Mlll ltiple Choke Question :

t DFFINlTIONS

NET PRESENT V AI.UE

CHAPTER 7 Net P11esenr Va.lue and Other I 11Vestment Rules

a 1. Tite djffere.nce betv.•e.en the presem \'alue of illl 1n,o.esttnerlt ilfld ~m.s cost is. tl1e: a. net present value. lb. intcmal rate of lfclu m .

(·. pa)back fJeriod. d. proti [ab~~ ity i ooex. e. disc-oum.ed payi)ack period.

Dif!i ulry JeJ~el.: &Hy

NET PRESENT V ALUJE. RULE c 2. Which one oflhe foJIO\\.'mng statements on-cerniln~ ttle[ present ruue (NPV) ~s. (·orre.(·t?

a. At:l ~nvestment s.houM be a(·-cepled if. and only ~f. the PV is. exactly equaJ to z.ero. lb. Aml ~nvestment s.hould be acc:epled om1ly 1 f Ule N PV is ~ua~ [0 the 1 nit~al c:as!h flow. c. Attl ~nve~tment s.hould be acc:epled. if the NPV ~s. pos.illivc and rejecte.d if it is negat~ve. d, An i pv~;."iimen1 wiih glie~rc-r c :;.:o;h 1n0n\?.'~ mhun <.:ii!s!h m1Mlnw:o.;, rcg:JJn:iles ' -Llf when il-te

cash tlm s occur. win always have a pt.1s.ilil\<'e NPV and tllerefore should ah ays. be a.c(·etJtcd.

e. Any prt1joct that has pos;tive. (·asl1 tlO\'IS for every time. fleriod after the in ~Lial

investment should be accep[oo.

T>ijjiculty level: Easy

PAYBACK c 3. 'fihe lcnglh n r iil!lie rcttuin:d l{lr ;,m ·ip\.'cslmcni ln gepcmre c :;J:o;h ~l.ilW<i -o;tJi llic1epl lin

rec.:n\:e.- the in i i1 ;,IH ..::n, ~ ~)r 11 he 1n\.'c:o.;f mc.n'l i:o.; c~•lle£1 i 1-tc: a. net pt'es.e~1t \'alue. lh. ipkmal nlie n.r re rum. c pa.ybad:: period. d. pn.Jlii!.~bi l iiy index. e. cli $-C~llll nled ctJsh petiiml.

T>i}Jiclllty fr:vel: Easy

PAYBACK RULE ~ 4. \Vhich nne .f..lf mhe fnlluwi ng :o.;iJUemcnis is c.:m,-ed c~mcem1 ng th • payfNtCik perind?

Ja. An i pv~;."iimen1 is ~~cc.:epa1~blc if i rt c::tltt!ibled p•~yh!.lr.:k period isle '' ilrJ;,m :'iinme pre­-o;pec.:i mi t."C'lr ['(!rind nf i1 m ~'

lh. An ipvt."iimen1 shmdd he nocepmed if ihe ~yhm:k is pnsiiive ;,nd rejected i r 1 ~ i-o; neg::~Jt ive.

C'. An i nvc~l mc:nt S;nnuld he ruj,ecl 00 iHhc p~yh;n.: k i :s pus11 i vc ~Uild :j)CCL'l'lkid i r i m j<; 11C~liln1 ve.

d. An i nvc~l ment is ut:cepmJ•hlc i f ~·' (;:al cu i ~ted p:ayh.:~e k peri.,)d j:oo; grc'"der mhmiJ sum(!' .Pire­-;pecili G'tL pennd nflim ~.

An i nvc-c:l meQI sl'muld !he ltC<.:eplc:d any i ime the puy1:mc'k period is IC:$<; ln:m l he di~fiUn l ed. p~lyh:lck pe-rilld, gi\ten Jl pn!'il ive d i$<!fll!l nl mJe.

DISCOUNTED P A\"BACK c 5. Tihe lc ngJh n f lime required. r<~..n a pmjccfs dio;cft l!lnlod (;il<;h ~ltJW" lin equal mhc in11iul

cnsl nf lilru: pmj ee l i-; c;)Ued II he;

Ill. nd p1'c~nl v:alue. b. i nlem:al r:ale M remum. c. payback period. d. discounted profitability index. c. diiscotmtcd paybilCk period.

DISCOUNTED PA'\"BACK RULE d. 6. Tihe discnu ni e~l payh:ack rule smurc~ lh~d )'fH.J "ho uld uccepl pruj ecms:

;JJ. whkh have: a clisro~ntcd payba k period that is grcalcrr nhan s.ornc p~·c:-spccifjc:d period or li me.

b. 1f the discmmtcd payoodk is poslti vc: and rejected if it is negati vc:. c. only if tbc discountcrll payback per iod cqua l:s some· prc-spcdtiicd period of ti111-.c. d. 1f the discmmtcd payback period! ~s less than sorru: prc~pcciticd period of time. c. only if tbc discounted payback per iod is cqua~ to zero.

Difficulty lel-•el; Easy

A VERA(~!E At~t:OUNTIN(~ Rll:"FURN c 7. An j nvcstrncnt' s averragc net income dh~dcd by ~ ms average book value dd:i ncs tl:te

average: a. net present '\o'altae. b. lnlcrrnal rntc of return. c. ac<::ounting return. d. protitabi l~t}' ind.c~. c. payback period.

D{fficuJry level.· f;asy

A VKRA(J!E At~t~OU~TIN(~ RlrfURN fUJL!E b 8. An i nvc~mcnt is acceptable ~fits. average accounti ng rctum (AAR):

a. is. less than a target AAR. b. exceeds a target AAR. c. exceeds the tiirrn's return on equity (ROB).

d, i. IL."'i:o. ih~m I he f1rm ' s n :1 urn nq ~~ ·sc'l · (R OA ), c . is e qt,mul io zc.rn ;lnd n n I y when i I i (! [~uul tn ;ze>m,

I. T!ER AL RATE OF RETUR J

b. 9. The di-;cmm~ m re ·th:a1t makes ihe rn: l prc,c;enr \ ':;tl ue nf :m 1n\IC:simenl e:u~ ·i ly cqi,Ud Ito

~C"IiU i<i c~alled lllc;

a. external rnte of return. h. i nlarnrd r:aJc ~lf remtllifl .

c . ~•vc-mgc ;u:ouunl1n,g rc i urn.

d. p ll'u1ii tlb11 il y in «ex . c . e[~ual izer.

Difjiculf}' ltwel.· Eas)'

I. T!ER AL RATE OF RETUR Rut.E d I 0. An 1nvc"'ii lililt.:rll is ~ ·cep1;1blc if il ' I R R;

a. is e,;nclly equal to its net present vajue ( PV). b. is e,;nclly equal to zcm. c. is lcs:r; than the required ret11.1rn. d . cxce&.:d"' ihe n::c1 uin.<'·tl rei L~JITI.

e. is e,;acdy equal to ]00 pclicent.

Dif.ficulf}' ltwel: Easy

MUt. TIN.E RA TiES OF R£1' RN e 1 '1. Tihe pos:s] biUly tlilat more than one discount mle will mruce tlilc N!PV of an investment

equal to zero •s caUcd the problc m. a. net present vnlllliC prot1U ng b. operntio.n..,ll ambiguity c. llilUlu a!ll y exclusive investment dcdsion d. issues of &ealc: e. muhiple rntes of return

Difficulty level: ~fedirmz

A-UJTIJALL\' lf.XC Ll SJ\~E PR()JE·t l'S 12. A situation in whiclil accepting one i nve tment prevents mhe LWCcptilllce of another

investment is ciid l£d the: a. net present vnlllliC prot11c. b. operntio.naJ amb~guity decision. c. mutuiidJ y c."tdusivc illlvestmenl deds.ion. d. iss.'Ues of s.cal£ problcrn. c. tlJluhipLc chokes of operations decision.

DifjicuJry level: Easy

PROFIT ABILITY rNDEX d, 13' The pt"e~ni V<ll ue n r un illl e ' I men~ . :o.; hli ure C~ISQ n~)WS d1 .... i ded hy nh • in1 fiJd cuSJI ufi 1-te

i n'\l·estment ~s C' aJ led the: U~. 111ei preseni v:ll ue. b. irliern:al r:Ue nf return . '-'. U~'-''eruge accuurtl'i lilg rei Ltrn.

d.. pmfiiJabilii y index, c. profile period.

PROFIT ABILfTV INDE . RULE a 14. An invcsLmcnt ~s acceptable ~f me profitalbi IJty ~ndex (P]) of die j m•csi.ITK:nt is:

a. greater tb::m one. b. k s tiJ_l!Jn one·. c . lf!Tt'!:aier HaLSn the l lilfL!Tiiltd mie u( rc 'lum (IRR), d. less tbma lihc net prre cnt vah.LC (N PV ). c. greater th::m a prrc-spcdt1ed rate of rrctum.

Diffict~lry lewl: Easy

U. CO CEPTS

NET f'R!I:!:SENT VAI!.J JI. d 15. AU el c consumt, Lhe nc~ present "raliuc of a project increases when:

a. the discount rate· increases. b. <::3ch cash intlow is delayed by one year. c. the ini rial cost of a pmjcct ~ocreascs. d. the mtc of return decreases. c. all rash int1ows occur during the I:.JSm year of a project's life insmca.d of

pcri-odicall)' lhmllllgoout the L~fe of ihe projcC"t.

D~fjicL"'.~lry I e ll.el.: J::asy

NET fiR[._ ENT A I!...~J E a 16. The primLU)" reason tlrml company projects with pos~livc net present valt~es arc

considered! acceptable ms tlrlmt: a. iliey create "'alue t'oli the mvncrs of the fin111. b. the plfoje.{'l • s. r-al!e of rctum exceeds. the mte of i ntlalion_ c. they retllll:rrn Lhe ~nWaJ cash outlay witbjn three years odes~. d. ilie rreqrui red cash intlows exceed the artllllal cash i ntlows. c. the investment's cost exceeds the pre~c:nl vrurue oftloc cash intlmv:s.

