Corporate Finance, 12e (Ross)
1) The difference between the present value of an investment’s future cash flows and its initial
cost is the:
A) net present value.
B) internal rate of return.
C) payback period.
D) profitability index.
E) discounted payback period.
2) If a project is assigned a required rate of return of zero, then:
A) the timing of the project’s cash flows has no bearing on the value of the project.
B) the project will always be accepted.
C) the project will always be rejected.
D) whether the project is accepted or rejected will depend on the timing of the cash flows.
E) the project can never add value for the shareholders.
3) Which statement concerning the net present value (NPV) of an investment or a financing
project is correct?
A) A financing project should be accepted if, and only if, the NPV is exactly equal to zero.
B) An investment project should be accepted only if the NPV is equal to the initial cash flow.
C) Any type of project should be accepted if the NPV is positive and rejected if it is negative.
D) Any type of project with greater total cash inflows than total cash outflows, should always be
accepted.
E) An investment project that has positive cash flows for every time period after the initial
investment should be accepted.
4) All else constant, the net present value of a typical investment project increases when:
A) the discount rate increases.
B) each cash inflow is delayed by one year.
C) the initial cost of a project increases.
D) the required rate of return decreases.
E) all cash inflows occur during the last year instead of periodically throughout the project’s life.
5) Proposed projects should be accepted when those projects:
A) create value for the owners of the firm.
B) have a positive rate of return.
C) return the initial cash outlay within the life of the project.
D) have required cash inflows that exceed the actual cash inflows.
E) have an initial cost that exceeds the present value of the future cash flows.
6) If a project has a net present value equal to zero, then:
A) the initial cost of the project exceeds the present value of the project’s subsequent cash flows.
B) the internal rate of return exceeds the discount rate.
C) the project produces cash inflows that exceed the minimum required inflows.
D) any delay in receiving the projected cash inflows will cause the project’s NPV to be negative.
E) the discount rate exceeds the internal rate of return.
7) Net present value:
A) cannot be relied upon when deciding between two mutually exclusive projects.
B) rule for project acceptance must be modified when comparing projects of varying sizes.
C) is less commonly used in business than the profitability index method of analysis.
D) is not as widely used in practice as payback and discounted payback.
E) provides the means for considering the risks associated with a specific project.
8) A project has an initial cost of $26,000, a discount rate of 11.7 percent, a life of 5 years, and
an NPV of $11,216. Given this, you know that the project is expected to earn a return:
A) equal to 11.7 percent of $26,000 plus an additional $11,216.
B) of $11,216 in total.
C) equal to 11.7 percent of $37,216 (= $26,000 + 11,216).
D) of 11.7 percent of $11,216.
E) of $26,000 minus $11,216.
9) When a firm commences a positive net present value project, you know:
A) the project will pay back within the required payback period.
B) the present value of the expected cash flows is equal to the project’s cost.
C) the inherent risks within the project have been ignored.
D) that all the projected cash flows will occur as expected.
E) the stockholders’ value in the firm is expected to increase.
10) The net present value method of capital budgeting analysis does all of the following except:
A) incorporate risk into the analysis.
B) consider all relevant cash flow information.
C) discount all future cash flows to their current value.
D) consider the initial cost of the project.
E) provide a specific anticipated rate of return.
11) The payback method of analysis:
A) discounts cash flows.
B) ignores the initial cost.
C) considers all project cash flows.
D) applies an industry-standard recoupment period.
E) has a timing bias.
12) The payback method:
A) is the most frequently used method of capital budgeting analysis.
B) is a more sophisticated method of analysis than the profitability index.
C) considers the time value of money.
D) applies mainly to projects where the actual results will be known relatively soon.
E) generally results in decisions that conflict with the decision suggested by NPV analysis.
13) If a firm is more concerned about the quick return of its initial investment than it is about the
amount of value created, then the firm is most apt to evaluate a capital project using the
________ method of analysis.
A) internal rate of return
B) net present value
C) modified internal rate of return
D) payback
E) profitability index
14) Payback is frequently used to analyze independent projects because:
A) it considers the time value of money.
B) all relevant cash flows are included in the analysis.
C) it is easy and quick to calculate.
D) it is the most desirable of all the available analytical methods from a financial perspective.
E) it produces better decisions than those made using either NPV or IRR.
15) One characteristic of the payback method of project analysis is the:
A) use of variable discount rates.
B) standardized cutoff point for cash flow consideration.
C) bias towards liquidity.
D) consideration of the risk level of each project.
E) discounting of all cash flows.
16) All else equal, the payback period for a project will decrease whenever the:
A) initial cost increases.
B) required return for a project increases.
C) assigned discount rate decreases.
D) cash inflows are moved earlier in time.
E) duration of a project is lengthened.
17) The length of time required for an investment to generate cash flows sufficient to recover the
initial cost of the investment is called the:
A) cash period.
B) net working capital period.
C) payback period.
D) profitability index.
E) discounted payback period.
18) An investment is acceptable if the payback period:
A) is less than some pre-specified period of time.
B) exceeds the life of the investment.
C) is negative.
D) is equal to or greater than some pre-specified period of time.
E) is equal to, and only if it is equal to, the investment’s life.
19) Which method(s) of project analysis is(are) best suited for use by a department manager who
has no knowledge of time value of money but can estimate the cash flows of small projects with
short lives fairly accurately?
A) Payback
B) Discounted payback
C) Profitability index
D) Net present value
E) Either payback or profitability index
20) The payback method:
A) determines a cutoff point so that all projects accepted by the NPV rule will be accepted by the
payback period rule.
B) determines a cutoff point equal to the point where all initial capital investments have been
fully depreciated.
C) requires an arbitrary choice of a cutoff point.
D) varies the cutoff point with the market rate of interest.
E) is irrelevant to the accept/reject decision.
21) Which of the following methods of project analysis are biased towards short-term projects?
A) Profitability index and internal rate of return
B) Discounted payback and payback
C) Net present value and payback
D) Payback and profitability index
E) Profitability index and discounted payback
22) The length of time required for a project’s discounted cash flows to equal the initial cost of
the project is called the:
A) net present value.
B) discounted net present value.
C) payback period.
D) discounted profitability index.
E) discounted payback period.
23) The discounted payback period of a project will decrease whenever the:
A) discount rate applied to the project is increased.
B) initial cash outlay of the project is increased.
C) time period of the project is increased.
D) amount of each cash inflow is increased.
E) costs of the fixed assets utilized in the project increase.
24) The discounted payback method:
A) considers the time value of money.
B) discounts the cutoff point.
C) discounts the initial cost.
D) is preferred to the NPV method.
E) ignores project risks.
25) The discounted payback rule may cause:
A) projects with discounted payback periods in excess of the project’s life to be accepted.
B) the most liquid projects to be rejected in favor of less liquid projects.
C) projects to be incorrectly accepted due to ignoring the time value of money.
D) some projects with negative net present values to be accepted.
E) some positive net present value projects to be rejected.
26) For investment projects, the internal rate of return (IRR):
A) rule indicates acceptance of an investment when the IRR is less than the discount rate.
B) is the rate generated solely by the cash flows of the investment.
C) is used primarily to rank projects of varying sizes.
D) is the rate that causes the net present value of a project to equal the project’s initial cost.
E) can effectively be used to compare all types and sizes of mutually exclusive projects.
27) The internal rate of return for a project will increase if:
A) the initial cost of the project can be reduced.
B) the total amount of the cash inflows is reduced.
C) each cash inflow is moved such that it occurs one year later than originally projected.
D) the required rate of return is reduced.
E) the discount rate is increased.
28) You are considering an investment project with an internal rate of return of 8.7 percent, a net
present value of $393, and a payback period of 2.44 years. Which one of the following is correct
given this information?
A) The discount rate used in computing the net present value was less than 8.7 percent.
B) The discounted payback period will be less than 2.44 years.
C) The discount rate used to compute the net present value is equal to the internal rate of return.
D) The required payback period must be greater than 2.44 years.
E) This project should be rejected based on the net present value.
29) The internal rate of return is:
A) more reliable than net present value whenever you are considering mutually exclusive
projects.
B) equivalent to the discount rate that makes the net present value equal to 1.0.
C) computed using a project’s cash flows as the only source of inputs.
D) dependent on the interest rates offered in the marketplace.
E) a better methodology than net present value when dealing with unconventional cash flows.
30) The internal rate of return tends to be:
A) easier for managers to comprehend than the net present value.
B) extremely accurate even when cash flow estimates are faulty.
C) ignored by most financial managers.
D) used primarily to differentiate between mutually exclusive projects.
E) utilized in project analysis only when multiple net present values apply.
31) The discount rate that makes the net present value of an investment exactly equal to zero is
called the:
A) external rate of return.
B) internal rate of return.
C) average accounting return.
D) profitability index.
E) equalizer.
32) Using the internal rate of return method, a conventional investment project should be
accepted if the internal rate of return is:
A) equal to, and only if it is equal to, the discount rate.
B) equal to or greater than the discount rate.
C) less than the discount rate.
D) negative.
E) positive.
33) The internal rate of return for an investment project is best defined as the:
A) discount rate that causes the net present value to equal zero.
B) difference between the market rate of interest and the discount rate.
C) market rate of interest less the risk-free rate.
D) minimum project acceptance rate set by management.
E) maximum rate that can be earned for a project to be accepted.
34) Which one of the following statements is true?
A) You must know the discount rate to compute the NPV but not the IRR.
B) You must have a discount rate to compute, NPV, IRR, PI, and discounted payback.
C) Payback uses the same discount rate as that applied in the NPV calculation.
D) Financing projects can only ever have one IRR.
E) Financing projects are acceptable if the NPV is negative.
35) A financing project is acceptable if its internal rate of return is:
A) exactly equal to its net present value.
B) exactly equal to zero.
C) greater than the discount rate.
D) less than the discount rate.
E) negative.
36) The elements that cause problems with the use of the IRR in projects that are mutually
exclusive are referred to as the:
A) discount rate and scale problems.
B) timing and scale problems.
C) discount rate and timing problems.
D) scale and reversing flow problems.
E) timing and reversing flow problems.
37) Assume you use all available methods to evaluate projects. If there is a conflict in the
indicated accept/reject decision between two mutually exclusive projects due to the IRR-based
indicator, you should:
A) accept both projects if both are acceptable according to NPV.
B) combine both projects into one larger project.
C) ignore the IRR and rely on the decision indicated by the NPV method.
D) base the final decision on the payback method.
E) reject both projects due to ambiguity in the decision-making process.
38) Project A is opening a bakery at 10 Center Street. Project B is opening a specialty coffee
shop at the same address. Both projects have unconventional cash flows, that is, both projects
have positive and negative cash flows that occur following the initial investment. When trying to
decide which project to accept, given sufficient funding to accept either project, you should rely
most heavily on the ________ method of analysis.
A) profitability index
B) internal rate of return
C) payback
D) net present value
E) discounted payback
39) The possibility that more than one discount rate will make the NPV of an investment equal to
zero presents the problem referred to as:
A) net present value profiling.
B) operational ambiguity.
C) the mutually exclusive investment decision.
D) issues of scale.
E) multiple rates of return.
40) A situation in which accepting one investment prevents the acceptance of another investment
is called the:
A) net present value profile.
B) operational ambiguity decision.
C) mutually exclusive investment decision.
D) issues of scale problem.
E) multiple rates of return decision.
41) The modified internal rate of return:
A) is used as the discount rate for all NPV calculations.
B) applies only to profitability calculations.
C) is used to make accept/reject decisions when no discount rate can be assigned.
D) is computed by combining cash flows until only one change in sign remains.
E) assumes all projects are financing projects.
42) A mutually exclusive project is a project whose:
A) acceptance or rejection has no effect on the acceptance of other projects.
