978-0134730417 Test Bank Chapter 9 Part 2

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18) Heartland, Inc. is considering an eight-year project that has an initial after-tax outlay or after-

tax cost of $180,000. The future after-tax cash inflows from its project for years 1 through 8 are

the same at $38,000. Heartland uses the net present value method and has a discount rate of

11.50%. Will Heartland accept the project?

A) Heartland accepts the project because the NPV is about $12,114.

B) Heartland accepts the project because the NPV is about $11,114.

C) Heartland rejects the project because the NPV is about -$11,114.

D) Heartland rejects the project because the NPV is less than -$12,000.

19) Axios, Inc. is considering Project A and Project B, which are two mutually exclusive projects

with unequal lives. Project A is an eight-year project that has an initial outlay or cost of

$180,000. Its future cash inflows for years 1 through 8 are $38,000. Project B is a six-year

project that has an initial outlay or cost of $160,000. Its future cash inflows for years 1 through 6

are the same at $36,000. Axios uses the equivalent annual annuity (EAA) method and has a

discount rate of 11.50%. Will Axios accept the project?

A) Axios accepts Project B because it has a more positive EAA.

B) Axios rejects both projects because both have a negative NPV (and thus negative EAA).

C) Axios accepts Project A because its EAA is about $2,396 and Project B’s EAA is only about

$1,097.

D) Axios accepts Project A because its NPV (and thus EAA) is positive and Project B’s NPV

(and thus EAA) is negative.

20) Crossborder, Inc. is considering Project A and Project B, which are two mutually exclusive

projects with unequal lives. Project A is an eight-year project that has an initial outlay or cost of

$140,000. Its future cash inflows for years 1 through 8 are the same at $36,500. Project B is a

six-year project that has an initial outlay or cost of $160,000. Its future cash inflows for years 1

through 6 are the same at $48,000. Crossborder uses the equivalent annual annuity (EAA)

method and has a discount rate of 13%. Which project(s), if any, will Crossborder accept?

A) Crossborder will take Project B because it has a positive NPV and its EAA is greater than that

for Project A.

B) Crossborder rejects both projects because both have a negative NPV (and thus negative

EAA).

C) Crossborder accepts both projects because both have a positive NPV (and thus positive EAA).

D) Crossborder accepts Project A because its EAA of about $7,975 is greater than Project B’s

EAA of about $6,440.

21) The assignment of a discount rate to each project is an integral part of the NPV process.

22) To determine the current value of a project, discount all future cash flows to the present and

add up all cash inflow and outflow.

23) Finding the equivalent annual annuity (EAA) is a good way to deal with projects with

unequal lives and should only be used with mutually exclusive projects.

24) To be considered acceptable, a project must have an NPV greater than 1.0.

25) Stanton, Inc. wants to analyze the NPV profile for a five-year project that is considered to be

very risky. The project’s initial outlay or cost is $80,000 and it has respective cash inflows for

years 1, 2, 3, 4 and 5 of $15,000, $25,000, $35,000, $45,000 and $55,000. Stanton wants to know

how the NPV will change for the following required rates of returns: 9%, 14%, 19%, 24%, and

29%. From the NPV profile, at about what rate will the NPV be equal to zero?

26) Ace, Inc. is considering Project A and Project B, which are two mutually exclusive projects

with unequal lives. Project A is an eight-year project that has an initial outlay or cost of $18,000.

Its future cash inflows for years 1 through 8 are the same at $3,800. Project B is a six-year

project that has an initial outlay or cost of $16,000. Its future cash inflows for years 1 through 6

are the same at $3,600. Ace uses the equivalent annual annuity (EAA) method and has a discount

rate of 11.50%. Which, if any, project will Ace accept?

9.4 Internal Rate of Return

1) The most popular alternative to NPV for capital budgeting decisions is the ________ method.

A) internal rate of return (IRR)

B) payback period

C) discounted payback period

D) profitability index

2) The IRR is the discount rate that produces a zero NPV or the specific discount rate at which

the present value of the cost equals ________.

A) the future value of the present cash outflows

B) the present value of the future benefits or cash inflows

C) the present value of the cash outflow

D) the investment

3) Without a computer and special calculator, ________.

A) computing the payback period is much more difficult than computing the IRR

B) finding the IRR will typically be a very easy process

C) finding the IRR may be a very tedious process only if the NPV is negative

D) finding the IRR may be a very tedious process since it is an iterative process

4) Which of the statements below describes the IRR decision criterion?

A) The decision criterion is to accept a project if the IRR falls below the desired or required

return rate.

B) The decision criterion is to reject a project if the IRR exceeds the desired or required return

rate.

C) The decision criterion is to accept a project if the IRR exceeds the desired or required return

rate.

D) The decision criterion is to accept a project if the NPV is positive.

5) The hurdle rate should be set so that it reflects the proper risk level for the project. If we have

to choose between two projects with similar risk and therefore similar hurdle rates, we would

select the project that ________.

A) has a higher internal rate of return

B) has a lower internal rate of return

C) has a hurdle rate that is consistent with the payback period method

D) has a hurdle rate that is consistent with the discounted payback period model

6) Which of the statements below is TRUE?