. ET PRESENT VALUE £1 n. lr u pn'l-j t t:i h:as Ill llf!i prescni \'tJ~ Llt! f!'C]LltJ~ tn :tj;li£1, ihen:

I' 11-te J1reseni \t~d li.C [J r ihe cash in tlt:nV'Ii cxcccd!-i ~h ~ ini ~ i•d t"(:: , 0 r ihe Jlmjecl. n. 11-K: p:rfljccl J1T4Xli,JCCS it! r;.de uf rulum lh ;_d j liS I ~~u:;IIl<i i 1-K: rn£c required ill ;,c.:'(:cpl [h ·•

project . m. 11-fe J1Tnj,ec'l l"i e xptclcd Ill iJlH'Idu.cc nnl}• llrte n'liliiJim:a.lly rClJUired CU.'h inllm'l:li. ~V, nny de I ay in rccei \li 111;!?, i be prnj c.crcd <;:a.<ilh i nflm'I'S will t:~usc lhe pmjeci rn h~n'e 111

negtli i\•e llf!l preseni val nc , ,., 11 ur){l m ~m 1 y b. ll and JV o:nly c. I, II , :md IV ~)nl y

d . 11, Ill , tlnd IV nnfy e , J, IJ, :md Ill fm l}•

ET PRESE T VALUE b ~ 8. N t'l pn.""ienm \'ulu ·:

a. :.mnO( be used when deciding bet""'cen two mutuaHy cxdush•c projects. b. is more rn~cful to dct'ismon malk.crn. than d:te intcmru rate of rctmn \\rhcn compadng

ditlerent sized projc1:ts . c. is easy to explain to non-t1nancial managcr.s ;md tbus is lhe primary method of analysis

used by the lowest le·.,.rds of m;magcmcnt. d. is not an as widely used tool as payback and discoll!lntcd ·payback c. is ' 'cry siLlllililf in its mclhodology to lhc average account~ng return.

Difficulty le,rtd: Easy

PAYBACK c ~ 9.

il.

b. (;,

d.

c.

Payback is mqucnt~y l!lscd to ~llllal)'7..e htdepcndcnt pmjc.('ts because: it considers lhc tim-e val~JC of money. all rdcvant cash t1ows i.lfC induded in th-e tl.IIDiysms. it is easy and Qll!lick to calculate. it is the mo&t dcsinili1c of aU the a"·LlHabk: amu}tk al methods from a t1n;md ru perspective. it produce'S beucr decisions tb:.m those made using cJ ther NPV oc :IRR.

Difficulty le~re/: Easy

!PAVBAt~K c 20. l 'hc ad"'illltagcs. of the :payback method of project illJalysis indude the:

t D!pplkation of a discount rate to each separate cas!h tlow. It bias towards ~ iq11 idhy. ~ l J. case of use. ~ V. a.ubiu·;y-y cutoff point. a.. I and II Oil ~y

b. .I and II I on ~y c. 11 and JD on~y

d. 'II und IV n11ly e, II, Ill , and IV nnly

Difficulty fe~-ef: Medr~nn

PA BACK d 21. A 11 e 1 se cc1~Lal, i he p.ui}'hack pe·ril..nJ fnr ~• prtlje~;;i wi 11 dtl"Teu ' • wihene ver rhe;

<l. i nif i:a.l .t~)sf in ·re:t..;e:t-;, b. required return for a pmjcct •ncrcas~. c. ~~ ·-;igned di~nU111i Jr<de d.et'rens.e ' ,

d , C'•ISh in rJ n W' Jar~ 1110\1txl f.orw~mJ i 11 ri me , e, d.ru.r;,i iun nf u p!rojet:i is l cngf hene~i

DISCOUNTED PAYBACK d 'J'') --·

tl t

b. c, d. c,

Tbc- di ' m ti11iCd p:~~yh:lck period nf Ill ]ll'Uj'-~• "''ill tlet:rea:t-;e wt.t~ne\•er rhe: di " 1C1Ui11i r:de ::tppl ied m~) i lfte prnje~i i " i ocreasetl, i nitia~ C:JJShJ outlay of tbc project ms in-creased. time period of the proje-cm is i ncrca...~d~

al!llotml of each project cash t1ow is 'ncreased. C't.)Ms t.)f ihe 1i xecl :as sCI · Ull il i zed 1 n 'I he ]ll·ojec t i ocre~c.

.Difficulty le~rel: Medfum

DISCOUNTED PAYBACK a 23. The· d:Ls.countcd payback ru[c ~IWJY carus.e:

a.. orne posith•c net pliC ent \o':liue projects ~o be rejected. b. d1c mo::.t IU quid projects lo be rcj cctcd in favor of less liqt~ id projects. c. proje-c~s to llx: incorre-ctly ~cpted dl!tC to •grmring the time· v~ue of money. d. proje-cts with negative net pre:scnt value:s to be accepted. -c. some p~jects to be a~epted whkh would o mhcnvis.<: be rejected under the payback

rule.

INTER AL RATE OF RIE R. h 24. 'f hc 'nternal rare of return UK.R):

[, rule states tnat a projec-t \.?'ith an IRR that ms less than the roequh·ed rate should be accepted.

[[. is the rate generated solely by the cash tlmvs of an investment. [[[. is. the rate that cm.11scs l:hc net plrC ent value of a pr~jcct to exactly cquat zcm. IV. can etlcctively be used to analyze all i nvcsLrncnt sec nruios. a. I and IV o:nJy b. II and Ill on ~y c, 1. II, and I U on~y d. n, m I and IV on~y

INTER AL RATE OF Rl:: R. :a, 25.

:i-.

b. c. d . e,

Tile i rtlt.'T'rt:l1 nHe t)f rerum rnr •• pmjec.:i wi 11 int.,·.ea-;c i r: I 1-te i rtil i ~~1 ens I nf rt he pll'oj(!l(;l ~an he n."tlu~cd, 11-te lumul anltmnl nf mhc c:;~-;t. i udlnw~ i-; ruduc.:ed,

each cash intlow is moved st!c'll tmm h occurs one year later than origilllliiUy projected. Il-K: required mile [1 r relum i ' reduoe~i

11-te s:a.lv;,~gc V~ihLe nf rihc pr.f..ljccm i ' nmiUt.."tL fmm ~ hot! ~m:a.l ~i s.

INTER AL RA TB OF Rl:: R r 26. l'he· inter nail rate of return is:

;,t, molic reli ~lh1e :a..o; ~ decisiu111 m~ai.Ji ng ~~~lll mlhun lilcl presc n I val uc- whcrae\•t-r you ;il.re mn · ick-riqg n'mfUull y e · t: In · i \1c pmjeel-;,

b. equivalent to the discount rntc th..1l mnkcs the net present 'ln~oe equal to one. c. diffic!Jllt to compute without the usc of either a nnanc~al calculator m a computer. d. dependent upon the interest rates oftered ~n the mnrkctiplace. e. u bctiL'T' mc'l'hod()lngy lhun net pn:,.elll \ 1ulnc when dc .. ding wilh uncn:n venmitmal c:a..;lh

t1mvs.

Difficulty fe~~/: Medium

INTER AL RA TB OF Rl:: R a 27. l'he inter nail ITtle of return tends to be;

a. easier for managers to comprehend thnill the net present va.h.1c. b. extremely accurate C'\'Cn w·hcn cash tlow estimates arc ·faulty. c . ignored by mosttinrn1ciaJ rnml_yst:s . d. U"iod primari ~)' to diffcrcntbtc bct,.~·ccn mutually e.xch.1:shrc P~.iccts. c. utilized in projc"Cm ;:mn1)"5ls only when mu~tiple net pres.enl vaBrues. apply.

Difficulty fe~re/: Easy

I <CRE:ME TAL INTER AL RATE OF RETURN c 28. You arc try~ng to dctciJTIIline 'i.ll,rhelher lo accept project A or pmjc.ct B. These :pmjccts

DJFC munml1y exdusivc. As p'<!JIIt ofyom analysis. you :should compute the ~ncK:mcnted IR R by det€ml•nh11g:

iL tlrlc i nEcrna.l rate of return for the cash Hm~ of ellC'h pmjccl. b. tl!tc net present ••ralue of each projec-m using the ~ntcrnal mtc of return as the di cmuu

rate. c _ the di scount rate tllat equates. l!he dm countca payback periods for eac-h project d. toc di scount rate that ma!kes. the net. present value 1.1f each project cqua.l to ·1. c. the inlcrnal rate of return for the dr~ftcrenrcs an the rash tlows ot'llhc two p-HJ:ic- ts.

Difficllltj• (e~-el: M edr11m

I CREMENTAL lNTERNAL RATE OF RETURN b 29. Graphing Htc i liJcremcnm:al TRR helps cxplai 11:

tl . Wh)1 ~me ptt'loject is :al W;tys S\l.pcriur mn mm•her prf~ojcd .

b. lhnv.1 de c1· · iun::;. .tnnccmi11g mUll mtl ly e:-;c 1 u~ i ve prnjecm~ :are dcri \ICd .

c. fh«)V~! H1c tlum~iup n f :a projcc• Jaffec r •he decision ;1' ~n which pmjecl 10 ~C'---ep•. d . lhnV~l i he. nem IJlllt;SA;n• v;tilue :md II he i mi i al cu.~h n nMlnw ~)f :l. pmj~LI m·e rel :decl

c. lbow the protlmbility ~ndc:-.~ and tbc net prc~ent value arc lidated.

PROFIT A81LIT\' D:EX d 30. The profitabmty index ~s d osdy rdatcd to:

:1. payback. b. d i ·counted paybar k. <:. ihc ~'i,:crugc :;tC'cmmling rciurn,

d. 111e• rreserd '!,.-;til ue. c. muu.mlly cxdusive wrojccts.

Difficulty {ew!l: Easy

PROF1T A81LITY D:E b 3 t. Anallysis using the profitability •ndex:

:1. frcquendy oonili cts with the: accept and Kjc:ct dedsions generated by the application of the net present value rnk.

b. is usd111l as a decision tool '1.\tlen investment f11.mds ru-e ~intitcd. c. is us.cful }vhen trying to detemJj nc which one ot' two mu ttmUy ex.dush•e pJrOjC(:l:S

shoold be accepted. d. uti~ izes the :same basic vari abk:o. as those used in the a,,.crn,gc accmml ing rctiJm. c. fPI OOU(:CS reslll!~ts \.'1-'hkh l:yfPtc<illy arc difficult to comprehend or app~y.

Difficulty {e~rel: Metffum

PROFIT A81LITY D:EX e 32.

a. b. C.

d. c.

