) 21%

D) 24%

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

23) What is the decision criterion while using the payback rule?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Revised

24) What is the decision criterion using the Net Present Value rule?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Revised

25) What is the decision criteria using internal rate of return (IRR) rule?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Revised

8.4 Choosing Between Projects

1) When diferent investment rules give conlicting answers, then decisions should be

based on the Net Present Value rule, as it is the most reliable and accurate decision rule.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

2) Internal rate of return (IRR) can reliably be used to choose between mutually exclusive

projects.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

3) When comparing mutually exclusive projects which have diferent scales, you must know

the dollar impact of each investment rather than percentage returns.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

4) The cash lows for four projects are shown below, along with the cost of capital for these

projects. If these projects are mutually exclusive, which one should be taken?

A) Year: 0 1 2 3 4 5

Cash low: -$20,000$6000 $6000 $6000 $6000 $6000

Cost of Capital: 8.2%

B) Year: 0 1 2 3 4 5

Cash low: -$15,000$4000 $4000 $4000 $4000 $4000

Cost of Capital: 7.0%

C) Year: 0 1 2 3 4 5

Cash low: -$18,000$5000 $5000 $5000 $5000 $5000

Cost of Capital: 7.6%

D) Year: 0 1 2 3 4 5

Cash low: -$12,000$4000 $4000 $4000 $4000 $4000

Cost of Capital: 5.0%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

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

If WiseGuy Inc is choosing one of the above mutually exclusive projects (Project A or

Project B), given a discount rate of 7%, which should the company choose?

A) Project A

B) Project B

C) Neither project — both have negative NPV.

D) Both projects — both have positive NPV.

AACSB Objective: Analytic Skills

Author: JP

Question Status: Revised

6) The cash lows for four projects are shown below, along with the cost of capital for these

projects. If these projects are mutually exclusive, which one should be taken?

A) Year: 0 1 2 3 4 5

Cash low: -$5000 $2000 $2000 $2000 $2000 $2000

Cost of Capital: 6.0%

B) Year: 0 1 2 3 4 5

Cash low: -$6000 $2500 $2500 $2500 $2500 2,500

Cost of Capital: 7.5%

C) Year: 0 1 2 3 4 5

Cash low: -$7000 $3000 $3000 $3000 $3000 $3000

Cost of Capital: 7.5%

D) Year: 0 1 2 3 4 5

Cash low: -$8000 $3200 $3200 $3200 $3200 $3200

Cost of Capital: 9.2%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

7) An investor has the opportunity to invest in four new retail stores. The amount that can

be invested in each store, along with the expected cash low at the end of the irst year, the

growth rate of the concern, and the cost of capital is shown for each case. It is assumed

each investment will operate in perpetuity after the initial investment. Which investment

should the investor choose?

A) Initial investment: $100,000; Cash low in year 1: $12,000; Growth Rate: 1.25%; Cost of

Capital: 9.1%

B) Initial investment: $90,000; Cash low in year 1: $10,000; Growth Rate: 1.50%; Cost of

Capital: 9.3%

C) Initial investment: $80,000; Cash low in year 1: $8,000; Growth Rate: 1.75%; Cost of

Capital: 8.0%

D) Initial investment: $60,000; Cash low in year 1: $6,000; Growth Rate: 2.50%; Cost of

Capital: 7.2%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

8) The following show four mutually exclusive investments. Which one is the best

investment?

A) Initial investment: $1.1 million; Cash low in year 1: $160,000; Annual Growth Rate: 2%;

Cost of Capital: 9.1%

B) Initial investment: $1.2 million; Cash low in year 1: $150,000; Annual Growth Rate: 2%;

Cost of Capital: 7.2%

C) Initial investment: $1.3 million; Cash low in year 1: $160,000; Annual Growth Rate: 1%;

Cost of Capital: 5.6%

D) Initial investment: $1.4 million; Cash low in year 1: $150,000; Annual Growth Rate: 2%;

Cost of Capital: 8.4%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

9) The cash lows for four investments have been identiied as follows:

Investment A B C D

Cash Flow Today

in thousands of

dollars -8.0 -12.2 -6.0 -2.2

Cash Flow in One

Year

in thousands of

dollars 9.4 14.3 7.05 2.59

Based on the above information, and with an interest rate of 5%, which is the best

investment?

A) Investment A

B) Investment B

C) Investment C

D) Investment D

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

10) Two mutually exclusive investment opportunities require an initial investment of $7

million. Investment A pays $2.0 million per year in perpetuity, while investment B pays $1.4

million in the irst year, with cash lows increasing by 4% per year after that. At what cost

of capital would an investor regard both opportunities as being equivalent?

A) 3%

B) 7%

C) 13%

D) 15%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

11) A company has identiied the following investments as looking promising. Each

requires an initial investment of $1.2 million. Which is the best investment?

A) a perpetuity that generates a cash low at the end of year 1 of $100,000, has a growth

rate of 1.25%, and a cost of capital of 11.0%

B) a perpetuity that generates a cash low at the end of year 1 of $800,000, has a growth

rate of 2.25%, and a cost of capital of 11.8%

C) an investment that generates a cash low of $400,000 at the end of each of the next ive

years, when the cost of capital is 6.1%

D) an investment that generates a cash low of $200,000 at the end of each of the next ten

years, when the cost of capital is 6.1%

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

12)

Time: 0 1 2 3

Investment

A: -$1 million $300,000 $400,000 $500,000

Investment

B: -$1 million $500,000 $400,000 $300,000

An investor is considering the two investments shown above. Her cost of capital is 8%.

Which of the following statements about these investments is true?

A) The investor should take investment A since it has a greater net present value (NPV).

B) The investor should take investment A since it has a greater internal rate of return

(IRR).

C) The investor should take investment B since it has a greater net present value (NPV).

D) The investor should take investment B since it has a greater internal rate of return

(IRR).

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised