11
56) Which of the following statements is MOST correct?
A) If a project’s internal rate of return (IRR) exceeds the required return, then the project‘s net present
value (NPV) must be negative.
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
IRR.
D) A project with a NPV = 0 is not acceptable.
Keywords: Internal Rate of Return, Net Present Value, Reinvestment Rate
Learning Obj.: L.O. 10.2
AACSB: Reflective Thinking
57) DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is
expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one,
$325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI‘s required rate of return is 8%.
What is the payback period of this project?
A) 4.00 years
B) 3.09 years
C) 2.91 years
D) 2.50 years
Keywords: Payback Period
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
58) DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is
expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one,
$325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI‘s required rate of return is 8%.
What is the net present value of this project?
A) $104,089
B) $100,328
C) $96,320
D) $87,417
Keywords: Net Present Value
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
12
59) DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is
expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one,
$325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI‘s required rate of return is 8%.
What is the internal rate of return of this project?
A) 10.87%
B) 11.57%
C) 13.68%
D) 15.13%
Keywords: Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
60) DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is
expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one,
$325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI‘s required rate of return is 8%.
What is the modified internal rate of return of this project?
A) 10.87%
B) 11.57%
C) 13.68%
D) 15.13%
Keywords: Modified Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
61) Project LMK requires an initial outlay of $400,000 and has a profitability index of 1.5. The project is
expected to generate equal annual cash flows over the next twelve years. The required return for this
project is 20%. What is project LMK’s net present value?
A) $600,000
B) $150,000
C) $120,000
D) $80,000
Keywords: Net Present Value, Profitability Index
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
13
62) Project LMK requires an initial outlay of $500,000 and has a profitability index of 1.4. The project is
expected to generate equal annual cash flows over the next ten years. The required return for this project
is 16%. What is project LMK‘s internal rate of return?
A) 19.88%
B) 22.69%
C) 24.78%
D) 26.12%
Keywords: Internal Rate of Return, Profitability Index, Ordinary Annuity
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
63) A capital budgeting project has a net present value of $30,000 and a modified internal rate of return of
15%. The project’s required rate of return is 13%. The internal rate of return is
A) greater than $30,000.
B) less than 13%.
C) between 13% and 15%.
D) greater than 15%
Keywords: Modified Internal Rate of Return, Net Present Value, Internal Rate of Return, Required Return
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
64) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is
expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected
to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. The
firm’s required rate of return for these projects is 10%. The net present value for Project A is
A) $12,358.
B) $16,947.
C) $19,458.
D) $26,074.
Keywords: Net Present Value
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
14
65) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is
expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected
to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four.
Lithium, Inc.’s required rate of return for these projects is 10%. The net present value for Project B is
A) $58,097.
B) $66,363.
C) $74,538.
D) $112,000.
Keywords: Net Present Value
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
66) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is
expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected
to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four.
Lithium, Inc.’s required rate of return for these projects is 10%. The profitability index for Project A is
A) 1.27.
B) 1.22.
C) 1.17.
D) 1.12.
Keywords: Profitability Index
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
67) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is
expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected
to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four.
Lithium, Inc.’s required rate of return for these projects is 10%. The profitability index for Project B is
A) 1.55.
B) 1.48.
C) 1.39.
D) 1.33.
Keywords: Profitability Index
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
15
68) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is
expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected
to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four.
Lithium, Inc.’s required rate of return for these projects is 10%. The internal rate of return for Project A is
A) 31.43%.
B) 29.42%.
C) 25.88%.
D) 19.45%.
Keywords: Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
69) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is
expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected
to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four.
Lithium, Inc.’s required rate of return for these projects is 10%. The internal rate of return for Project B is
A) 29.74%.
B) 30.79%.
C) 35.27%.
D) 36.77%.
Keywords: Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
70) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is
expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected
to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four.
Lithium, Inc.’s required rate of return for these projects is 10%.The modified internal rate of return for
Project A is
A) 19.19%.
B) 24.18%.
C) 26.89%.
D) 29.63%.
Keywords: Modified Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
16
71) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is
expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected
to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four.
Lithium, Inc.’s required rate of return for these projects is 10%. The modified internal rate of return for
Project B is
A) 17.84%.
B) 18.52%.
C) 19.75%.
D) 22.80%.
Keywords: Modified Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
72) The net present value method
A) is consistent with the goal of shareholder wealth maximization.
B) recognizes the time value of money.
C) uses all of a project’s cash flows.
D) all of the above
Keywords: Net Present Value
Learning Obj.: L.O. 10.2
AACSB: Reflective Thinking
73) Arguments against using the net present value and internal rate of return methods include that
A) they fail to use accounting profits.
B) they require detailed long-term forecasts of the incremental benefits and costs.
C) they fail to consider how the investment project is to be financed.
D) they fail to use the cash flow of the project.
Keywords: Net Present Value, Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Reflective Thinking
74) All of the following are sufficient indications to accept a project EXCEPT (assume that there is no
capital rationing constraint, and no consideration is given to payback as a decision tool)
A) the net present value of an independent project is positive.
B) the profitability index of an independent project exceeds one.