:If you wanl to rc"'ic"\' a projC(:t from a bcnciil~ost peupcctive. )'01.11 shouldlus.c lhc __ method of ana~ys~s.

net present value paybac:k ·i ntcrmd rate of return avcrngc acc:omllh ng return profitability •ndex

Di!Jk.:ulty l€vt1: Easy

PlltOtTF A81LlT\' INDILX

b 33.

a. h. c. d. c.

When the present va•ue of the cash ~nt1ows exceeds. the ~nhial cost of a project. then the prrojcct should be: m.cceptcd because the httemal rate. ot' Ietum is posmd ve. m.ccepted because the prontabrli my i ndcx j s. greater than I . m.cceptcd because the pronrabrlit)' index is negative. Jeject cd because the internal rate of rerurn is ne,gad vc_ Jejeoted because the net present value. is. ncgarive.

MUTUALI.Y F.XCl.UST\fiE. PROJECTS c 34. Which one of the fo.llowing ~s d11c best example of two mutually exc.lusive pmjccts?

a. planning to build a ... ,raJiehousc and a rt:taH outLet side by side b. buying s.uftlcient equ~pmcnt to ma.m.11facmure both desks. and cha.itrS simulta.ncous.•y c _ us.i 111~ an emJ'my watehouse for s.tora,ge or 1'ent:i l'llg it ent•re 1 y out to aoother fintl d. us.itl~ the company s.ales. force fo protnote s.aJes. of both shoos. and socks e. buyi1~g bolll •nveJitory and fixed ass.et.s ILI.Si ng t'unds. fmn'll the smY.h~ bond issue

Diffi~'ulry lev.el.: Medium

MUTUA Ll~ Y F.XCLUST\ff.. PROJ IE.CTS d 35. 'll:Je Liberty Co. is cons.idcr~ng two projects . .!Project A consists of buillding a wholesale

book oollel on lut #169 of !.he E~~glem')od Relad Center. iProject B consist:s of building il sit-down restaurant Otllm #169 ofthe En~lewood Relail Center. When try~ng to d~.cide whether or blili ld the book ourJet OJ~ the tes.taue.ant, man~enl~JU s.l!'tould rely most hea ~lyon ll11~ .ana.l:yi~s. results. fmllr'li the __ l!r"teUlod of <Hlalys.is..

a. pmtitab~ht:y index b. if:itema.~ r.uc of relllrl'll c. payback d. net presem va•ue. e. accooflting rale of return

.MUTUA L Y EXeLUSIVE PROJECTS c 36. When two p.t'Oje.cls. both requ:i re the total use of the same Jitn~Le..d eoono~~r'tric resource,

l1le pmjects. are gene.rnlly considered to be: a. independent b. mar~im11U y prnfiriJab le. c _ mutual ~)' exclusive. d . :ltX:epi:ahle. e. intenm~ly protitalbJe.

~IUTUALL Y EXCLUSIVE PROJECTS c 37. Matt is analyzin~ two nmtually e~dusi ve projects. ·of s.im~lar s.ize aftd has. prepared the

toiJmv~ng rlala. Both p:rojccms have 5 year J h:cs.

Net p•·cs.cnt val uc I ~ayback period A veragc a{'COuttti ng relll1111

ttequ ~red rcl.UJ:n ttcqu~rca AAR

l~roject A $15J~O 2.76 years Y .3 percent 8.3 perce ttt Y .0 perce 111

Pro ject B $14.6Y3 2.51 years ii)_6 percent 8.0 percent ii)_O percent

Matt has been a~d for h ~s, bes.l recommendlll.iol1 gi vcn this. iuformatio:t:L Hi s. ·~rcrorrullCndation should be to accept

a. :project B because ~t has the s.hmtcst payback period. b. both p~rojc..cts as they both have po-siti·ve oct prcse nt vah.Lcs. c. project A and rejecm.proj eel B based on their net pmscnt vaJ ues. d prnje t B and reject project A 'based 011 ~their iil.\'erage accourrlt~n~ returns. e. project B iil.fld reject project A based OJl ibom the payback period ru1dl the avemge

accoontim1g rebllrl'll.

lNVE li'M ENT ANA t VSIS a 38. Given tlmt the net present vaLue (NPV) is geocraUy cons.iderccl to be the lbesm n1ciliod

of analysis , why shoo ld yt:.u sli U use tlle otl 1er n'tetl1ods·~ a. TI 1e otltel' nteLhods help \'ali date whether OJ' f lot tlle results. front the m1el pres.cnl value

ilJJlalys.is arc m'C.~i.able.

b. You ne.ed lOuse me orl1er metbo!llii s.i11ce oon cntiona~ praaice dictates. []);at you on~y accept projects. after you have genermed mrec accept i ooicillOrs.

c. You need lO use oilier tnelht'lds because the net prcseJ1t •.?a:! uc. mctbod is U!fireliahle 'i.'.rlren a pmjoct has unconventional cash flow~.

d TI.1e average accoulflling rerum n1ust ah a)'S. indicrue acceptance s.ince tl11is. is. t!11e best method ftmn a financial penpectjve.

e. TI1e cliscou nledl payback methoo ~tmst always be ompuled lo deterrtlli ne i r a project. I'CllH"'ElS. a positive casl1 flow s.ince N PV does. oot med!lum'e tll is. aspect of a. m)rojecl.

Dijj'i.c;ulty le."t>·.el: Medium

J ~ViES'J tE · T A L YSJS e 39 . In acmal [practice., mana._~s. rrequemily us.e tlre:

I. AAR: ht:cm1~c ihe infmrm~a~inn is ~u ~reu,dil y :1\':a.ilu,hl ~. II . IRR lk.X"aus.e r.he re.su~ts. are. easy to corr•mur1icate. and under~tand.

Ill, p::tybu, •k Oet:~IIIS(: nf i m~ ' impl ~ci•y.

IV. net pr.ese nl vaLue ibecaus.e it is cons.jdeted by ltillnY lo be lhc bes.t method of ana•ys.~~-a. 1 ilJJ~d 1~1 only h. n ilml m only c:. I. H], a nd TV [mly d. II . m. und ]V only e. 1 U. Jll. and IV

INYEST~IiENT ANA LYSIS a 40. Ncl m;_U icr hnw many rnrms n f inv.e:..rmenl tlnuly:!iois ynu tin;

~ 11-te u hud re, ulr'i fmm :a. prnjecm m :l}' vury si~n i l'lc:milll y f rom mhe expecred re"'iUlt . h. I t.e i 11Et.'TiiJ:Jl rnle nf mi urn willl ul WJays pmdut"C I he nll.) rdi:alhfc re~ulh. <.:. ~~ pmje~;.: r "ri ll ne\'eli be. a ·cepled urde ' :o; Hte p~ayb:Jck periud ~..;mer .

d. 11-te i rtil i 1.1l cosrs will ~elilf!mll y \ 'aliy c:nn ' idcr~b[y fmm I he c"'il ima~C£1 cosl'i. e. only the ti~t three y~ru-s. of a proj e'Ct ever atlect its. tinal outcome.

Drffic~~v fe~-el; E(ZS)'

INYESTMIEJ T J\ AL YSIS b 4] . \Vbicb of the followilllg methods. of p~jcct ~al~ts.i are bias.ed to'Willfds short-teml

projocts? [. i ntcmall rate of return ~ ~ . n ' t"'Ulllilf ·i ng r:;JII(! n f reatJJrn ~ ~ J. p.aybtJck [V , d ~SCOUIJlted IJXIyb.aC k a. J ~md J1 only b. 1 II and IV only <.:. II nrtd llll1m I y d. 1 and ]V only e. ]] :md IV only

Difficulty few!/: Medium

INV ESTMIE. T ANALYSIS a 42. lf a pr0:ject is assigJJJcd a rcqui red mtc of rctm n equal to zero. then:

il. tlrlc: timing of the project's cash flows bas liiO bcari ng Olil lhc value of me pmjccl. b. tlrlc: projec-t will a~ways be accepted. c. thlc project will ili1ways be rejected. d. whctlllcr the project is accepted or rejected wiU depend on the tim~ng of dll: cash now . e. tbc project can never add valll!.c for the shareholders.

Difficulty few!/: Medium

b i£CIS U) Rl "LES e 43. Y oo arc consider~ng a pmjcct whh the followilllg data:

[nternal mtc of return ProtitaWHty ratio Net Jnesc!tt va.J.uc I ~ayback period Kcquircd return

8. 7 percclilt .98

.. $393 2.44 years. 9. 5 percent

\Vhicn one of the fol]o.,v:i ng ~s comet gmvcn this illlformation~

t~. Tt1t: tli ' ouni wie used in C:l lcllifmiing ihe pel pn::sc:nl \1uluc mu$m h~\'c hoen le. · ~ h:;m 8.7 pen:: '!ilt .

b. Tbc:: di sccm111ied puyn:.J.ck pt:ri<~..uJ wi~ l h::t e io he ks<.i 1han 2.44 y'<=:;J.N,

<:. Tile di ' cm111i nlie u~d iu ~;;nrrrpnie mlhe pmfii ahi lirt y r:art in w:as '-xtu:a.l mn ilrte i llltt::rml.ll'a~e

nf1'C:i urn . d . Tllis rmjed . lilmdd lhe :act:ep~t:tl h~J~t:d nn II he profiiJIInil iiy r~liin. e. Tl'tis rmjecl llould lhe rc j cc I ctl hus.ed !l n II he i niem:al .!Tale Cl f re~um .

Difficlllf!• fe~rel: Medi10n

NE'f PRF.SE T VALUE c: 44. Ac:c: ·p~ing pl.lsiiivc Nf'V prnje~;;i ' henl.'-lli~ ihe ~ll'lckhnldcr htGmsc:

••· i i i ' mt.c: mnsr eusil y undcr-o;inotl valu:ai if•r• prnCc"'is. h. II he prcsenll \'ill LIC n r 'lli'Je e,; j!)L~med <:ar<;h rn n w ' Jlrf.' ei}IUJil fn • he en~ .

c. the present vru.ue of t1tK: exp~tcd cash tlows. arc greater than the cost. d. ~l ~s the mo t easily calculated. c. None of the above.

NE'f PRF.SE T VALUE :a, 45. \Vhich nr i llc rnll1lWi ng dnc~ nni chmnderi 2't.: NPV?

a. NPV does not incorporate r~sk i111to tllc :.malysis. b. N PV in-corporates all rdev:mt intbrmation. c. NPV u es aU of the project's cash t1ow . d. NPV dhco!r!inls aU future cash flows. c. Us~ng N PV will ~cad to decisions that maximkrc s·lil::u-cboldcr '\vc..'llth.

PAVBACK e 46. The payba-ck period rule:

a. dri comus cash tlows. b. ~gnores initial cost. c. aiwa~--s rnscs aJ lpossib~c cash tlows ~Iii its. calcublion. d. B()th A and C. c. None of the above.

Diffic:ulty few/: Easy

PA\'BA€: K c 47. The paybock period mle accepts alll ~nve:stment project s i111 .,-.,·bich lhe payback pcr]od foli

the cash tlmvs 1 ~: a.. equal to the cutoff poi111t. b. greater rtha.n the cuto1ilf poilllt. c. less than dle cutoff point. d. pos~ti vc.

e. Nnrte n r the uhu,.·c.

PAVBACK d 48. T he p:t)'l:li!i k perie•d rule i · n r~ln \<'emeni mild usdul M~ll IJcc(':mse:

••· i i pro\'ide · •• quick c..""ii i [TI~de of lmw mpidly ihe· irui ial in\ 'e 'rtmeni \.Yilllhe realuped. 10, resulf<; nf ~~ shuri fl~l}'b:;Jck_ nl le dcci"'iitt..m W'i ll IJe Ctuick) Y seen, c. ~l dbcs not take into ac<:ount time , raJue of money. tl, All nnhe ~·b£1\lC ,

e. Nnrte [) r lhc uht.We.

DISCOUNTED PAYBACK a 49. The discmmted payback period ndc :

~•. ccmsit&!:P.) I he lime \1ulue uf mnney. 10, tl i srnun'l · I he (;uinflf pninl ,

c . ~gnores liliACeitain -cash tlows.. dl. ~s p referred to the NPV mle. c. None of the above.

Difficulty fe~re/: Easy

PAVBACK c 50. The payback period 111 le:

a. ~lcnnincs a cutoff point so that all projects accepted lby tthc N PV ruk wiU be· accepted lby the paybadk fP'=riod r!Jlle.

lb. determines a 'CUtoff point oo that dcpreciiltion is jltls.t equal to posid ... •c 'Cash flow's in the payba'Ck year.

c. requires an ml'litrary choice of a cutotf point. d. varks the cutoff point wilh llhe ~nlerc:sl rate. c. B()ili A and D.

AVERAGE ACCOUNTI G RETUR c 51 . The average acrounli no retl.!lm is detcrrni ned by:

a. dh~ding the yearly 'Cash tlo\VS by the investment. lb. divjdJing lDc average c-a£0 tlows by the mn'\o'eSIIIUClll.

c. dh~ding the a verngc net mcome by the a' rerngc investment dl. dh~ding the a vcrngc net income by lhc in~li all investment. e. cli\Fjcling tbc net inco:mc by tloc ca£h t1ow.

Diffit:ulty fervt;.~/: Ea~·

AVERAGE ACCOUNTI G RETURN In 52. The in\'c">lmcnm dtlt~<.;~nn rul • mh~r n.::l:ailcs :a,\•cr:a,gc nci im:nmc ~ n :ave rng<= 1 n ve~h,ienl is

rlhc;

n. t~i ~c:nun ied ca~ll llo'i. mcHeud. b. average acoounti ng return method. c. JIVt'r:lge PJ•)'ID::.ck melhnd. tl, uvcr~1gc prnfil••bi fil y imle . e. Nnne nr lhe uhtw~ .

.Difficulty fe~•el: Easy

MODIFIED 1 TERNAL RA TIE OF RET RN d 5''. 1\•tndified 1n1 cm.al mrc uf rd nm :

••· h~•ndle . mhe muhiple IRR pr.f..lblem hy comhirn~ng cU~ 'h llmvs unm1 1 only nrrtt ch:tngc ill s ~gn change remains.

b. requJ res tlhe usc of ::11 discount rate. c. dOc not reqt~he the usc of a dj s.oount r.ate. tL. Rurh A uml R. c. llotJh A and C .

.Difficulty fe~•el: Medium

A \'ERA(iE ACCOUNT [N(i Rli.T IJRN d 54. The :slbmtcoming(s) of the a':emge a-ccounti ng rctlll!m (AAR method Is (are):

a. the me of net income instead of caslb tlows., b . the pattern of income tlows. bas no impact on the· AAR. c. there is no elcar~cnt decision mle. d. All of the above. c. None of the above .

.Difficulty fe~•el: Medium

INTER AL RATE OF RIE c. 55. The avo fatal flaws of tbc i ntem:aB ra.tc of return rule arc:

a. arbitrary detcrmi nation of a ruscoUJnl rate and fuilure to considtcr inilial expe.ndr~L11.ucs. b. arbitrnry dctcnmnation of a d1sroUJnl rate and faih.m:: to .corrccl~y ttnal:yze m!JJLual.ly

exclusive investment pn~i c ~ts. c. arbitrnry determination of a d1sC1JIJJnl rate and tlrtc mll!IILip!e rnte of return pmb~em. d. t"aHI!lrc to consider initia.l cxpcnditl!llfcs and faill!lrc to cmTc.cdy analyze muruaHy

exclusive itn•cstment pn~j ce>ts. e. ·faHI!lrc to concctly ana.Jy.zc. mutual ly exd usive in es.uuem projec ts and the LlrmJtiplc rate.

of liCtlll!rn problem.

MIJT UALL V E'.~H;LUSl I£ PROJE ,l .S d 56. A m!l!ltuaUy cxdusmve project is a proj cx;t whose:

a. acceptance or rejection has no effect on other projects. b. NPV is always negative. c. IRR is always negative. d. acceptance or rejection affects other projects. e. cash !low panern exhibits more than one sign change.

Dijjicu./1)> level: Easy

INTERNAL RATE OF RETURN d 57. A project wi ll have more than one IRR if:

a. the IRR is positive. b. the IRR is negative. c. the NPV is zero. d. the cash !low panern exhibits more than one sign change. e. the cash tlow pattern exhibits exactly one sign change.

Dijjicully level: Easy

INTERNAL RATE OF RETURN RULES b 58. Using internal rate of return, a conventional project should be accepted if the internal

rate of return is: a. equal to the discount rate. b. greater than the discount rate. c. less than the discount rate. d. negative. e. positive.

Dijjicully level: Easy

INTERNAL RATE OF RETURN a 59. The internal rate of return may be detlned as:

a. the discount rate that makes the NPV cash tlows equal to zero. b. the difference between the market rate of interest and the NPV. c. the market rate of imerest less the risk-free rate. d. the project acceptance rate set by management. e. None of the above.

Dijjicully level: Medium

MULTIPLE INTERNAL RATE OF RETURNS d 60. The problem of multiple IRRs can occur when:

a. there is only one sign change in the cash tlows. b. the tlrst cash tlow is always positive. c. the cash tlows decline over the lite of the project. d. there is more than one sign change in the cash tlows. e. None of the above.

Difficulty level: Easy

TTh'ONG AND SCALE ISSUES WITH INTERNAL RATE OF RETURN b 6 1. The elemems thar cause problems with rhe use of rhe IRR in projects rhar are mutually

exclusive are: a. the discount rate and scale problems. b. tirni ng and scale problems. c. the discoum rme <md timing problems. d. scale and reversing flow problems. e. Liming and reversing tlow problems.

Difficulty level: Meditun

NET PRESENT VALUE DECISION c 62. If there is a contlicr between mutually exclusive projects due ro the IRR, one should:

a. drop the rwo projects immediately. b. spend more money on gathering information. c. depend on the NPV as i t will always provide the most value. d. depend on the AAR because ir does not suffer from these same problems. e. None of the above.

Difficulty level: Meditun

PROFITABILITY INDEX e 63. The profitability index is rhe rati o of:

a. average net income to average investmem. b. internal rare of rerum to current market interest rare. c. net presem value of cash flows ro i merna I rate of return. d. net present value of cash flows to average accounting remrn. e. present value of cash tlows to ini t ial investment cosr.

D({]iculty level: Emy

INVESTMENT DECISION RULES a 64. Which of rhe fo llowing statement is rrue?

a. One musr know rhe discoum rare to compute the NPV of a project but one can compute the IRR without referring ro the discoum rate.

b. One musr know rhe discoum rate ro compur.e the IRR of a pn:~jecr bur one can compute rhe NPV without referring ro the discoum rate.

c. Payback accounts for rime value of money. d. There will always be one TRR regardle-ss of cash tlows. e. Average accounting renun is the ratio of total assets to total net income.

Di{]iculty level: Medium

CAPITAL BUDGETING PRACTICE

b 65. Gr!.lh:a.m :a.ntl Harvey (100 I) r~ld ntl ih:a11 _nod_ were ~he l \Vo nlll ' l pof!Ular capiilal hudgci in;g mci llud~.

a. lnietn ul R!.lie of Reium; P•tYh!.l.t·k Periud h. lnietn<tl R<lie nf Reium; Nem Pr~enE Value c:. Nem Prc-.;enF V aluc; Payb:ack Period d. Mndified lrderpul R::tie nr" Rei urn ; lniem:a.l R::de ~lf Rei urn e. Mf>t~ified l11ierpul R::tie or" Re iiJrn ; Nei Pre~pi Vulue

I n . PROBILEMS

. ET PRF.SE T \ 1 ALUIE b 66. Wh!.li is ihe llet pll'esen'l value nf a prnjecm wiih ii i'Je fullnw ing CJISh n~m!$ ::tllld Jl rt:t{Ui red

return of l2 percent?

Y carr _c~sb ElmY 0 -$28.900 ~ $~ 2.450 2 $l9.630 3 $ 2.750

a. -$287 .22 b. -$177.62 c. $177.62 d. $204.36 c. $28.7.22

Difficulty {e\ref: Easy

NEt· rRESENl ' \ ·'ALUIE n 67. \Vhat is Lhc net present ,,.nluc of a pr~jcc-~ that !has an initial cash oud1ow of l 2.6i'O

and Lhc to~ lowing casb intlows? The rcq lll!ircd return is ] ·t • .5 pe1rrcnt.

