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11) The ________ is the discount rate that equates the present value of the cash inflows with the
initial investment.
A) payback period
B) net present value
C) cost of capital
D) internal rate of return
12) The ________ is the compound annual rate of return that a firm will earn if it invests in the
project and receives the given cash inflows.
A) risk-free rate
B) internal rate of return
C) opportunity cost
D) cost of capital
13) A firm with a cost of capital of 13.5 percent is evaluating three capital projects. The internal
rates of return are as follows:
The firm should ________.
A) accept Project 1 and 2, and reject Project 3
B) accept Project 2, and reject Projects 1 and 3
C) accept Project 1, and reject Projects 2 and 3
D) accept Project 3, and reject Projects 1 and 2
14) An insurance company specializes in selling warranties for consumer electronics products.
For selling these warranties they receive cash up front, but later they must pay out cash for
policyholders who file claims. Suppose a particular product they sell brings in $1 million in cash
right away but requires them to pay $1.2 million in claims a year later. The firm's cost of capital
is 10%. Calculate the IRR that the firm earns on the product and comment on whether it is a
good investment.
1) A project's net present value profile is a graph that plots a project's NPV for various discount
rates.
2) A project's net present value profile is a graph that plots a project's IRR for various discount
rates.
3) Projects A and B both require an initial investment of $100,000. Project A produces $200,000
in cash flows in the subsequent 5 years. Project B produces cash flow of $400,000 next year,
$300,000 in year 2, $200,000 in year 3, and $50,000 in years 4 and 5. Which of the following is
TRUE?
A) The NPV of project A will be more sensitive to changes in the cost of capital compared to the
NPV of project B.
B) The NPV of project B will be more sensitive to changes in the cost of capital compared to the
NPV of project A.
C) The two projects have NPVs that are equally sensitive to changes in the cost of capital.
D) Neither project's NPV is sensitive to changes in the cost of capital.
4) Net present value profiles are most useful when selecting among independent projects.
5) For conventional projects, both NPV and IRR techniques will always generate the same
accept-reject decision.
6) Net present value profiles are most useful when selecting among mutually exclusive projects.
7) Consider the following projects, X and Y, where the firm can only choose one. Project X costs
$600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and
generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment
should the firm choose if the cost of capital is 10 percent?
A) Project X, since it has a higher NPV than Project Y
B) Project Y, since it has a higher NPV than Project X
C) Project X, since it has a lower NPV than Project Y
D) Project Y, since it has a lower NPV than Project X
8) Consider the following projects, X and Y where the firm can only choose one. Project X costs
$600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and
generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment
should the firm choose if the cost of capital is 25 percent?
A) Project X, since it has a higher NPV than Project Y
B) Project Y, since it has a higher NPV than Project X
C) neither, since both the projects have negative NPV
D) neither, since both the projects have positive NPV
9) Which of the following is TRUE regarding an NPV profile?
A) It is used for evaluating and comparing independent projects when conflicting ranking exists.
B) It is a graph that illustrates a project's IRR against various values of NPV.
C) It shows an inverse relationship between a project's IRR and NPV.
D) It charts the net present value of a project as a function of the cost of capital.
10) Tangshan Mining Company is considering investing in a new mining project. The firm's cost
of capital is 12 percent and the project is expected to have an initial after-tax cost of $5,000,000.
Furthermore, the project is expected to provide after-tax operating cash flows of $2,500,000 in
year 1, $2,300,000 in year 2, $2,200,000 in year 3, and ($1,300,000) in year 4?
(a) Calculate the project's NPV.
(b) Calculate the project's IRR.
(c) Should the firm make the investment?
11) Conflicting rankings in the case of mutually exclusive projects using NPV and IRR often
result from differences in the magnitude and/or timing of cash flows.
12) Projects having higher cash inflows in the early years tend to be less sensitive to changes in
the cost of capital and are therefore often acceptable at higher discount rates compared to
projects with higher cash inflows that occur in the later years.
13) In general, projects with similar-sized investments and lower cash inflows in the early years
tend to be preferred at higher discount rates.
14) In general, the greater the difference between the magnitude and/or timing of cash inflows,
the greater the likelihood of conflicting ranking between NPV and IRR.
15) Certain mathematical properties may cause a project with a nonconventional cash flow
pattern to have multiple IRRs; this problem does not occur with the NPV approach.
16) On a purely theoretical basis, NPV is a better approach when selecting among two mutually
exclusive projects.
17) On a purely theoretical basis, IRR is a better approach when selecting among two mutually
exclusive projects.
18) The appeal of the IRR technique is due to the general disposition of business people to think
in terms of rates of return rather than actual dollar returns.
19) If the firm in Table 10.3 has a required payback of two years, it should ________.
A) accept Project A and Project B
B) accept Project A and reject Project B
C) reject Project A and accept Project B
D) reject both the projects
20) The new financial analyst does not like the payback approach (Table 10.3) and determines
that the firm's required rate of return is 15 percent. Based on IRR, his recommendation would be
to ________.
A) accept both the projects
B) accept Project A and reject Project B
C) reject Project A and accept Project B
D) reject both the projects
Table 10.4
A firm must choose from six capital budgeting proposals outlined below. The firm is subject to
capital rationing and has a capital budget of $1,000,000; the firm's cost of capital is 15 percent.
21) Using the internal rate of return approach to ranking projects, which project(s) should the
firm accept? (See Table 10.4)
A) 1, 2, 3, 4, and 5
B) 1, 2, 3, and 5
C) 2, 3, 4, and 6
D) 1, 3, 4, and 6
22) Using the net present value approach to ranking projects, which projects should the firm
accept? (See Table 10.4)
A) 1, 2, 3, 4, and 5
B) 1, 3, 5, and 6
C) 2, 3, 4, and 5
D) 1, 3, 4, 5, and 6
23) When the net present value is negative, the internal rate of return is ________ the cost of
capital.
A) greater than
B) greater than or equal to
C) less than
D) equal to
24) A firm with a cost of capital of 15% is evaluating two independent projects utilizing the
internal rate of return technique. Project X has an initial investment of $80,000 and cash inflows
at the end of each of the next five years of $25,000. Project Z has an initial investment of
$120,000 and cash inflows at the end of each of the next four years of $40,000. The firm should
________.
A) accept both the projects because they have equal IRR
B) accept Project X and reject project Z
C) accept Project Z because its IRR is higher than Project X
D) reject both the projects because they have negative IRR
25) Comparing net present value and internal rate of return ________.
A) always results in the same ranking of projects
B) always results in the same accept-reject decision
C) may give different accept-reject decisions
D) is only necessary on independent projects
26) Which capital budgeting method is most useful for evaluating a project that has an initial
after-tax cost of $5,000,000 and is expected to provide after-tax operating cash flows of
$1,800,000 in year 1, ($2,900,000) in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?
A) net present value
B) internal rate of return
C) payback
D) accounting rate of return
27) Which of the following is a reason that makes NPV a better approach to capital budgeting on
a purely theoretical basis?
A) It measures the benefits relative to the amount invested.
B) It measures the actual value created by an investment.
C) Financial decision makers are inclined to higher rates of return.
D) Interest rates are expressed as annual rates of return.
28) In comparing the internal rate of return and net present value methods of evaluation,
________.
A) internal rate of return is theoretically superior, but financial managers prefer net present value
B) net present value is theoretically superior, but financial managers often prefer to use internal
rate of return
C) financial managers prefer net present value, because it is presented as a rate of return
D) financial managers prefer net present value, because it measures benefits relative to the
amount invested
29) Consider the following projects, X and Y where the firm can only choose one. Project X
costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and
generates cash flows of $500 and $275 for the next 2 years, respectively. Sketch a net present
value profile for each of these projects. Which project should the firm choose if the cost of
capital is 10 percent? What if the cost of capital is 25 percent? Show all work.