B) NPV is always negative.
C) IRR is always negative.
D) acceptance or rejection affects the acceptance of other projects.
E) cash flow pattern exhibits more than one sign change.
43) A project will have more than one IRR if, and only if, the:
A) primary IRR is positive.
B) primary IRR is negative.
C) NPV is zero.
D) cash flow pattern exhibits more than one sign change.
E) cash flow pattern exhibits exactly one sign change.
44) You are trying to determine whether to accept Project A or Project B. These projects are
mutually exclusive. As part of your analysis, you should compute the incremental IRR by
determining the:
A) internal rate of return for the cash flows of each project.
B) net present value of each project using the internal rate of return as the discount rate.
C) discount rate that equates the discounted payback periods for each project.
D) discount rate that makes the net present value of each project equal to 1.0.
E) internal rate of return for the differences in the cash flows of the two projects.
45) Comparing the NPV profile of an investment project to that of a financing project
demonstrates why the:
A) incremental IRR is computed differently for financing projects than for investment projects.
B) IRR decision rule for investment projects is the opposite of the rule for financing projects.
C) life span of a project affects the decision as to which project to accept.
D) NPV rule for financing projects is the opposite of the rule for investment projects.
E) profitability index and the net present value are related.
46) Blue Bird Café is considering a project with an initial cost of $46,800, and cash flows of
$8,500, $25,000, $19,000, and −$4,500 for Years 1 to 4, respectively. How many internal rates
of return do you expect this project to have?
A) 0
B) 1
C) 4
D) 3
E) 2
47) Which one of the following is the best example of two mutually exclusive projects?
A) Planning to build a warehouse and a retail outlet side by side
B) Buying sufficient equipment to manufacture both desks and chairs simultaneously
C) Renting out a company warehouse or selling it outright
D) Using the company’s sales force to promote sales of both shoes and socks
E) Buying both inventory and fixed assets using funds from the same bank loan
48) An investment with an initial cost of $4,000 produces cash flows of $3,400, −$500, $2,800,
−$100, and $6,000 for Years 1 to 5, respectively. How many IRRs does this project have?
A) 4
B) 3
C) 5
D) 6
E) 2
49) How should a profitability index of zero be interpreted?
A) The present value of the cash flows subsequent to the initial cash flow is equal to (−1 × Initial
cash flow).
B) The project has an internal rate of return equal to the discount rate.
C) The project produces a net income of zero for every year of its life.
D) The project’s cash flows subsequent to the initial cash flow have a present value of zero.
E) The project also has a net present value of zero.
50) The profitability index:
A) rule often results in decisions that conflict with the decisions based on the net present value
rule.
B) is useful as a decision tool when investment funds are limited and all available funds are
allocated.
C) method is most commonly used when deciding between mutually exclusive projects of
varying size.
D) rule states that the project with the lower index value should be accepted.
E) produces results which typically are difficult to comprehend.
51) If you want to review a project from a benefit-cost perspective, you should use the ________
method of analysis.
A) net present value
B) payback
C) internal rate of return
D) discounted payback
E) profitability index
52) The profitability index of an investment project is the ratio of the:
A) average net income from the project to the average investment cost.
B) internal rate of return to the current market rate of interest.
C) net present value of the project’s cash outflows divided by the net present value of its inflows.
D) net present value of every cash flow related to the project compared to the initial cost.
E) present value of the cash flows subsequent to the initial cost compared to the initial cost.
53) An independent investment is acceptable if the profitability index (PI) of the investment is:
A) greater than 1.0.
B) less than 1.0.
C) greater than the internal rate of return.
D) less than the internal rate of return.
E) greater than a pre-specified rate of return.
54) No matter how many forms of investment analysis you employ:
A) the actual results from a project may vary significantly from the expected results.
B) the internal rate of return will always produce the most reliable results.
C) a project will never be accepted unless the payback period is met.
D) the initial costs will generally vary considerably from the estimated costs.
E) only the first three years of a project ever affect its final outcome.