C) the IRR of a mutually exclusive project exceeds the required rate of return.
D) the NPV of a mutually exclusive project is positive and exceeds that of all other projects.
Keywords: Net Present Value, Profitability Index, Internal Rate of Return, Mutually Exclusive Projects, Independent
Projects
Learning Obj.: L.O. 10.2
AACSB: Reflective Thinking
17
75) When reviewing the net present profile for a project,
A) the higher the discount rate, the higher the NPV.
B) the higher the discount rate, the higher the IRR.
C) the IRR will always be a point on the horizontal axis line where NPV = 0.
D) the IRR will always be a point on the horizontal axis equal to the required return.
Keywords: Net Present Value Profile, IRR, NPV
Learning Obj.: L.O. 10.2
AACSB: Reflective Thinking
76) A project requires an initial investment of $389,600. The project generates free cash flow of $540,000 at
the end of year 4. What is the internal rate of return for the project?
A) 138.6%
B) 38.6%
C) 8.5%
D) 6.9%
Keywords: Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
77) Raindrip Corp. can purchase a new machine for $1,875,000 that will provide an annual net cash flow
of $650,000 per year for five years. The machine will be sold for $120,000 after taxes at the end of year five.
What is the net present value of the machine if the required rate of return is 13.5%.
A) $558,378
B) $513,859
C) $473,498
D) $447,292
Keywords: Net Present Value
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
18
78) Given the following annual net cash flows, determine the internal rate of return to the nearest whole
percent of a project with an initial outlay of $750,000.
Year
Net Cash Flow
1
$500,000
2
$150,000
3
$250,000
A) 9%
B) 11%
C) 13%
D) 15%
Keywords: Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
79) A machine that costs $1,500,000 has a 3-year life. It will generate after-tax annual cash flows of
$700,000 at the end of each year. It will be salvaged for $200,000 at the end of year 3. If your required rate
of return for the project is 13%, what is the NPV of this investment?
A) $291,417
B) $400,000
C) $600,000
D) $338,395
Keywords: Net Present Value
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
80)
Initial Outlay
Cash Flow in
Period 1
Cash Flow in
Period 2
Cash Flow in
Period 3
Cash Flow in
Period 4
$4,000,000
$1,546,170
$1,546,170
$1,546,170
$1,546,170
The Internal Rate of Return (to nearest whole percent) is
A) 10%.
B) 18%.
C) 20%.
D) 24%.
Keywords: Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
19
81) We compute the profitability index of a capital budgeting proposal by
A) multiplying the internal rate of return by the cost of capital.
B) dividing the present value of the annual after-tax cash flows by the cost of capital.
C) dividing the present value of the annual after-tax cash flows by the cash investment in the project.
D) multiplying the cash inflow by the internal rate of return.
Keywords: Profitability Index
Learning Obj.: L.O. 10.2
AACSB: Reflective Thinking
82) What is the payback period for a project with an initial investment of $180,000 that provides an
annual cash inflow of $40,000 for the first three years and $25,000 per year for years four and five, and
$50,000 per year for years six through eight?
A) 5.80 years
B) 5.20 years
C) 5.40 years
D) 5.59 years
Keywords: Payback Period
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking
83) The advantages of NPV are all of the following EXCEPT
A) it can be used as a rough screening device to eliminate those projects whose returns do not materialize
until later years.
B) it provides the amount by which positive NPV projects will increase the value of the firm.
C) it allows the comparison of benefits and costs in a logical manner through the use of time value of
money principles.
D) it recognizes the timing of the benefits resulting from the project.
Keywords: Net Present Value
Learning Obj.: L.O. 10.2
AACSB: Reflective Thinking
84) The disadvantage of the IRR method is that
A) the IRR deals with cash flows.
B) the IRR gives equal regard to all returns within a project’s life.
C) the IRR will always give the same project accept/reject decision as the NPV.
D) the IRR requires long, detailed cash flow forecasts.
Keywords: Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Reflective Thinking
20
85) The internal rate of return is
A) the discount rate that makes the NPV positive.
B) the discount rate that equates the present value of the cash inflows with the present value of the cash
outflows.
C) the discount rate that makes NPV negative and the PI greater than one.
D) the rate of return that makes the NPV positive.
Keywords: Internal Rate of Return
Learning Obj.: L.O. 10.2
AACSB: Reflective Thinking
86) All of the following are criticisms of the payback period criterion EXCEPT
A) time value of money is not accounted for.
B) cash flows occurring after the payback are ignored.
C) it deals with accounting profits as opposed to cash flows.
D) None of the above; they are all criticisms of the payback period criteria.
Keywords: Payback Period
Learning Obj.: L.O. 10.2
AACSB: Reflective Thinking
87) Southeast Compositions, Inc. is considering a project with the following cash flows:
Initial Outlay = $126,000
Cash Flows:
Year 1 = $44,000
Year 2 = $59,000
Year 3 = $64,000
Compute the net present value of this project if the company‘s discount rate is 14%.
A) $1,193
B) $561
C) $209
D) $715
Keywords: Net Present Value
Learning Obj.: L.O. 10.2
AACSB: Analytical Thinking