Year C~sb Tnt1mv1i l $4.375 2 $ 0 3 $8.750 4 $4JOO

a. $218.68 b_ $37tU 6 c. $768.20 d _ $1..249_65 c. $1.37L02

Difficult)' lew!: Easy

NEt · PRE'iE 1' \"AlUIL b 68. A project wi] l prod'ncc cash intlo.,..,·s of $l . 750 a )'Car for four years. Tbc project

iniliall)• (.'\l) • s .$1 0,600 II ~J gci · raricEi l,n yc:ar fi\1c, 11 he pmjoc• \~i U he c.:luscd and ;,1s a ru 'ulf <ihnuld pn'lllhJce ~~ cu.<ih i n~lnw nf 8.500. \Vh<1• i" mhc nei pre~cnl \o'aluc ,,fHtis prnjccm i f ~lht: rer~U i ll'ed rut·c nf n:~urn 1s I 3.75 pcrt:en•1

iJ. -$5,4 7 4. 76 b. -$1 .m 1.4o <:. -$9 35 .56 d. $1 ,011 L40 e. $5 ,474.76

.Difficulty {e~rel: Easy

NET PRF.SE T VALUE ::1. 69. Ynu arc cnnsidet'ing ihe l'nllm\/ing liWn muiiL~::~Hy c xcl ~~"ii \le pnlj.ed~ mlhum wili 1110i be

repe:ded. The rt:tfuin:d r:de of remum i"i 11.25 pcrceni fwr pmjed A :1ml 10.75 pen.;eni fulf project B. \Vhich proj eel hould yo1111 accept and why?

Y £.'1.( f__mb;_ t A E!ro j£ctB 0 -$48,000 -$ 126,900 ~ I 8.400 $ 69,700 2 3l ,300 $ 8.0,900 3 U ,700 $ 0

a. project A~ bccaus.e its NPV is about $33:5 mnore than the NPV of project B n. prnjccm A; hocuus.e ii h::~"i ihe higher rot.Juirud r:de nr ruuam c. project :B~ bccau e· it has. the ] ~es.t aota.J cash inflow d. project :B ~ bee au e· it returns aU ~ts cash flows "'"'~ th in two year c. project :B ~ bee au e· it is the large'St s.iJzcd project

.Difficult)' fewd: Medium

NET PRESENT VALUE a 70. Yoo rue· ronsider~ng n.vo mlll!l11.1ally cxclushrc projects. with the foUo"-""'ing cash t1ow.;;.

\ViH your choice between lhe l '\J,'O projects differ if doc required mtc of return is 8 pc:rcenl rather than l] percent'] 1f so, what should you. do?

Ysnr Jf!roi!;.QLA (!m j£ctB 0 -$240.000 -$ 19 &.000 ] 0 $110.800 2 0 $ &2.500 3 32:5,000 $ 45,000

a.. yes; S:cJect A at & percent and B a t 11 pel' cent b. yc:s; Select B at 8 percent and A at 11 pcrccnt. c. yes; &eJect A at & percent and s.ck ot ndd:Jcr illl I I perc-ent. d. no; Regardless ohhc r-cqujred rate, project A ruways ha5 the hJgller NPV. c. no; RcgardJc:ss ohhe· requhrcd rate, project B always has. tbc higbcr NPV.

Diffk·ulty fe~rel: Medfum

INTERNAL RA l 'E ot· REll R~

b 71. What is the internal rate of return on an investment with the following cash t1ows'?

a. 5.93 percent b. 5.96 percent c. 6.04 percenr d. 6.09 percent e. 6.13 percent

Year 0 I 2 3

Dijjicu./1)• level: Easy

INTERNAL RATE OF RETURN

Cash Flow -$123,400 $ 36,200 $ 54,800 $ 48,100

a 72. An investment has the following cash !lows. Sho uld the project be accepted if ir has been assigned a required remrn of9.5 percent? Why or wh)' not?

Year Cash Flow 0 -$24,000 I $ 8,000 2 $12.000 3 $ 9,000

a. yes; bemuse the IRR exceeds the required return by about 0.39 percent b. yes; bemuse the IRR is less t han the required renurn by about 3.9 percent c. yes; bemuse the IRR is positjve d. no; because the IRR exceeds the required return by about 3.9 percen t e. no; because the IRR is 9.89 percent

Dijjicully level: Medium

INTERNAL RATE OF RETURN AND NET PRESENT VALUE e 73. You are considering two independent projects wlith the following cash tlows. The

required :remrn for both projects is 10 percenr. Given this information, which one of the following statements is conect?

Year Project A Project B 0 -$950,000 -$.)25,000 I $330,000 $ 55,000 2 $400,000 $ 50,000 3 $450,000 $ 50,000

a. You should accept project B since it has the higher IRR and reject pr-oject A because you can not accept both projects .

b. You should accept project A because it has the lower NPV and rejecn project B. c. You should accept project A because it has the higher NPV and you can nor accept

both projects. d. You should accept project B because it has the higher IRR and reject project A.

e. You should accept both projects if the funds are available to do so since both NPV's are >0.

Difficulty level: Meditun

INTERNAL RATE OF RETURN e 74 . You are considering an invesunent with the following cash tlows. If uhe required rate

of rew m for this investment is 13.5 percent, shouJd you accept it based solei)• on the internal rate of return rule? Why or why not?

Year Cash Flow 0 -$ 12,000 I $ 5,500 2 $ 8,000 3 -$ 1,500

a. yes ; because the IRR exceeds the required return b. yes ; because the IRR is a positive rate of return c. no; because the IRR is less than the required return d. no; because the IRR is a negative nue of return e. You can not apply the IRR rule in this case because there lU"e multiple IRRs.

Difficulty level: Medium

PROFITABILITY INDEX d 75. What is the protltabili ty index for an investment with the following c.ash !lows given a

9 percent required return?

Yeru· Cash Flow 0 -$21 ,500 I s 7,400 2 s 9,800 3 s 8,900

a. .96 b. .98 c. 1.00 d. 1.02 e. 1.04

Difficulty level: &1sy

PROFITABILITY INDEX e 76. Based on the profi tability ind.ex (PI) rule, should a project with the following cash

tlows be accepted if the discount rate is 8 percent? Why or why not?

Year 0 I 2

Cash Flow -$18,600 $10,000 $ 7,300

3 $ 3.700 ;,s, yc.··~ ~ IJcctuJJ"ic 11 he PI i ' I . 008 h. )'L':'i~ IJcctuJJ"ic 11hc PI i ' .992 c. )'e:<i~ bcc;JU"ie li he PI i ' .999 d. nn; becau"ie ~he PI i ' I .008 t:, nn; bec:afU"ie ~file PI i ' .992

Difficui('l' fe~re/; MedilDn

PROFIT ABU ILITY INDEX c 77. Yn•J arc cfmsicte:.."T"i ng h~n independe nt prnjt:cl$ huih of v.1hi<.:tt h.Jtve heen JIS ' igned

n dis~;;num nde nr 8 pc,n.·cni, R:ascd un mhc pmfiio.ilii li1y i111dt:;'lrl, u.•lrt.U is your rc<.:nflllmcmkd i em c.·uliJCt."T'Iililllg i hese prnjed-.?

Project A Project B Ye.Dr C~sh,Flm\' Y car C:JJsh Elqw

0 -$38,500 0 -$412.000 1 $20.0{1() I $10,000 2 $24JJOO 2 $40,000

a. You should accept bO(h projects since· both of thtcir Pis me positive. b. You should accept pr~icct A s~ncc it has the higher Pl <.:. Yl'tl]l shllUid :attepl bnH1 prc~f!!(;i"i .. ~ nee hn'lh nr H.eir Ph Uli"C ~:dell" ih••n I. d. Y 04.1 hould only accept p11ojcc1 B since it has llbe la11gest PJ and the PI exceeds ·1 . e. d th:eT project is acceptable.

Difficulty few!/: Medium

PROFIT ABILITY I DEX d 78. You would 11 kc to in\•es.t in tbe t'oUowing project.

Ye.Dr c~-.h Flow 0 -$55,000 ] $30.000 2 $37.000

Victorla. ym1r boss, ins.sts that only projects tbat can retwm at least $L to in today's doUrus tb11 every $] invested can be at:ccptcd. Six also insists on applfy~ng a ] 0 percent d ~scount rate to all >Cash tlmvs. B ascd on these critcri a. YOl' shrn1ld~

a. accept tlrle proje.cm because it retm:ns ill.hnost $ ·1.22 for every $ J i nvcsmcd. b. at:ccpl the projc'Cm bcca!!lsc it has a pos ~ tj vc Pl c . accept tlrle proje.cm because lihc N 1•v is 2.,8.5]. d. reject dR: project because the PI is ! .05. e. reje'Clilhe proj e ~t because the IRR exceeds l 0 percent.

Diffil:ulty level: CllaHeuge

rA 'VBAt~K PI!:RJ( )D

c: 79. If \'!t ill cn"i• 2,600 h"Ltc:'-.Lui re u smuU ice cn:um em. Cart · tlc:o; nlie c~pccm.c.•d ro he $1 .400 :a ycu.- I"M mhn...-e ye~11 ' . A freTii he Uilrec year'. mhc carl is e ~:rx:de~Ut.l be \\1Hni hie ' :<i

U ' rlh:;Jil is •he .e:~.pec:led remaining life nr HJC c:noling ~l.tn'l. Wtu~m ~ •~rte ~}TI::tck period nf ri he ice cream c::u,i?

~l . .&6 ye:ar; b. 1.46 year"i c. 1.86 year"i d. 2.46 year" e. 2.86 year"i

Difficlllty fe~rel: E(lsy

PA BACK PERIOD e 8:0. Ynu me cnl!lsidcring u plrujL-c• wirlh a11 inirlial ct:l"i1 nf $41,300. \\'tutl i-; Hte )R~yh:Jd:

period foli thh projccm if the cash jnt1ows arc $5:50, 970. $2.600, and $500 a year o.,·cr dl!: rnexm four years, rcspect~vcly.

a. 2.04 _years b. c. d. c.

