38
17) Mutually exclusive projects occur when
A) projects have uneven cash flows.
B) more than one firm can use the projects.
C) a set of investment proposals perform essentially the same task.
D) projects are independent.
Keywords: Mutually Exclusive Projects
Learning Obj.: L.O. 10.4
AACSB: Reflective Thinking
18) Which of the following methods of evaluating investment projects can properly evaluate projects of
unequal lives?
A) the net present value
B) the payback
C) the internal rate of return
D) the equivalent annual annuity
Keywords: Equivalent Annual Annuity
Learning Obj.: L.O. 10.4
AACSB: Reflective Thinking
19) Your firm is considering an investment that will cost $920,000 today. The investment will produce
cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate
that your firm uses for projects of this type is 11.25%. What is the investment’s equivalent annual
annuity?
A) $52,377
B) $42,923
C) $41,387
D) $40,399
Keywords: Equivalent Annual Annuity
Learning Obj.: L.O. 10.4
AACSB: Analytical Thinking
39
20) 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%. Which project would you recommend
using the replacement chain method to evaluate the projects with different lives?
A) Project B because its NPV is higher than Project A‘s replacement chain NPV of $47,623
B) Project A because its replacement chain NPV is $76,652, which exceeds the NPV for Project B
C) Project A because its replacement chain NPV is $45,642, which is less than the NPV for Project B
D) Both projects will be valued the same since they are now both four year projects.
Keywords: Replacement Chain, Net Present Value
Learning Obj.: L.O. 10.4
AACSB: Reflective Thinking
21) 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 equivalent annual annuity amount for
project B, rounded to the nearest dollar, is
A) $17,385.
B) $20,936.
C) $22,789.
D) $26,551.
Keywords: Equivalent Annual Annuity
Learning Obj.: L.O. 10.4
AACSB: Analytical Thinking
22) Different discounted cash flow evaluation methods may provide conflicting rankings of investment
projects when
A) the size of investment outlays differ.
B) the projects are mutually exclusive.
C) the accounting policies differ.
D) the internal rate of return equals the cost of capital.
Keywords: Capital Budgeting Decisions, Size, Cash Flows vs Accounting Income
Learning Obj.: L.O. 10.4
AACSB: Reflective Thinking
40
23) The Net Present Value (or NPV) criteria for capital budgeting decisions assumes that expected future
cash flows are reinvested at ________, and the Internal Rate of Return (or IRR) criteria assumes that
expected future cash flows are reinvested at ________.
A) the firm’s discount rate; the internal rate of return
B) the internal rate of return; the internal rate of return
C) the internal rate of return; the firm’s discount rate
D) Neither criteria assumes reinvestment of future cash flows.
Keywords: Net Present Value, Internal Rate of Return, Reinvestment Rate
Learning Obj.: L.O. 10.4
AACSB: Analytical Thinking
24) What is the net present value’s assumption about how cash flows are reinvested?
A) They are reinvested at the IRR.
B) They are reinvested at the APR.
C) They are reinvested at the firm’s discount rate.
D) They are reinvested only at the end of the project.
Keywords: Net Present Value, Reinvestment Rate Assumption
Learning Obj.: L.O. 10.4
AACSB: Reflective Thinking
25) Consider the following two projects:
Net Cash Flow Each Period
Initial Outlay
1
2
3
4
Project A $4,000,000
$2,003,000
$2,003,000
$2,003,000
$2,003,000
Project B $4,000,000
0
0
0
$11,000,000
a. Calculate the net present value of each of the above projects, assuming a 14 percent discount rate.
b. What is the internal rate of return for each of the above projects?
c. Compare and explain the conflicting rankings of the NPVs and IRRs obtained in parts a and b above.
d. If 14 percent is the required rate of return, and these projects are independent, what decision should
be made?
e. If 14 percent is the required rate of return, and the projects are mutually exclusive, what decision
should be made?
Keywords: IRR, NPV, Mutually Exclusive Projects, Independent Projects
Learning Obj.: L.O. 10.4
AACSB: Analytical Thinking
41
26) The Meacham Tire Company is considering two mutually exclusive projects with useful lives of 3 and
6 years. The after-tax cash flows for projects S and L are listed below.
Year
Cash Flow S
0
-$60,000
1
38,000
2
25,000
3
35,000
4
5
6
The required rate of return on these projects is 14 percent. What decision should be made? As part of
your answer, calculate the NPV assuming a replacement chain for Project S, and also calculate the
equivalent annual annuity for each project.
Keywords: NPV, Replacement Chain, Equivalent Annual Annuity
Learning Obj.: L.O. 10.4
AACSB: Analytical Thinking
27) The Dickerson PR Firm is considering two mutually exclusive projects with useful lives of 3 and 6
years. The after-tax cash flows for projects S and L are listed below.
Year
Cash Flow S
0
-$60,000
1
40,000
2
20,000
3
17,000
4
5
6
Calculate the equivalent annual annuity for each project assuming a required return of 15%. What
decision should be made?
Keywords: NPV, Equivalent Annual Annuity
Learning Obj.: L.O. 10.4
AACSB: Analytical Thinking
42
28) Company K is considering two mutually exclusive projects. The cash flows of the projects are as
follows:
Year
Project A
0
-$2,000,000
1
500,000
2
500,000
3
500,000
4
500,000
5
500,000
6
500,000
7
500,000
a. Compute the NPV and IRR for the above two projects, assuming a 13% required rate of return.
b. Discuss the ranking conflict.
c. What decision should be made regarding these two projects?
Keywords: NPV, IRR
Learning Obj.: L.O. 10.4
AACSB: Analytical Thinking
43
29) What are mutually exclusive projects? How might they complicate the capital-budgeting process?
Keywords: Mutually Exclusive Projects
Learning Obj.: L.O. 10.4
AACSB: Reflective Thinking