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Multiple Choice
1. Which of the following is NOT used when evaluating mutually exclusive investments having unequal lives?
a.
Equivalent annual annuities
b.
Replacement chains
c.
Linear programming
d.
All of these are used to evaluate mutually exclusive investments having unequal lives.
c
2. Each of the following is true EXCEPT ____.
a.
the equivalent annual annuity method is often computationally simpler than the replacement chain technique
b.
the equivalent annual annuity method simplifies the handling of the time discrepancies that frequently arise in
the replacement chain method
c.
the equivalent annual annuity method is theoretically superior
d.
the equivalent annual annuity and replacement chain methods usually give the same decision
c
3. When two or more mutually exclusive alternative investments have unequal ____, neither the net present value nor the
internal rate of return method yields reliable accept-reject information unless the projects are evaluated for an equal period
of time.
a.
lives
b.
net cash flows
c.
net investments
d.
None of these are correct
a
4. Dorati Inc. is considering two mutually exclusive projects. Dorati used a 15% required rate of return to evaluate capital
expenditure projects. Assuming the two projects have the costs and cash flows shown below, determine the NPV for each
using a replacement chain.
Year
Project S
Project T
0
–$70,000
–$100,000
1
$50,000
$ 60,000
2
$60,000
$ 70,000
3
$ 80,000
4
$ 90,000
Assume in two years Project S will still cost $70,000 and produce the same two years of cash flows.
a.
NPVs = $8,860: NPVT = $109,240
b.
NPVs = $14,690: NPVT = $109,240
c.
NPVs = $40,020: NPVT = $109,240
d.
None of these are correct
c
5. Lakeland Ramblers is considering two mutually exclusive projects to boost their tourist revenue. Project A costs
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$60,000 and would produce net cash flows of $25,000 for 5 years. Project B costs $100,000 and will produce annual net
cash flows of $25,000 for 10 years. If Lakeland’s cost of capital is 12%, which project should be chosen using the
equivalent annual annuity method?
a.
Project A, as NPV is $17,941 higher
b.
Project B, as NPV is $11,125 higher
c.
Project A, as NPV is $28,383 higher
d.
Project B, as NPV is $21,567 higher
a
6. Casa Chica is considering replacing a piece of equipment. Alternative A costs $80,000, has an eight year life and would
produce net cash flows of $18,000 in each of the eight years. Alternative B costs $65,000, has a six year life and would
produce net cash flows of $18,000 in each of the six years. If Chica’s cost of capital is 13%, which alternative should be
chosen using the equivalent annual annuity method?
a.
Project A
b.
Project B
c.
Indifferent between the two projects
d.
Neither, because both projects have a negative NPV
b
7. Toy Manufacturers (TM) is considering two mutually exclusive machines to use in its manufacturing process. The net
cash flows for each are given below:
Year
Axa
Beta
0
–$90,000
–$105,000
1
45,000
35,000
2
45,000
35,000
3
45,000
35,000
4
35,000
5
35,000
If the cost of capital for TM is 13%, which machine should it purchase?
a.
Beta, because it has the higher total net cash flows.
b.
Beta, because it has the higher NPV.
c.
Axa, because it has the higher NPV using infinite replacement.
d.
Beta, because it has the higher NPV using infinite replacement.
c
8. Quorex is evaluating two mutually exclusive projects. Project A has a net investment of $48,000 and net cash flows
over a six-year period of $12,500 per year. Project B also has a net investment of $48,000, but its net cash flows of $8,640
per year will occur over a 12-year period. If Quorex has a cost of capital of 14% for these projects, which project, if either,
should be chosen, and what is its NPV?
a.
Project A, $862
b.
Project A, $1,800
c.
Project B, $2,475
d.
Project B, $902
d
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9. Marvec needs to replace an extruder and two replacements look good. Extruder A costs $102,000 and has a 10-year
life. Extruder B costs only $56,000, but its expected life is 6 years. Extruder A will generate net cash flows of $17,600 per
year for 10 years and B will generate net cash flows of $13,800 per year for 6 years. If Marvec’s cost of capital is 11%,
which extruder should be chosen and what is its NPV? Use equivalent annual annuities.
a.
Extruder B, $564
b.
Extruder B, $2,388
c.
Extruder A, $1,646
d.
