Finance Chapter 12 2 Which project would be preferable if both projects were of average

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25) Using the risk-adjusted discount rate method of project evaluation, the better investment for

Tangshan Mining is ________. (See Table 12.3)

A) Project M because it has a higher NPV

B) Project N because it has a higher NPV

C) Project N because it has a higher IRR

D) Project M because it has a higher IRR

26) Which project would be preferable if both projects were of average risk as the overall firm and

Tangshan Mining has a beta of 1.0? (See Table 12.3)

A) Project M because it has a higher NPV

B) Project N because it has a higher NPV

C) Project N because it has a higher IRR

D) Project M because it has a higher IRR

27) The shares of firms with diversified operations are________.

A) generally positively affected by diversification, because of the reduction in risk

B) generally negatively affected by diversification, because of the increase in risk

C) generally not affected by diversification, because investors can easily diversify their own portfolios

D) generally negatively affected by diversification, because of the increase in the required rate of return

28) Firms do not usually get rewarded by diversifying investments in different lines of business because

________.

A) the capital markets are efficient and they quickly respond to change in economic conditions

B) cash flows from such projects tend to respond less to changing economic conditions

C) investors themselves can diversify by holding securities in a variety of firms; they do not need the firm

to do it for them

D) it is not possible for a firm to diversify its risk as the inflation premium is different for different

projects

Table 12.4

Johnson Farm Implement is faced with two mutually exclusive projects, P and Q. The following are the

data about the two projects.

29) Evaluate the projects using risk-adjusted discount rates. (See Table 12.4)

30) Which project do you recommend? (See Table 12.4)

Table 12.5

Nico Manufacturing is considering investment in one of two mutually exclusive projects X and Y which

are described below. Nico Manufacturing’s overall cost of capital is 15 percent, the market return is 15

percent and the risk-free rate is 5 percent. Nico estimates that the beta for project X is 1.20 and the beta for

project Y is 1.40.

31) Calculate the risk-adjusted discount rates for Project X and Project Y. (See Table 12.5)

32) Using the risk-adjusted discount rate method of project evaluation, find the NPV for projects X and Y.

Which project should Nico select using this method? (See Table 12.5)

33) Calculate the NPV of projects X and Y assuming that the firm did not employ the RADR method and

instead used the firm’s overall cost of capital to evaluate projects X and Y. (See Table 12.5)

34) What potential biases exist in project selection if Nico Manufacturing did not adjust for the difference

in risk between Projects X and Y (See Table 12.5).

12.5 Capital budgeting refinements

1) In case of unequal-lived, mutually exclusive projects, the use of net present value to select the better

project results in an incorrect decision.

2) When unequal-lived projects are independent, the length of the project lives is not critical.

3) When unequal-lived projects are independent, the impact of differing lives must be considered because

the projects do not provide service over comparable time periods.

4) Annualized net present value approach is the most efficient technique for dealing with projects of

unequal lives.

5) In selecting the best group of unequal-lived projects, if the projects are mutually exclusive, the length

of the projects lives is not critical.

6) The annualized net present value approach used to evaluate projects with unequal lives converts the

net present value of unequal-lived, mutually exclusive projects into an equivalent annual amount.

7) The risk-adjusted discount rate approach to evaluating projects with unequal lives converts the net

present value of unequal-lived, mutually exclusive projects into an equivalent annual amount.

8) The ________ approach is used to convert the net present value of unequal-lived projects into an

equivalent annual amount (in net present value terms).

A) internal rate of return

B) investment opportunities schedule

C) risk-adjusted discount rate

D) annualized net present value

Table 12.6

Yong Importers, an Asian import company, is evaluating two mutually exclusive projects, A and B. The

relevant cash flows for each project are given in the table below. The cost of capital for use in evaluating

each of these equally risky projects is 10 percent.