A) The hurdle rate is the cost of debt needed to fund a project.

B) If the IRR exceeds a project’s hurdle rate, the project should be rejected.

C) If the IRR clears the hurdle rate, the project is rejected.

D) The hurdle rate should be set so that it reflects the proper risk level for the project.

7) Darrox, Inc. is considering a four-year project that has an initial outlay or cost of $90,000. The

future cash inflows from its project are $50,000, $30,000, $30,000, and $30,000 for years 1, 2, 3

and 4, respectively. Darrox uses the internal rate of return method to evaluate projects. What is

the approximate IRR for this project?

A) The IRR is less than 12%.

B) The IRR is between 12% and 20%.

C) The IRR is about 22.80%.

D) The IRR is about 28.89%.

8) Idaho Industries Inc. is considering a project that has an initial after-tax outlay or after-tax cost

of $450,000. The respective future cash inflows from its five-year project for years 1 through 5

are $95,000 each year. Idaho expects an additional cash flow of $60,000 in the fifth year. The

firm uses the IRR method and has a hurdle rate of 10%. Will Idaho accept the project?

A) Idaho accepts the project because it has an IRR greater than 10%.

B) Idaho rejects the project because it has an IRR less than 10%.

C) Idaho accepts the project because it has an IRR greater than 5%.

D) There is not enough information to answer this question.

9) Alcan, Inc. is considering a project that has an initial outlay or cost of $220,000. The

respective future cash inflows from its four-year project for years 1 through 4 are: $50,000,

$60,000, $70,000, and $80,000, respectively. Alcan uses the internal rate of return method to

evaluate projects. Will Alcan accept the project if its hurdle rate is 12%?

A) Alcan will not accept this project because its IRR is about 9.74%.

B) Alcan will not accept this project because its IRR is about 7.63%.

C) Alcan will not accept this project because its IRR is about 6.50%.

D) Alcan will not accept this project because its IRR is about 4.66%.

10) Moepro, Inc. is considering a five-year project that has an initial outlay or cost of $120,000.

The respective future cash inflows from its project for years 1, 2, 3, 4 and 5 are: $55,000,

$45,000, $35,000, $25,000, and $15,000. Moepro uses the internal rate of return method to

evaluate projects. What is the project’s IRR?

A) The IRR is less than 22.50%.

B) The IRR is about 19.16%.

C) The IRR is about 17.86%.

D) The IRR is over 25.50%.

11) Leanard, Inc. is considering a very risky five-year project that has an initial outlay or cost of

$70,000. The future cash inflows from its project for years 1, 2, 3, 4, and 5 are all the same at

$35,000. Leanard uses the internal rate of return method to evaluate projects. Will Leanard

accept the project if its hurdle rate is 41.00%?

A) Leanard will probably reject this project because its IRR is about 39.74%, which is slightly

below its hurdle rate.

B) Leanard will probably accept this project because its IRR is about 41.04%, which is slightly

above its hurdle rate.

C) Leanard will accept this project because its IRR is about 41.50%.

D) Leanard will accept this project because its IRR is over 45.50%.

12) The Internal Rate of Return (IRR) Model suffers from three problems. Which of the below is

NOT one of these problems?

A) Comparing mutually exclusive projects

B) Cumbersome computations not resolvable by the latest technology

C) Incorporates the IRR as the reinvestment rate for the future cash flows

D) Multiple IRRs

13) Which of the following in NOT a potential problem suffered by the IRR method of capital

budgeting?

A) Multiple IRRs

B) Disagreement with the NPV as to whether a project with ordinary cash flows is profitable or

not

C) Incorporates the IRR as the reinvestment rate for the future cash flows

D) Comparing mutually exclusive projects

14) Two projects intersect, in terms of NPV, at a discount rate labeled the ________.

A) crossover rate

B) internal rate of return

C) discount rate

D) yield to maturity

15) The crossover rate is the discount rate where both projects have the same ________.

A) IRR

B) PI

C) NPV

D) length to completion

16) Which of the statements below is FALSE?

A) Project A has a higher y-axis intercept for its NPV profile than mutually exclusive Project B.

As long as the profile of Project A is above the profile of Project B, Project A will have a higher

NPV value for that particular discount rate.

B) Project A and Project B are mutually exclusive. The two projects intersect in terms of NPV at

a discount rate labeled the crossover rate.

C) Project A has a higher y-axis intercept for its NPV profile than mutually exclusive Project B.

As we proceed past the crossover rate to the right on the x-axis, Project B’s profile will be above

Project A’s profile.

D) Project A has a higher y-axis intercept for its NPV profile than mutually exclusive Project B.

This means that Project A has a lower NPV than Project B when the discount rate is zero.

17) Which of the statements below is TRUE?

A) One problem with IRR as a decision rule is that if the cash flow is not standard, there is a

possibility of multiple IRRs for a single project.

B) When we talk about standard cash flow for a project, we assume an initial cash outflow at the

beginning of the project and negative cash flows in the future.

C) When we apply IRR to standard cash flow, we have the potential for more than one IRR

solution.

D) For every period that the cash flow has a change of sign (negative to positive or positive to

negative), the NPV profile could cross the y-axis, generating a MIRR.