Extruder A, $280
b
10. Kaneb is evaluating two alternative pipeline welders. Welder A costs $310,000, has a 7-year life, and is expected to
generate net cash inflows of $78,000 in each of the 7 years. Welder B costs $320,000, has a 5-year life, and is expected to
generate annual net cash inflows of $68,900 in each of the 5 years. Kaneb’s cost of capital is 16%. Using the equivalent
annual annuity method, which alternative should be chosen and what is its NPV?
a.
Welder B, $4,920
b.
Welder A, $7,111
c.
Welder B, $10,650
d.
Welder A, $7,800
c
11. Rollerblade, a maker of skating gear, is evaluating two alternative presses. Press A costs $88,000, has a 4-year life,
and is expected to generate annual cash inflows of $30,100 in each of the 4 years. Press B costs $122,000, has an 8-year
life, and is expected to generate annual cash inflows of $24,600 in each of 8 years. The cost of replacement for A is
$96,000, and the replacement press will generate cash inflows of $30,100 for another 4 years. Rollerblade uses a 12% cost
of capital. Which press should be chosen?
a.
Press A
b.
Press B
c.
Both Presses A and B
d.
Neither Press A nor B
a
12. Boomerang Bungee Corp. is considering the following project. Determine the equal annual annuity for the project if
the cost of capital is 14%.
Initial Investment: $75,000
Year
Cash Inflows
1
$30,000
2
$35,000
3
$40,000
Year
a.
$5,527.89
b.
$4,355.25
c.
$7,768.67
d.
$2,259.62
d
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13. What would be the equal annual annuity for Wallflowers Florist, Inc. if the cost of capital is 10% and the initial
investment is $50,000 (rounded)?
Year
Cash Inflows
1
$25,000
2
$30,000
3
$10,000
a.
$2,024
b.
$5,033
c.
$1,257
d.
$8,358
a
14. What is the equal annual annuity for Scorch & Burn Fire Extinguishers if their cost of capital is 8% and the initial
investment is $75,000 (rounded)?
Year
Cash Inflows
1
$25,000
2
$25,000
3
$45,000
a.
$5,304
b.
$6,271
c.
$2,058
d.
$4,157
c
15. The best way to measure projects with unequal lives is ____.
a.
the Gordon Model
b.
the payback period
c.
the net present value method
d.
equivalent annual annuity approach
d
16. Under most conditions the equivalent annual annuity method will give the same decision as ____.
a.
the net present value method
b.
linear programming
c.
the replacement chain method
d.
the internal rate of return
c
17. Creative Furniture is considering two mutually exclusive projects that would automate part of their
production facilities. Project A costs $120,000 and would produce net cash flows of $37,000 annually for 5 years. Project
B also costs $120,000 and will produce annual net cash flows of $25,000 for 10 years. Creative’s cost of capital is 11%.
Using a replacement chain, which project should be chosen? Assume that in 5 years, Project A will still cost $120,000 and
produce 5 more years of $37,000 annual net cash flows.
a.
Project B, as NPV of A is negative.
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b.
Project A, as NPV of B is negative.
c.
Project B, as NPV is $492 higher.
d.
Project A, as NPV is $6,468 higher.
c
18. Creative Furniture is considering two mutually exclusive projects that would automate part of its production facilities.
Project A costs $120,000 and would produce net cash flows of $37,000 annually for 5 years. Project B also costs
$120,000 and will produce annual net cash flows of $25,000 for 10 years. Creative’s cost of capital is 11%. Assume that in
5 years, Project A will still cost $120,000 and produce 5 more years of $37,000 annual net cash flows. Using the
equivalent annual annuity method, which project should be chosen?
a.
Project B, as NPV is approximately $823 higher.
b.
Project A, as NPVB is negative.
c.
Project B, as NPV is approximately $10,473 higher.
d.
Project B, NPV is approximately $90.56 higher.
a
Essay
19. The importance of time discrepancies depends on several items when making capital budgeting decisions. State those
items.
the discrepancy can be ignored.
20. What does a firm ignore if it chooses the longer-lived project based solely on the net present value or internal rate of
return data?
of cash flows could create a higher net present value overall for the shorter-lived project.
21. How does the equivalent annual annuity approach solve the time discrepancy problem?
capital, thereby eliminating any differences in time.