32) Which of the following is a disadvantage of payback period approach?
A) It does not examine the size of the initial outlay.
B) It does not use net profits as a measure of return.
C) It does not explicitly consider the time value of money.
D) It does not take into account an unconventional cash flow pattern.
33) Which of the following is a strength of payback period?
A) a disregard for cash flows after the payback period
B) only an implicit consideration of the timing of cash flows
C) merely a subjectively determined number
D) It’s simple to calculate and understand.
34) Which of the following is a reason for firms not using the payback method as a guideline in
capital investment decisions?
A) It gives an explicit consideration to the timing of cash flows.
B) The optimal payback period cannot be specified in light of the wealth maximization goal.
C) It is a measure of risk exposure and projects the possibility of a calamity.
D) It is easy to calculate and has intuitive appeal.
1) Net present value is considered a superior capital budgeting technique relative to payback
since it gives explicit consideration to the time value of money.
2) The discount rate is the return that an investment project must meet or exceed to maintain or
increase the firm’s value.
3) The net present value is found by subtracting a project’s initial investment from the present
value of its cash inflows discounted at a rate equal to the project’s internal rate of return.
4) A capital budgeting technique that can be computed by subtracting a project’s initial
investment from the present value of its cash inflows discounted at a rate equal to a firm’s cost of
capital is called net present value.
5) A capital budgeting technique that can be computed by subtracting a project’s initial
investment from the present value of its cash inflows discounted at a rate equal to a firm’s cost of
capital is called profitability index.
6) The NPV of a project with an initial investment of $1,000 that provides after-tax operating
cash flows of $300 per year for four years where the firm’s cost of capital is 15 percent is
$856.49.
7) The NPV of a project with an initial investment of $2,500 that provides after-tax operating
cash flows of $500 per year for four years where the firm’s cost of capital is 15 percent is
$427.49.
8) If the net present value of a project is greater than zero, the firm will earn a return greater than
its cost of capital. The acceptance of such a project would enhance the wealth of the firm’s
owners.
9) If the NPV is greater than the initial investment, a project should be rejected.
10) If the NPV is less than the initial investment, a project should be rejected.
11) If the NPV is greater than $0, a project should be accepted.
12) For a project that has an initial cash outflow followed by cash inflows, the profitability index
(PI) is equal to the present value of cash inflows divided by the cost of capital.
13) Economic value added is the difference between an investment’s net operating profit after
taxes and the accounting profit.
14) The NPV of a project is the difference between an investment’s net operating profit after
taxes and the cost of funds used to finance the investment, which is found by multiplying the
dollar amount of the funds used to finance the investment by the firm’s weighted average cost of
capital.
15) Which of the following is an advantage of NPV?
A) It measures the risk exposure.
B) It takes into account the time value of investors’ money.
C) It is highly sensitive to the discount rates.
D) It measures how quickly a firm can breakeven.
16) The return that must be earned on a project in order to leave the firm’s value unchanged is
________.
A) the internal rate of return
B) the interest rate
C) the cost of capital
D) the compound rate
17) Thinking in terms of the goal of wealth maximization, a project breaks even for shareholders,
meaning that it neither creates nor destroys value, if ________.
A) its NPV equals 0
B) its IRR equals 0
C) its net profit after taxes equals 0
D) its payback period is one year or less
18) A firm can accept a project with a net present value of zero because ________.
A) the project would maintain the wealth of the firm’s owners
B) the project would enhance the wealth of the firm’s owners
C) the project would maintain the earnings of the firm
D) the project would enhance the earnings of the firm
19) A firm is evaluating an investment proposal which has an initial investment of $5,000 and
cash flows presently valued at $4,000. The net present value of the investment is ________.
A) -$1,000
B) $9,000
C) $4,000
D) -$4,000
20) What is the NPV for a project whose cost of capital is 15 percent and initial after-tax cost is
$5,000,000 and is expected to provide after-tax operating cash inflows of $1,800,000 in year 1,
$1,900,000 in year 2, $1,700,000 in year 3, and $1,300,000 in year 4?
A) $1,700,000
B) $371,764
C) -$137,053
D) -$4,862,947
21) What is the NPV for a project if its cost of capital is 0 percent and its initial after-tax cost is
$5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1,
$1,900,000 in year 2, $1,700,000 in year 3, and $1,300,000 in year 4?
A) $1,700,000
B) $371,764
C) $137,053
D) $6,700,000
22) What is the NPV for a project if its cost of capital is 12 percent and its initial after-tax cost is
$5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1,
$1,900,000 in year 2, $1,700,000 in year 3, and ($1,300,000) in year 4?
A) -$1,494,336
B) $158,011
C) -$158,011
D) $3,505,664
23) A firm is evaluating three capital projects. The net present values for the projects are as
follows:
The firm should ________.
A) accept Projects 1 and 2, and reject Project 3
B) accept Projects 1 and 3, and reject Project 2
C) accept Project 3, and reject Projects 1 and 2
D) accept all projects
24) What is the profitability index of a project that has an initial cash outflow of $600, an inflow
of $250 for the next 3 years and a cost of capital of 10 percent?
A) 0.667
B) 2.036
C) 1.036
D) 2.739
25) Given the information in Table 10.1 and 15 percent cost of capital,
(a) compute the net present value.
(b) should the project be accepted?
29
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Table 10.2
26) Given the information in Table 10.2 and 15 percent cost of capital,
(a) compute the net present value.
(b) should the project be accepted?
1) The internal rate of return (IRR) is defined as the discount rate that equates the net present
value with the initial investment associated with a project.
2) The IRR is the discount rate that equates the NPV of an investment opportunity with $0.
3) The IRR is the compounded annual rate of return that a firm will earn if it invests in a project
and receives the estimated cash inflows.
4) An internal rate of return greater than the cost of capital guarantees that the firm will earn at
least its required return.
5) A capital budgeting technique that can be computed by solving for the discount rate that
equates the present value of a project’s inflows to the present value of its outflows is called net
present value.
6) A capital budgeting technique that can be computed by solving for the discount rate that
equates the present value of a project’s inflows to the present value of its outflows is called
internal rate of return.
7) If a project’s IRR is greater than 0 percent, the project should be accepted.
8) If a project’s IRR is greater than the cost of capital, the project should be rejected.
9) What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is
expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year
2, $1,700,000 in year 3, and $1,300,000 in year 4?
A) 15.57%
B) 0.00%
C) 13.57%
D) 12.25%
10) What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is
expected to provide an after-tax operating cash outflow of ($1,800,000) in year 1, followed by
inflows of $2,900,000 in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?
A) 5.83%
B) 9.67%
C) 11.44%
D) 31.53%