2.'"'6 year"i 2.89 ye:ar""i 3.04 _years 3.36 _years

Di.fficulry (e~·el: £(lsy

PA \'BA<:K Pli:Rl()b d 81 . A project has an irnjtiaJ cosr of $1,900. The cash int1ows rulic $0, $500, $900. and $700

ova the nc.xrt four )'"Cru-s, respccdvdy. What Ls the payback [PCriod? a. 2.71 years b. 2.98 years c. 3.11 years d. 3.71 ycru:s C. IJ]C\fCf

Difficulty {e~rel: Easy

PAYBACK PERIOD c 82. Jack ~s considcr~ng ad.dirng toys to his general store. He esthnatcs tlmt the cost of

inventory wiU be $4.200. The remodeling CXfPCns.cs and sheh .. ~ng costs arc estimated at $1 jUU. Toy s.alles mrc expected to produc.c net cash int1m\rs of$ ·~ ,200, $1 jUU, $] ,600. and $1 ,7 50 over the next four ycru-s, rcspccth•cly. Should J ilc!k add loys to his -slorc if !he assigns a three-ycru payback: period to this project?

a. yes ; bc~ause the payback [PCrioo is 2.94 yerus b. yes ; because the payback period is 2.02 yerus c. yes ; lbccat1se the paylback period ~s 3.80 ycalis. d. rno~ because the payback period is 2.02 years c. no; !because tbc payback period is 3. 80 years

.Difficulty lew!/: Medium

DISCOUNTED PAY HACK PERIOD c 83. A iJmljee'l h1.1, ' un ini mi•d OOM ~lr $8,500 ;~nd produc:e · t::;tSh in fl nw · of $2,600, 54.900.

and $1.500 over the next ihrcc .:Y-ears, respecth•cly. \Vhat is llle discounred payback perind if rhe requi red mre uf m lum 1<i 7 pen:enr~

:1, 2,1"' y¢:;J.T"i

b. 2.33 yerJ.T"i

(;, 2.67 y¢:a.T"i

d. 2. 91 years e. ne.,."Cr

Diffic~lty fe~ref: Metli~Dn

DISCOUNTED PA YHACK PERIOD c 84. Yanc}• ms considedng a project \Vhich wiD prodm;e cas!h intlows of $900 a yc;:~.r for 4

years. The project has a ~ pc!J"CICnt n::qui rf.':d rate of retnm nndl an i rul:i :II cost of 2.800. \Vhni is rhe d1scnun~oo payhJ.c!k pcrind?

a. 3.11 .years b. 3.1& years c. 3.8.2ycars d. 4.18. years C. IJC"'Cf

Difficulty le\~1: Medium

DISCOUNTED PAYHACK PERIOD e 85. Gilmy Tmcblood ~s considcri lllg an i n,.·cslnlc:nt which wi U cost her $] 20.000. The

invc Lmcnt produce.., no C'ash nov .. • tor tlllc first ycrn:. In the second ycru lhc cash intlow is 35JlUO. Th~s. int1ow wW ~ncreasc to $55.~ ill.lld then $75,000 for loc following two years before ccasmng pcnnancndy. Ginny requires a l 0 percent rate of return and has a requ ired! drlscountcd 1XJiy'back period of thrf.':e years. Ginny shou~d __ d"Jj s pmjcct bcca~ars.c the discm.11ntcd payback period is __

:.~. accept~ 2.03 )~.

b. accept~ 2.97 years.. c. accept; 3.97 years. d. reje~t; 3.03 years. c. reject; 3. 97 ye-ars.

lJiffil:ulty level: Medium

A \t'ERAfiE ACl."C:liJNTl G RET UR c 86. t.urry•s l...antcms is c-onsi dcri ng Cl project which wm produce sales of $240.000 Cl year

for the ncxl nvc years .. n 11c protil n1ar_gjn is estimated at 6 percent. '11tc project "'~,r~IJ rost $290J1lX!l a.nd be depreciated slrnight-linc lO a book value of zem over tllc life of toc project .. Lany's ihas a H:qu~n:::d account~n,g rctl!lrn of8 percent l 'his project shouM be becal!lis.e the AAIR is

a. rejected~ 4.14 pcn.--ent.

h. rejecletl; 6 pen:erd. <.:. rejecletl; 8.28 pen.--cfl._ d. u<:t-eph=d; S. 28 percenl. c. u~ccpred; 9.93 pen.·enl,

Diffic11.fty fe~-el: Medr11m

AVERAGE ACCOUNT~NG RETURN d 87. A proJect has <m initial oosm of$ 3&.000 and! a four-year life. Tihe comptmy uses

:d rnigh i -lint: dep..eci::~ li ic~on li cJ ::t. hllllk value Elf zern nver rhe 1 i fe nf illilf: pr<l~ecm, The projected l!ll!l i RC<l)m~ fr.om lhe rmjecl i"i $1,000. $ 11.200, I.SOO, :mtl $ L700 u year fnr rt.t 111e:-:~ fnur yt;;tJT"i, re~~C'i ~\• ~ly. \.Vh;~~ is rhe avem~"rt :K"<.lnUni ing ren11rn1

:1. 3 .55 pen.-eni b. 4. I 3 pen.--cni c. 4 .2S percent d. i .ll percent c. ·t4.2 l percent

AVERAGE ACCOUNTI G RETUR d 88. A pmjte'l prnduces i~n nu;)l !lei ipc:nme nf $9.500, 12.500. ;)nd 15.500 El\'e r ihe mhrce

years of its li fc. rc-spoct~vcly. The i11hi al cost of the: proj cct is 260.400. 'fhis cost ~s. dcp11eciated stra.ight-Hne to a zcro book "'aluc over tl:Jrcc yeaJJs. \Vha.l is the average at:ooll!lntj ng rntc of rctum ~t' the 11e-qu ired disc:oont mtc is i ]XIfcent?

a. 4. SO ·percent b. i. 32 pen..--cnt c. 8.97 percent d. 9 .60 percent c. ·10.21 percCTit

Difficufty {e~re/: Med;um

AVERA(.i:E ACl.""-OIJNTI (i RET UR d 89. A project has avcrngc nc~ irn.:omc of $2.1 00 a year ovc11 its 4-yot:ar l~tc. The ~n~lht.l rosl

of the project ]s. $65.000 ""·hich wi~~ be depreciated "sing slrniight-l]nc dep:rc:dat~on to a book value: of zero over the ~j tc of tbc project. Tlrtc fi lim wants to CLUll a .ru Llimal avcmgc ocoom11n.i ng lfC:tli.ll.m of 8.5 pclirenL The lilrm should tlrtc project based o:n the AAit of

a. a~cepl~ 6.46 p;:rcenm. b. accept; i) .69 percent c. a~cepl~ I 2.92 perocent. d. reje-ct~ 6.46 percent. C.. reject ~ rl.92 peTCCIIlL

Difficulty {eve/: MeJfum

AVERAGE l\CCOUNT G RETUR a 90. Ji.·furl1n i$ ~mul j•:.ri ng a pll"uje:d ~md t lil!' g.amlhelied ilrtc f4)11nwing d:U~•. "BtLc~ietl nn ihis d:iJ~•,

\:\o'h:art ; ... ilrle n.,_-emge uo;;ou.nling r~lie nf rc'lum? The fillTI <lepn..--c1il!mt.-.; im tL~set s n ·ing slr~aigh I- Ii nc dc p n::ci:all ~nn 11 u a ZcT4) b t.)l.lk ~,o· :dt.Le m rer ihe li fc nf 11 he ~l!i<id .

Yc:a.l' 0 I 2 .., ..)

4 ;,1. 13.08 pcrccnl b. 15,77 pcrccni c, 2 I , 8-3 pcrccni d. 26. I 7 pcrc cnl c. 31 . 54 percent

Difficulty level: Medium

C :)!oin Fln.w -$642,000 $ ~ 70,000 $240,000 $205.000 $ ~ 95,000

N c'l l lilt n mc

nliJJ 9500

579.500 4.500

34.500

l NCREJ\·l EN'FAL JNTERNAL RA"I E ()If RI!:'I."URN c 9]. Yoo arc analyzing tlbc tblllowing two nmtrnally cxdusivc Jinojccls and have dcvdopcd

tlrtc foUowing irtformatio:n. \Vnat i ~he ~nC'IfCnlentall IRR?

Year 0 ]

2 3

a. II , l l percent b. 13.UJ. percent c. 14.9l percent d. 16. 7'5 ·percent c. 17.90 percent

Diffil:ulty lew/: Medium

Project A c~~h [Jo).'l

84,500 $29,000 $40,000 $27.000

Project B Cash Flo_w -$16,900 $25,000 $35 ,000 $26,000

l NCREJ\·l EN"FAL JNTE.R AL RA"FE (n' REl"URN b 92. Toe \Vin ton Co. 1s considering two nmtuaUy cxdush•c projects \'\rith lhc fotlow·ing

c-ash flow'S. The i ll{'rcme ntal I RR is a!lld it' llhe rcqu ired rate is h~ghcr fhan the c1rossovcrr rate tbcn proje<::t __ slrtould be accepted.

Projc-t A P~jcct B Year Cash flow Cash Flow·

0 - 7S..OOO -$60.000 ] $30.000 $25 .000 2 $3S.,OOO $30.000 3 $3S.,OOO $25 .000

~l. 13.94 pc~cnf~ A b. 13.94 pt~~cnt B c, 15.44pc~cni~ A d. 15.44 pc~cni~ B e, 15.8.6 pc:re:cni~ A

Yc:;~.r

0 ]

2 3 4

R eq 11 ired PJ•yb:ad:: periE'Id Required AAR Required rerum

PROFIT A81LITY DEX

C:ash tlnw -$ 169,00) $ 46,200 $ 87,300 $ 41 ,000 $ 39,(MX) 2.5 }'t.'-'JIT$

1'.25 percent S. 50 percent

b 93. Based on the proti tabi1ity inde.~ of __ for thJs proJect, you -should _ _ the projc'Cm.

a. .91'; accept b. 1.05; acrepl c. 1 . ·1 S; a-crept d. .9'7'; reject e. 1.05; reject

Difficulty le~rel: Easy

INTER AL RATE OF R!E R. tl 94. 'Based on the ~llt crn;rl Ji'LllC of return ot' __ for th~s project, j'O!III SOOU~d the

projc'Cm. :1. 8.95 pcrocnt; acccpm b. 10.'7'5 percent; accept c. 8 .44 pcrocnt; rcj ect d. '::J .67 perc-ent~ reject -c. 10.33 percent; reject

Difficulty lew!!: Easy

~1!:1.· !rRE..~.E NT \" AL Ull: c 95. Based on the. net [present value of tbr this pL·ojcc·t, you should !.!he

proje'Cm. a. -$2.02] .28~ n:jccl

h. -$406. 1 9~ rej~• c. $7.978.72~ ~u:ot:pf d. $9.1B6. 74~ m:ccpt t: $12.684.23~ i.U.:l't:pi

Difficui~v few/: Ecsy

PAYBACK PER.OD c 96. Based on the 'JX!Iyback period of __ tbr lh LS pmjcct. ) fOU shou[d __ the

prnjccr. i.l. I . 87 ~(::a.T-.; ; :a.cccpl h. 2.87 yem-.; ; :a.ttcpi <.:. 2.8.7 yeat"i; rcj t:c: i

d . 3.13 yer1r<;; n:jt:c:'l

c. 3. &7 years ; rcjcot

Use u~e fo:lh~Wiln&! rirlf:OI'IIIJatimill to iUJlswer· questions 91 tl~nu~b l Ol ..

