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85. A project's payback period is determined to be 4 years. If it is later discovered that
additional cash flows will be generated in years 5 and 6, then the project's payback period will:
86. A polisher costs $10,000 and will cost $20,000 a year to operate and maintain. If the
discount rate is 10% and the polisher will last for 5 years, what is the equivalent annual cost of
the tool?
87. NPV fails as a decision rule when the firm encounters:
88. The investment timing decision is aimed at analyzing whether the:
89. In order for a manager to correctly decide to postpone an investment until one year into
the future, the NPV of the investment should:
90. To justify postponing a project for one year, the NPV needs to increase over that year by
a rate that is equal to or greater than:
91. What happens to the equivalent annual cost of a project as the opportunity cost of capital
decreases?
92. What is the equivalent annual cost for a project that requires a $40,000 investment at
time zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost
of capital is 10%?
93. A currently used machine costs $10,000 annually to run. What is the maximum that
should be paid to replace the machine with one that will last 3 years and cost only $4,000
annually to run? The opportunity cost of capital is 12%.
94. Because of its age, your car costs $4,000 annually in maintenance expense. You could
replace it with a newer vehicle costing $8,000. Both vehicles would be expected to last 4 more
years. If your opportunity cost is 8%, by how much must maintenance expense decrease on the
newer vehicle to justify its purchase?
95. Projects A and B are mutually exclusive lending projects. Project A has an IRR of 20%
while Project B has an IRR of 30%. You would be most apt to select Project A if:
96. What is the decision rule in the case of sign changes that produce multiple IRRs for a
project?
97. If a project has a payback period of 5 years and a cost of capital of 10%, then the
discounted payback will:
98. You can continue to use your less efficient machine at a cost of $8,000 annually for the
next 5 years. Alternatively, you can purchase a more efficient machine for $12,000 plus $5,000
annual maintenance. At a cost of capital of 15%, you should:
99. A firm is considering a project with the following cash flows: Time 0 = +$20,000, Years 1-
5 = -$4,500. Should the project be accepted if the cost of capital is 10%?
100. A firm plans to use the profitability index to select between two mutually exclusive
investments. If no capital rationing has been imposed, which project should be selected?
101. A project costs $200,000, produces annual cash inflows of $20,000, and has a discount
rate of 8%. Explain how you can quickly determine the difference in the NPV of the project if the
cash inflows last only 30 years rather than 40 years. Show the calculations needed to determine
the amount of the NPV difference.
102. A new machine will cost $100,000 and generate after-tax cash inflows of $35,000 for 4
years. What is the minimum rate of return the project must earn to be acceptable? Prove that
your rate is correct.
103. The use of NPV as an investment criterion is said to be more reliable than using IRR.
Discuss potential problems with the use of IRR.
104. Spending $40,000 on a new truck would increase delivery revenues by $18,000 annually
over the truck's 4-year life. Graph the relationship between NPV and the discount rate for this
project. (
Hint:
Assume for simplicity that the relationship is linear and find two points on the
line's graph.) Is this project acceptable at a discount rate of 16%? What is the highest discount
rate at which this project is acceptable?
105. Evaluate the following mutually exclusive projects using IRR as a selection criterion.
Assuming a discount rate of 14%, which project—if either—would be selected? Project A costs
$50,000 and returns $15,000 after-tax annually. Project B costs $35,000 and returns $11,000
after-tax annually. Both projects have a 5-year life.
106. Why might a firm want to impose soft capital rationing?
107. ABC Corporation is experiencing hard capital rationing and will not be able to invest more
than $1,000,000 this year. Develop a profitability index for the following four projects and indicate
which projects will be accepted. All four projects will last 3 years and the firm uses a 10%
discount rate.
108. Calculate the payback period for each of the following mutually exclusive projects, then
comment on the advisability of selection based on the payback period criterion: Project A has a
cost of $15,000, returns $4,000 after-tax the first year with this amount increasing by $1,000
annually over a 5-year life; Project B costs $15,000 and returns $13,000 after-tax the first year,
followed by 4 years of $2,000 per year. The firm uses a 10% discount rate.
109. Low-energy light bulbs typically cost $3.50, have a life of 9 years, and use about $1.60 of
electricity a year. Conventional light bulbs are cheaper to buy, for they cost only $.50. On the
other hand, they last only about a year and use about $6.60 of energy. If the real discount rate is
5%, what is the relative cost of the two products?
110. What is the net present value of an investment, and how do you calculate it?
111. How is the internal rate of return of a project calculated and what must you look out for
when using the internal rate of return rule?
112. Why doesn't the payback rule always make shareholders better off?
113. How can the net present value rule be used to analyze three common problems that
involve competing projects: when to postpone an investment expenditure; how to choose
between projects with unequal lives; and when to replace equipment?
114. How is the profitability index calculated and how can it be used to choose between
projects when funds are limited?
115. Sometimes, comparing project NPVs properly can be surprisingly tricky. What are three
important, but often challenging decisions which managers commonly face?