9) The NPVs of Projects A and B are ________. (See Table 12.6)

A) $95,066 and $56,386, respectively

B) $56,386 and $95,066, respectively

C) -$56,386 and -$95,066, respectively

D) $45,000 and $650,000, respectively

10) The annualized NPV of Project A is ________. (See Table 12.6)

A) $22,674

B) $12,947

C) $38,227

D) $21,828

11) The annualized NPV of Project B is ________. (See Table 12.6)

A) $11,673

B) $12,947

C) $38,227

D) $21,828

12) Which project should be chosen on the basis of the normal NPV approach? (See Table 12.6)

A) Project A because its NPV is higher

B) Project B because its NPV is higher

C) Project A because its IRR is higher

D) Project B because its IRR is higher

13) Which project should be chosen using the Annualized NPV approach? (See Table 12.6)

A) Project A because its annualized NPV is higher

B) Project B because its NPV is higher

C) Project A because its IRR is higher

D) Project B because its annualized NPV is higher

14) A firm is evaluating two mutually exclusive projects that have unequal lives. The firm must evaluate

the projects using the annualized net present value approach and recommend which project they should

select. The firm’s cost of capital has been determined to be 14 percent, and the projects have the following

initial investments and cash flows:

A) Choose Project R because its ANPV is $6459

B) Choose Project S because its ANPV is $6459

C) Choose Project R because its ANPV is $18,274

D) Choose Project S because its ANPV is $10,637

15) A firm is evaluating two mutually exclusive projects that have unequal lives. The firm must evaluate

the projects using the annualized net present value approach and recommend which project they should

select. The firm’s cost of capital has been determined to be 18 percent, and the projects have the following

initial investments and cash flows:

16) Real options are opportunities that are embedded in capital budgeting projects that enable managers

to alter their cash flows and risks in a way that affects project acceptability.

17) The objective of capital rationing is to select the group of projects that provides the highest overall net

present value and does not require more dollars than are budgeted.

18) A firm with limited funds for investment in capital assets must ration those funds by allocating them

to projects that will maximize share value.

19) The objective of capital rationing is to select the group of projects that provides the quickest overall

payback and does not require more dollars than are budgeted.

20) The option to develop follow-on projects, expand markets, expand or retool plants, and so on that

would not be possible without implementation of the project that is being evaluated is called a ________.

A) growth option

B) timing option

C) flexibility option

D) abandonment option

21) A(n) ________ allows management to avoid or minimize losses on projects that turn bad.

A) abandonment option

B) growth option

C) timing option

D) put option

22) A firm with unlimited funds must evaluate five projects. Projects 1 and 2 are independent and

Projects 3, 4, and 5 are mutually exclusive. The projects are listed with their returns.

A ranking of the projects on the basis of their returns from the best to the worst according to their

acceptability to the firm would be ________.

A) 4, 1, 2 or 5, and 3

B) 4, 1, and 2

C) 3, 2 or 5, 1, and 4

D) 4, 1, 5, and 3

23) Which of the following proposed projects should be accepted for the upcoming year since only $6

million is available for the next year’s capital budget. What is the total NPV of the projects that should be

accepted?

A) A, B, & F; total cost = $5.5 million; Total NPV = $1.57

B) F, B, & D; total cost = $6 million; Total NPV = $1.72

C) E, F, & D; total cost = $5.5 million; Total NPV = $1.45

D) A, E, & F; total cost = $5 million; Total NPV = $1.3

24) The objective of ________ is to select the group of projects that provides the highest overall net present

value and does not require more dollars than are budgeted.

A) capital rationing

B) scenario analysis

C) real options

D) sensitivity analysis

25) An IRR approach to capital rationing involves graphically plotting project IRRs in descending order

against total dollar investment on an ________ graph.

A) ANPV

B) NPV

C) RADR

D) IOS

26) If a firm has a limited capital budget to fund its capital projects, it is said to be facing the problem of

________.

A) constrained capital

B) wealth optimization

C) capital rationing

D) profitability

27) An approach to capital rationing that involves graphing project returns in descending order against

the total dollar investment to determine the group of acceptable projects is called the ________.

A) net present value approach

B) internal rate of return approach

C) payback approach

D) profitability index approach