Yol.ll ilfC considering the tbUov.•ing 1:\\ '0 m1r.ttually exclusive pmjccts. Both p~iccts r;.vHl be dtprec:i :dod u~illl~ -;i mi gh m-li 1i1C deprcciul ion II n a zcm ht.)llk valUe nver ihe I i fc c)f i llc )ll'njcc m. Ndthcr project has. any salvage vaJ.nc.

Rcqruircrl rate of return Rcqruircrl payback per iod Reqru.rcrl acoounli ng return

Nl£1. PRE.~ENl' \ ' ALU[

Project A Year

0 [

2

Cash E!ow -$75.000

[9,000 8,000

12,000 10%

2.0 years 8 %

~jcot B .Year

0 1 2 3

CU5h Row -$70,(0} $10,04J) $16.000 $72.(0)

13% 2.0 years

11 %

c 97. B~L·:;cd on the nc~ present value mctt.Jod of analysis and gh·en ·tt.Je information in the problem, }IOU should~

a. accept both project A and project B. b. accept project A and reject project B. c . accept project H and rej cc t proj-ect A. d. rcjc(;tlboth project A and project B. c . accept wihkhcvcr one )IOU wam as they rcplicscnt equal oppon unitBes..

Difficulty fe~~/: Medium

INTI£RNAL RA l'E Oli RETl RN e 98. Based UfPOll the ~ntcmal liatc of return (JRR) and the •ntbnnali on pro,•idcd in dle

probkm, you should:

[l, 1,\(:Cepl N lth prnjeL"I A ;,mtl prujL"CI n. b. rujed ho11l iJ1mj,cd A ::mtl p ll'njcx:t B, <:.. U<;t."Cpl f"·t~r.:ct A and l!'ejec: I pmjec:l B. d. 1,\<;cepl f"·t~cd R und rej e.cm pmjccm A. e. 1g111.m.: II tle IR R !iU~ • a111d U<lc ~lQG\1 1-te:r rnr.:Htud n{ nn ~lil ysi<~.

PAYBACK PERIOD b 99. Ra.··~ed t!Jpon tile. p tl.yb:ack JlL"ri od uprl I he in l~lrm:a.i ifm I"·n\o'i de.tl in lile iJ1m'hl e.m, you

:o.llc"MJld : ~l, u<;cepl llxlth prnjred A ;,mtl pr·ujLocl R. b. rujed hn11l iJ1mjeC'i A rJlll tl p mjt.'>Ct R. <:. utoepl f"·t~t.o:cl A and l!'e jed pmjed B. d. m:cepl projc'Cl B and rej eel project A. c. require that management extend lllc paybaC'k. period tor project A since it has a h~gher

i niLia~ cost

PROFIT ABILITY I D:E e ~ 00. Ra .. ~d upn n mile pmnfil~•hi l ily index (Pn ::~ml ~ lrtt l lll~~nmal itlll pnw1tkd 1n lhe pmblem,

you shoU~Id: a. ;u:cept both project A :md project B. b. a-ccepl project A and licjcct project B. c. m:cept proje'Cl B and reject project A. d. reject both project A and project B. c. disregard the Pl method in tthis case·.

Difficulty le~re!: Medfum

AVERA(TIE ACCOIJNT[N(T RETUR c Wt Based upon tbc· a"¥'cragc a-cooLmtj ng retmm (AAR' and the infommion provJ<kd in the

prob lem, you: a. hotdd accept both ]project A and project B. b. shoold accept project A because ttle AAR e.'tcecds the requhcd rnte·. c. shoold accept pr~jcct A because thc AAR is less than the required rntc. d. shoold accept wh.idle' 'eli pmje~t .YOU prct<:r as they rur-c equhruent from an AAR

perspective. c. c:.m not corn pule the AAR of either p:roje'Ct

Difficulty {e~rel: Medium

~El' !PRES.E Nl' \1 ALUIJ: d 102. A :25 hwestmenl prodl!lccs. $27.50 at the end otftthc. year \\'Jdl no rts.k. Which oi the

tblilo'Lvi n,g is trw:? a. N PV i-s [POSitive if t.hc i ntercs.t rate ~s kss mhan l 0%.

lb. PV is ne~.alive iflthc inlelfcsll'me is les.s than 10%. c. N PV is zero if the i nlcresl rate is. equali to I 0%. d. Both A :rnd C. C~ one of' mfle albove.

D(fjkulry level: ChalltP1~i.'

PA\"HACK h 103. Corts.idet an iuvest rtl.enl with an ~nitia~ oost o f $20,000 ilf!ld i s expe.cred ~o la.s.L tbl' 5

yc:urs. '11te cxpeotcd cash t1ow in yean 1 :md 2. arc 5 .ouu, i 111 years 3 and 4 arc $5 ,500 and in year 5 is. $ ~ ,000. l'hc tot ali c-ash inr1m.v is. expected to be $22.WJ olf an a'\:cragc of $4.400 per year. C41~~nputc the pa)'back period ~ n years.

a. 3.1 8 years lb. 3.82 years C. 4.00 yeaJ'S

ct 4.55 yeru-s e. None or me ~ove.

DISCO Nli'ED PAYBACK c 104. An invcsmncnt '1.\ridJ an initial cos.t of$15.000 produces cas.h tlows. of $:5J..Jt.JV annuaily

for .5 yeat'S. If the cash tlm ~ s. evenly s.pread out ove1· the year and lhe firtn can borrow at 1 O!fi; , tile d~s.c·oulf.licd paybock period is years.

a. 3 t). 3.2 C. 3.75 d. 4 e. :S

DlSCO li'ED PAYBACK h l O:S. An i nveslrL-.eut pmjoct has. ll1e cas.h flow strerun of S--2j{). $7 5, 125. $ HJO, and $:50.

TI1e cost of cap1tal ~s. 12'i.o. Whlli ~s. tihe dis.count payba k: period? a. 3.15 yeru t). 3. 3 R yeru e. 3.45 yeru [l 3.60 Yttll"i

e. 4. 0.5 yeru-s

NET PRI:SE T VALUE A D INTERNAL RATE OF RE RN Ja I 06. An i 11~·e:~~hneni c~lSi 10.000 wiih t!:t[llC<:ied cush li~l\,'S nf $3,000 ft)r 5 }'t."Jlf!'. The

discount rme is 1:S.2JS2%. l lhe NPV i ~ _ allld the IR:R is._ fot the projeeL a. $0; 1 :5.2382%..

b_ $3.33; 27.2242%_ c. $5,U(JO: 0%_ 't Can nol ans.weJ ,, .. ~lhollit. one or the other value as ~nput. c. None of the above_

IV. F.S AYS

INTF.RXAI. RATF. OF RF..TURN ·ao7. list and brictly discuss the adva.Jlltag:cs and disad\ra.Jlltagcs of the jnt.crnru rate of return

{IKR) r l!llc.

The £JdVcmfa••e." ofrh.e mJe are ir.~ ·Jose reJarilm.'ilrip ·wirh NPV wld rh.e ea.\' t! ·wirlt rwhii..-h ir i." tmder.fluod ami l.·nmmuni ·ared. The hWJ di.wtf~·wda •e.-r £Jre rlw; 1l1ere rrw,v be 1W~liiJlle .wlurio-ru wulrlut rule may lemi lo a rauki.Jrg ·rmflii..·i iu e~aluaring rrwitwlly t:.,.x lrtsiPe inves'fme111s. The srudem .dwuM add a brief expJa.narhm demcm.urorinR their u.nderstanding t.if ea£.·h

PV VS. PI 1 OS. Exp 1 ai I'll the d ifferences. aJJ:ld si t:ni1 arities. betv.•een ~ 1et present \'alue (N PV) and l.lle

prontab~ljty index (f 1 .,_

The NPV wrJ PI are bct.'li aHy rhe same (;a/(;ularimr. a1uf b.orlr l'ule ... lead fo1f1e .t£Jme a ,·eprlrejec;i rle,·i,~imr. Tire main dif!eren,·e berweert tlu: l'wo iii th£Ji rhe Pi mlJy be useftd itt Jetermi~ting whi Jr r'roje,·r ... /(1 a{.- ·ept if. 'r.mtf.\' are linril'et f: lm'We~rer. rhe Pima,;· lead / (J i.rl m're,·t de<.·isimL'i i.n c;mrsidering murually exc:lusi.w: imre.~tmeJrt.~.

NPV ANn PROJF. T V AJ.UF.. 109. Gi\'eJ) the. gooD-s oflfltm value aJ'Id s!h:lli'ebolder wealth ttiaxi~nization. \rve have stre~oo

me irrnpt.xt:mce of net preseflt value (NPV)_ And yet. f!riany li oonc ia.l dec-i~ion-ftlak.efi ill some of l.he mosl p1~omj ncnl finns. j n llJe 'i. odd continue to us.e les.s. des.ir-.:11ble tne.amrcs. sucib as. the payback period and ll1e il\'el!'age acc·oulflling remm (AAR)_ W hy do you Lhi nk lllri s. i~ [Jle case?

