Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Principles of Finance, 6e
Besley/Brigham
Chapter 09
Cengage Learning Testing, Powered by Cognero
Page 61
−$8,554.84
PV of Health care costs
1,082.76
PV of parents' savings
−$7,472.08
Lump sum government must set aside
= 0
= 0
= −6,115.91
= −6,727.50
= −7,400.25
= −8,140.27
I
= 6
Solve for NPV = −8,554.84 = PV of Health care costs. Consequently, the government
must set aside $8,554.84 − $1,082.76 = $7,472.08 Alternatively,
= 0
= 100
= −6,115.91
= −6,727.50
= −7,400.25
= −8,140.27
I
= 6
Solve for NPV = −$7,472.08 = Lump sum government must set aside.
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
PV of an Uneven CF Stream
83. You have some money on deposit in a bank account which pays a simple (or quoted) rate of 8.0944 percent, but with
interest compounded daily (using a 365-day year). Your friend owns a security which calls for the payment of $10,000
after 27 months. The security is just as safe as your bank deposit, and your friend offers to sell it to you for $8,000. If you
buy the security, by how much will the effective annual rate of return on your investment change?
a.
1.87%
b.
1.53%
c.
2.00%
d.
0.96%
e.
0.44%
ANSWER:
c
Principles of Finance, 6e
Besley/Brigham
Chapter 09
Cengage Learning Testing, Powered by Cognero
Page 62
RATIONALE:
Cash flow time line: Numerical
solution:
Step 1:
Find the effective annual rate (EAR) of interest on the bank
deposit
rEAR Daily = (1 + 0.080944/365)365 −1 = 8.43%
Step 2:
Find the EAR of the investment
$8,000 = $10,000/(1 + r)2.25
(1 + r)2.25 = 1.25
1 + r = 1.25(1/2.25)
1 + r = 1.10426
r = 0.10426 ≈ 10.43%
Step 3:
Difference = 10.43% − 8.43% = 2.0%
Financial calculator solution: Calculate rEAR Daily using interest rate conversion feature
Inputs: P/YR = 365; NOM% = 8.0944. Output: EFF% = rEAR = 8.43%. Calculate rEAR of
the equal risk investment Inputs: N = 2.25; PV = −8,000; FV = 10,000. Output: I =
10.4259 ≈ 10.43%. Difference: 10.43% − 8.43% = 2.0%
POINTS:
1
DIFFICULTY:
Hard
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Effective Annual Rate
84. Your employer has agreed to make 80 quarterly payments of $400 each into a trust account to fund your early
retirement. The first payment will be made 3 months from now. At the end of 20 years (80 payments), you will be paid 10
equal annual payments, with the first payment to be made at the beginning of Year 21 (or the end of Year 20). The funds
will be invested at a simple rate of 8.0 percent, quarterly compounding, during both the accumulation and the distribution
periods. How large will each of your 10 receipts be? (Hint: You must find the effective annual rate and use it in one of
your calculations.)
a.
$7,561
b.
$10,789
c.
$11,678
d.
$12,342
e.
$13,119
ANSWER:
b
RATIONALE:
Cash flow time line:
Principles of Finance, 6e
Besley/Brigham
Chapter 09
Cengage Learning Testing, Powered by Cognero
Page 64
b.
The project's discounted payback period is greater than its economic life.
c.
As long as the new machine's initial investment outlay is fairly low, the firm should purchase if it is used to
replace an older machine that is required to produce inventory.
d.
The project's traditional payback period must be greater than the maximum payback period that the firm has
established.
e.
Two or more of these scenarios must be correct.
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Discounted Payback
87. Tara is evaluating two mutually exclusive capital budgeting projects that have the following characteristics:
Cash Flows
Year
Project Q
Project R
0
$(4,000)
$(4,000)
1
0
3,500
2
5,000
1,100
IRR
11.8%
12.0%
If the firm's required rate of return (r) is 10 percent, which project should be purchased?
a.
Both projects should be purchased, because the IRRs for both projects exceed the firm's required rate of return.
b.
Neither project should be accepted, because the IRRs for both projects exceed the firm's required rate of
return.
c.
Project Q should be accepted, because its net present value (NPV) is higher than Project R's NPV.
d.
Project R should be accepted, because its net present value (NPV) is higher than Project Q's NPV.
e.
None of the above is a correct answer.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Ranking Conflicts
88. Union Atlantic Corporation, which has a required rate of return equal to 14 percent, is evaluating a capital budgeting
project that has the following characteristics:
Year
Cash Flows
Principles of Finance, 6e
Besley/Brigham
Chapter 09
Cengage Learning Testing, Powered by Cognero
Page 65
0
$(170,000)
1
60,750
2
60,750
3
60,750
4
60,750
Union Atlantic's capital budgeting manager has determined that the project's net present value is $7,008. According to this
information, which of the following statements is correct?
a.
The project's internal rate of return (IRR) must be greater than 14 percent.
b.
The project's discounted payback must be less that its economic life.
c.
The project should be purchased by Union Atlantic.
d.
All of these statements are correct.
e.
None of these statements is correct.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-2 - Application
Business Program-3 - Analytic
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Ranking Methods
89. A college intern working at Anderson Paints evaluated potential investments⎯that is, capital budgeting projects⎯using
the firm's average required rate of return (WACC), and he produced the following report for the capital budgeting
manager:
Project
NPV
IRR
Risk
LOM
$1,500
12.5%
High
QUE
0
11.0
Low
YUP
800
9.5
Average
DOG
(450)
10.0
Low
The capital budgeting manager usually considers the risks associated with capital budgeting projects before making her
final decision. If a project has a risk that is different from average, she adjusts the average required rate of return by
adding or subtracting 2 percentage points. If the four projected listed above are independent, which one(s) should the
capital budgeting manager recommend be purchased?
a.
Project LOM only, because it has both the highest NPV and the higher IRR.
b.
Projects LOM, QUE, and YUP, because they all have positive NPVs and their IRRs.
c.
Projects DOG and QUE, because their IRRs are greater than their risk-adjusted discount he projects returns are
higher than the rates of return that capital budgeting manager uses to evaluate them.
d.
Projects QUE, YUP, and DOG, because their IRRs are greater than their risk-adjusted discount rates-that is,
the projects returns are higher than the rates of return that capital budgeting manager uses to evaluate them.
e.
There is not enough information to answer this question, because the firm's average required rate of return
cannot be determined.
ANSWER:
c
POINTS:
1
Principles of Finance, 6e
Besley/Brigham
Chapter 09
Cengage Learning Testing, Powered by Cognero
Page 67
© 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
a.
the discounted payback period is longer than the useful life of the project.
b.
the internal rate of return is lower than the discount used.
c.
the project is not acceptable on a risk adjusted basis.
d.
this project is preferred to any other mutually exclusive project.
e.
accepting the project increases the value of the firm.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
NPV
93. Which of the following is not a rationale for using the NPV method in capital budgeting?
a.
An NPV of zero signifies that the project's cash flows are just sufficient to repay the invested capital and to
provide the required rate of return on that capital.
b.
A project whose NPV is positive will increase the value of the firm if that project is accepted.
c.
A project is considered acceptable if it has a positive NPV.
d.
A project is not considered acceptable if it has a negative NPV.
e.
All of the above are true.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
NPV
94. Discounted payback's primary advantage over traditional payback is that
a.
discounted payback considers cash flows that occur after the discounted payback period.
b.
discounted payback is always shorter than traditional payback making more projects acceptable.
c.
discounted payback does consider the time value of money.
d.
discounted payback will let you accept projects whose discounted payback period is longer than the useful of
the project.
e.
all of the above are true.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Principles of Finance, 6e
Besley/Brigham
Chapter 09
Cengage Learning Testing, Powered by Cognero
Page 69
c.
the net present value allows you to compare mutually exclusive projects.
d.
the internal rate of return for a project is different for each firm.
e.
NPV contains information about a projects "safety margin" which is not inherent in IRR.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
NPV and IRR
98. The ____ involves comparing the actual results with those predicted by the project's sponsors and explaining why any
differences occur.
a.
discounted payback
b.
internal rate of return
c.
post-audit
d.
net present value
e.
economic value added
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Post-Audit
99. All of the following factors can complicate the post-audit process except
a.
each element of the cash flow forecast is subject to uncertainty.
b.
projects sometimes fail to meet expectations for reasons beyond the control of operating executives.
c.
it is often difficult to separate the operating results of one investment from those of a larger system.
d.
executives who were responsible for a given decision might have moved on by the time the time the results of
the long term project are known.
e.
the most successful firms, on average, are the ones that put the least emphasis on the post-audit.
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
Cengage Learning Testing, Powered by Cognero
Page 71
103. The process of discounting or finding the present value of a cash flow to be received in the future is really the reverse
of compounding.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Discounting Process
104. One of the potential benefits of investing early for retirement is that an investor can receive greater benefits from the
compounding of interest.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Retirement and Compounding
105. All other factors held constant, the present value of a given annual annuity decreases as the number of discounting
periods per year increases.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
Cengage Learning Testing, Powered by Cognero
Page 72
106. The greater the number of compounding periods within a year, the greater the future value of a lump sum invested
initially, and the greater the present value of a given lump sum to be received at maturity.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Compounding
107. Suppose an investor can earn a steady 5% annually with investment A, while investment B will yield a constant 12%
annually. Within 11 years' time, the compounded value of investment B will be more than twice the compounded value of
investment A (ignore risk).
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Comparative Compounding
108. The opportunity cost rate is only applicable if you as an investor actually have an alternative investment to compare.
If you are making a decision about a single investment, the opportunity rate concept does not apply.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Principles of Finance, 6e
Besley/Brigham
Chapter 09
Cengage Learning Testing, Powered by Cognero
Page 74
112. When a loan is amortized, the largest portion of the periodic payment goes to reduce principal in the early years of
the loan such that the accumulated interest can be spread out over the life of the loan.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Amortization
113. The effective annual rate is always greater than the simple rate as a result of compounding effects.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Effective and Simple Rates
114. If we calculate a periodic interest rate, say a monthly rate, in order to get the simple annual rate, we can multiply the
periodic rate by the number of periods within a year.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Periodic and Simple Rates
115. Financial calculator and tabular methods use different mathematical formulas to solve time value of money
problems, and that is why they always lead to different results.
a.
True
Principles of Finance, 6e
Besley/Brigham
Chapter 09
Cengage Learning Testing, Powered by Cognero
Page 75
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Tabular and Calculator Methods
116. Because we usually assume positive interest rates in time value analyses, the present value of a three year annuity
will always be less than the future value of a single lump sum, if the annuity payment equals the original lump sum
investment.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Lump Sum and Annuity
117. Effective capital budgeting can improve the timing of asset acquisition and the quality of assets purchased, thereby
providing an opportunity to purchase and install assets before they are needed.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Importance of Capital Budgeting
118. Although the payback method ignores the time value of money, relying solely on this capital budgeting method will
always lead to value maximizing decision.
a.
True
b.
False
Principles of Finance, 6e
Besley/Brigham
Chapter 09
Cengage Learning Testing, Powered by Cognero
Page 76
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Payback Period
119. An increase in the discount rate used in computing the NPV of a project will lower the value of the NPV for that
project.
a.
True
b.
False
ANSWER:
True
POINTS:
1
DIFFICULTY:
Moderate
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
NPV
120. Using the discounted payback method, a project should be accepted when the discounted payback is greater than the
project's expected life.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Discounted Payback
121. A capital budgeting project is acceptable if the rate of return required for such a project is greater than the project's
internal rate of return.
a.
True
b.
False
ANSWER:
False
POINTS:
1
Principles of Finance, 6e
Besley/Brigham
Chapter 09
Cengage Learning Testing, Powered by Cognero
Page 80
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Perpetuities
132. The present value of $3,000 to be received in 5 years at a 10% discount rate is $2000.
a.
True
b.
False
ANSWER:
False
POINTS:
1
DIFFICULTY:
Easy
ACCREDITING STANDARDS:
Blooms Taxonomy-5 - Knowledge
Business Program-6 - Reflective Thinking
DISC-FIN-05 - Financial Analysis and Cash Flows
DISC-FIN-09 - Investments
Time Estimate-a - 5 min.
TOPICS:
Present Value
