978-0133507676 chapter 8 Part 4

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Time: Year 0 Year 1 Year 2 Year 3 Year 4 Year 5Discount

Rate

Investment A: -$1.5 million $300,000 $300,000 $300,000 $500,000

$500,000 8%

Investment B: -$1.3 million $500,000 $400,000 $300,000 $200,000

$100,000 7%

13) An investor is considering the two investments shown above. 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) Neither investment should be taken since they both have a negative net present value

(NPV).

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

14) You are trying to decide between three mutually exclusive investment opportunities.

The most appropriate tool for identifying the correct decision is ________.

A) net present value (NPV)

B) proitability index

C) internal rate of return (IRR)

D) incremental internal rate of return (IRR)

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

15) 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

Assume that projects A and B are mutually exclusive. The correct investment decision and

the best rationale for that decision is to ________.

A) invest in project A, since NPVB < NPVA

B) invest in project B, since IRRB > IRRA

C) invest in project B, since NPVB > NPVA

D) invest in project A, since NPVA > 0

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

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 16

Beta -80 25 25 25 25 25 25 25 15

Assume that projects Alpha and Beta are mutually exclusive. The correct investment

decision and the best rationale for that decision is to ________.

A) invest in project Beta, since NPVBeta > 0

B) invest in project Alpha, since NPVBeta < NPVAlpha

C) invest in project Beta, since IRRB > IRRA

D) invest in project Beta, since NPVBeta > NPVAlpha > 0

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

17) How do you apply the Net Present Value rule when multiple projects are available and

you have the added constraint of accepting only one project?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Revised

18) What can you comment about the shape of the net present value (NPV) proile of a

multiple IRR project?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Revised

19) Is there a unique way for calculating the MIRR to resolve the multiple IRR situation?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Revised

20) What are some potential problems in using internal rate of return (IRR) for mutually

exclusive projects?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Revised

21) What is a safe method to use when confronted with mutually exclusive projects?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Revised

8.5 Evaluating Projects with Diferent Lives

1) You can evaluate alternative projects with diferent lives by calculating and comparing

their equivalent annual annuity.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

2) When using equivalent annual annuities to compare the costs of projects with diferent

lives, you should not consider any changes in the expected replacement cost of equipment.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

3) When comparing two projects with diferent lives, why do you compute an annuity with

an equivalent present value (PV) to the net present value (NPV)?

A) so that you can see which project has the greatest net present value (NPV)

B) so that the projects can be compared on their cost or value created per year

C) to reduce the danger that changes in the estimate of the discount rate will lead to

choosing the project with a shorter timeframe

D) to ensure that cash lows from the project with a longer life that occur after the project

with the shorter life has ended are considered

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

4) A janitorial services irm is considering two brands of industrial vacuum cleaners to

equip their staf. Option A will cost $1,500, require servicing of $200 per year, and it will

last ive years. Option B will cost $1,000, require servicing of $100 per year, and it will last

three years. If the cost of capital is 8%, which is the better option, given that the irm has

an ongoing requirement for vacuum cleaners?

A) Option A, since it has a lower equivalent annual annuity.

B) Option B, since it has a lower equivalent annual annuity.

C) Option A, since it has a greater equivalent annual annuity.

D) Option B, since it has a greater equivalent annual annuity.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

5) A garage is comparing the cost of buying two diferent car hoists. Hoist A will cost

$20,000, will require servicing of $1000 every two years, and last ten years. Hoist B will

cost $15,000, require servicing of $800 per year, and last eight years. If the cost of capital

is 7%, which is the better option, given that the irm has an ongoing requirement for a

hoist?

A) Hoist A, since it has a greater present value (PV).

B) Hoist B, since it has a greater present value (PV).

C) Hoist A, since it has a greater equivalent annual annuity.

D) Hoist B, since it has a greater equivalent annual annuity.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

6) A security company ofers to provide CCTV coverage for a parking garage for ten years

for an initial payment of $50,000 and additional payments of $30,000 per year. What is the

equivalent annual annuity of this deal, given a cost of capital of 5%?

A) -$21,885

B) -$25,533

C) -$29,180

D) -$36,475

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

7) A company buys a color printer that will cost $16,000 to buy, and last 5 years. It is

assumed that it will require servicing costing $500 each year. What is the equivalent

annual annuity of this deal, given a cost of capital of 8%?

A) -$3155

B) -$3606

C) -$4057

D) -$4507

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

8) A lawn maintenance company compares two ride-on mowers—the Excelsior, which has

an expected working-life of six years, and the Grassassinator, which has a working life of

four years. After examining the equivalent annual annuities of each mower, the company

decides to purchase the Excelsior. Which of the following, if true, would be most likely to

make them change that decision?

A) Fuel prices are expected to rise and raise the annual running costs of all mowers.

B) The mower is only expected to be needed for three years.

C) The prices of equivalent mowers are expected to grow in the future as lawnmower

manufacturers consolidate.

D) The number of customers requiring lawn-mowing services is expected to sharply

increase in the near future.

AACSB Objective: Relective Thinking Skills

Author: DS

Question Status: Revised

9) Jenkins Security has learned that a rival has ofered to supply a parking garage with

security for ten years for $45,000 up front and a further $15,000 per year. If Jenkins

Security ofers to provide security for eight years for an upfront cost of $60,000 and a

separate yearly payment, by what maximum amount can this yearly payment be over

$20,000, so that Jenkins‘ ofer matches the equivalent annual annuity of their rival’s ofer?

(Assume a cost of capital of 5%.)

A) -$89

B) -$94

C) -$100

D) -$111

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

10) A consultancy calculates that it can supply crude oil assaying services to a small oil

producer for $115,000 per year for ive years. There are some upfront costs the

consultancy will require the oil producer to absorb. What is the maximum that these

upfront costs could be, if the equivalent annual annuity to the oil company is to be under

$160,000, given that the cost of capital is 9%?

A) $45,000

B) $175,034

C) $201,289

D) $160,000

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

8.6 Choosing Among Projects When Resources Are Limited

1) When diferent projects put diferent demands on a limited resource, then net present

value (NPV) is always the best way to choose the best project.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

2) The proitability index can break down completely when dealing with multiple resource

restraints.

AACSB Objective: Analytic Skills

Author: DS

Question Status: Previous Edition

3) Initial Investment Cash low

Project A $35 million $14 million per year for four years

Project B $21 million $7 million per year for ive years

Project C $14 million $7 million per year for four years

Project D $21 million $10.5 million per year for three years

An investor has a budget of $35 million. He can invest in the projects shown above. If the

cost of capital is 8%, what investment or investments should he make?

A) Project A

B) Project B

C) Project B and Project C

D) Project C and Project D

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

4) Initial Investment Cash low

Project A $21 million $12 million per year for three years

Project B $18 million $9 million per year for three years

Project C $15 million $6 million per year for six years

Project D $12 million $4.5 million per year for eight years

An investor has a budget of $30 million. He can invest in the projects shown above. If the

cost of capital is 5%, what investment or investments should he make?

A) Project A

B) Project B

C) Project B and Project D

D) Project C and Project D

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised

5) 0 1 2 3

Investment B: -$1 million $550,000 $400,000 $325,000

The timeline of an investment is shown above. If the cost of capital is 8%, what is the

proitability index of this investment?

A) 0.110

B) 0.121

C) 0.275

D) 0.441

AACSB Objective: Analytic Skills

Author: DS

Question Status: Revised