Thi." i.-r an (Jpt!H-eJrrled que.~t~-mr wlu"dt atlm ... ·.~ the {..·re£Jiive .m~dem 111 ~JN! uJate tm the vafl~e (Jfmm-di.\·,·ow~led c:a:rh flow evafuali.t)Pl mea:rure.~- We tt:iie ir cH a .'iiln'iJrJ;fmarrl to st~.u thai e~t!ll ra.limwl {i.n£Jm:ial nrmragen ii.tmretiml!.\' find it e.:rpeJiem 111 u ... 'e a grrmp of mea.~ure.fi. For exanrple, firnr.ii may re('l rm the JRR beclJu.~e it is ew·ier 10 explain ro l10t:1Td members llr.o.n NPV. Al:io.fm· 141-rge projects. AAR pro~ides sharelr.o{de"t·s with some invigh.t.v lJ." io rlu! pmjec;t '.\' imp£Jc:1 rm net ini..·nme and t!lJming • .,· per $iwre.

] TER "AL RATE OF RETUR ·~ ]0_ The Z igg)' Tri tn and Cut Cornpa.ny C;:lJJl purchase equipment on sale. fOJ~ $4.300. The.

:a.~scJI h:a.., ::t li hree-ycmr I i fc, \'-'il l [JlTHttuce .. [.:~ISh n nw Cl r $1,200 in i be r1 11"S!I i.lJlld ~ecnn~l

yt.~r, :a.nd $3,000 i rt ih • mhird yeu!f. The ioicrc,o;i raft: 1~ 12%. C:;~.kuhlie mhe prnjt.~f'· payhac.:k. AI~~. c.:Jdcul :a'IC pmjt.~l 's ]RR. Shnuld ihe pmj cLI be li :alkeli1? Chec.:k ycmr answer by comput~ng iJhe pmje t's. NPV _

Payback - 2.63 years. IRR = 10.41%. Do not wkeprojectas IRR < 12% Reject 1he projecl NPV = ($136.60)

1\'fULTIPLE METHODS OF VA LUA TJON I ll. The Ziggy Tri m and Cut Comp<'ln)' can purchase e<tuipment on sale for $4,300. The

asset has a three-year li fe, wil l produce a cash flow of$1,200 in the lirst and second yem·, and $3,000 in the third year. The interest rate is 12%. Calculme the projec~·s Discounted Payback and Proliwbi li t)' Index assuming end of )'ear cash !lows. Should the project be taken? lf the Average Accouming Retum was positive, how would this affect your decision'!

Time 0 - Cashjlows = $-4,300, Presefl/ Value ofCashjlows = $-4,300 Time I and 2 - Cashjlows = $1,200 each period, Presefll Value ofCashjlows = $2,028.06for bolh periods, Stun oj'Prese11t Value ofCashj1ows = $ -2,271.94 a/ the end of lime 2 Time 3 - Cash .flows = $3,000, Presenl Value f?{Cash.flows = $2,135.34, Sum of Presem ValueofCashj7ows = $ -136.60 Discoumed Payback ca11not be calculated as NPV < 0; NPV = $ -136.60 PI= CFA7/ !In ilia/ Jnves/lnen/ = $4,163.40/$4,300 = .968 = .97 801h measures i11dica1e rejeclion. A posilive accouming rale of rewm should 1101 change !he decision. DPP and P I ilulica/e liwllhe coslf?{ capilal is 1101 being covered.

MULTIPLE METHODS OF VALUATION 112. 111e Walker Landscaping Company can purchase a piece of equipmem for $3,600. The

asset has a two-year life, will produce a cash tlow of $600 in the first year and $41,200 in the second yeru·. The i merest rate is 15%. Calculate the project's payback assuming steady cash !lows. Also calculat.e the project's IRR. Should the project be taken'! Check your answer by computing the project's NPY.

Payback = /.714 years Calculaled IRR = 16.67%. Accep11he projec/. NPV = $97.54.

INTERNAL RATE OF RETURN AND NET PRESENT VALUE 113. 111e IRR rule is said to be a special e<ISe of the NPY nile. Explain why this is so ;md

why it has some limitations NPV does not?

AI some K, NPV = $0; by de.finilion, whm NPV=O, K=IRR. Problems occur due to conjlicls with muwally exclusive projec/s, liming and size problems, mulliple sign clumges presenl problem for IRR NPV always !he best choice

SOLUTIONS TO TEST BANK PROBLEJ\IS

Chapter 7

66 NPV = - $28900+ $12

•450

+ $19

•630

+ $2

•750

· NPV = -$177.62(ne mive) . ' (1+ .12)1 (1+.12) 2 (1+.12)3 ' g

67.

CFo co, FOt co, F02

col F03 I = 12% NPV CPT -$177.62

-$28,900 $12,450 I $19,630 I $2,750 I

NPV = - $ 12670 + $4,375 + $0 + $8,750 + $4,100 ' (1+.115) 1 (1+.115) 2 (1+.115)3 (1+.115)4

NPV = $218.68

CF0 co, FO, co, FO, co) F03 co, FO, I = 11.5% NPVCPT $218.68

-$12,670 $4,375 I $0 I $8,750 I $4,100 I

68.

69.

70.

NPV = - $1 0,600 + .t l ,750 I '+' $1,750 , -r $1,750 3 + $1,750 0+. 1375) (I +.1 375 ~ ( ~ +. ~ 375) (1 +. 1375)

NPV ""' -$1.011 .40

CFo C{) l

All CHz Ah I= 13.7:5% NPVCPT

-$1 0,fi00 $1 750 4 $fl ._)(){)

1

-$ ~ .m 1AQ (negative)

$8,500 + . (1+ . 1375)~

Npv Q·4-o oo~, ~ s,4()() ·3 ~ ,3(1(1 $ u, 100 . P. .,. 3

;:_ - - .p Q v + + + · N V = 2. 2u.46

A • (1 + .1125)1 (l+ .J J25i (l+ .Jl25i 1

A

CFo col t-"0, co! ~ co3 Ah 1::: n .2:5% NPV CPT 2.326.46

-$48.000 $1SAOO 1 $31.300 ., $1 (.700 'I

NPV = - $· ~ 26 900+ .$uCJ,?Oll + SO,CJOO · NI~V ;;:: 56 R ~ (I + .1075)1 0 + . ~075) 2 ~ 11 I,W L

CFo co1 A) I

co! m I = 10.75% NPVCPT

1.991 .56

-$126.900 $69.700 I $80.900 I

Difference in NPV = $2.326.46 - $1,991.56 !:::! $334.90 llihc :m:s\Ver s•Illt."'i thut rlhc NPV nf Pmjed A e t.:ecd:s ihe NPV n f pr>~-lj~• R hy ~·b~lUi $335.

$325.000 NPV A ~'1{ = - $2401000 + . ~ PV II..K~ !!!! l7 .995.48

. (1 + .08)'

II' - $325.000 N PV"' 1 L ~ = - "'240,000 + _ ~ ~ N PV tL ,, 'l- = 2.362.80 (ncgath•c:-)

· · (l +.t l r

CFu -$240.000 co, $0 FO, COz Ah 1=8% NPV CPT

17,995.4S

2 $325 ,000 1

1=1 ] %

NPVCPT -$2,362.8() (ncgui i\'c)

1 _ ·. . . $liO,ROO $82.500 $45,000 . . _ NP\ 1H 1• -$198,000+ a + ., + ~, NPVa.R<.T- $1 L0 45.:50

. " (1 + .0~) (1 + .Ot;t 0 + .Ut;)"

$ 11 o_~oo $~2.soo 45,000 , NPV,3 11.._ ~ - $J 98~ooo + • + 7 + ~ Nl~v~~. ~~~ = $L682.28

. (l +.ll) I + .1 1)- (I + .1 ~ )

Cf'o co, FO,

-$19S.OOO $11 0.,800 I

COz Ah COio FTh 1=8% NPV CPT

[ 1.045.50

$~2. 5UD

1 $45,000 I

T= II% NPVCP'li" $1 ,6S2.28

A11 8 pt.."J"Cc.nl. PJ·t~oci A h~as 11hc h igher NPV. A11 [ I p<-'1'cenl, PrujfX!i ll h;,~~ ihe h1g}1er IPV,

71. Cf'o -$123.400 co, $ 36.200 F01 I CD:! $ 54,800 Ah I CO;. $ 48, 'I 00 f'0:3 I IRR CPT 5.96%

72. CF0 -$.24,000

73.

cv1 $ s.ooo FOI I cv! $ 12.000 ·m. ~

co $ 9.000 'F(h II IRR CPT 9.89 perce nt

Tih • prnjec~ <ihould be ~cccpted bcc:al.il"ic 11 he l R R uf 9.89 pen:cnr cxccccls the rcqu1red m l urn 4)f 9.5 pen.-enl.

Pmjccm A: Cfo -$95{),000 CO I $330.{)00 F01 l col $4oo.ooo 'f'O., 1 OJ, $450.000 'Ah t IRRCPT 1l .06 percent

l= w NPV CIPT

l8.670.17

Pr~lje<.:t R: CFn -$]25,0CIQ col 55,000 F01 l co 50,000 F01 1

IRR CPT ~] .79 percent

] ~ w NPVCPT $3,88&.05

Si nee these arc ~ndepcndcnt projects and both tloc JRR and IPV ndcs say accept. }'Otl

sho uld accept both pro:jccts •f lh crc ru-e suffidenl t\mds to do so.

74. Since CO, is a 11cgativc va~111e. tbcre arc nmJtiplc IRRs. l 'hus. lhc lRK mJc does. ool apply.

15.

76.

V $7,400 $9.800 $&.900 PV p b!\-c< = (t .09)1 + {1.09)! + (L ;09) ~ ~ uol'lon. =

CFo cu, FOt Ctlz ~ CUJ. F0_1

u $7.400 l $9.800 l $~,900 ]

I =9 NPV CPT 2 L909.8':l

Pl- 2 L,909.89 ; l.02 21,500

1.m.s9

$ 1 u.ooo $7.300 .... , 700 PV mn =

1 + , +

3 ; PV;,m...,., = $]8,45S.Ol

(1.08) (LOS) - (LOS)

CF,, ()

co, $10.00U FO, l co~ $7.,300

Ah l CO! $3.700 fO.J l I= 8 NPVCPT

18.455.01

Pl $18,455.0 I

- - 99" .$ LK,6UU - . -

77.

78.

. $20,000 $24,000 PV A. inf to .... ~ = .1 + . ? ~ PV t .. ;nn,,.,.,. = $39.094.65

(LO&) (LOSt

P.mjt::c'l A: CFJ) $ o co. $20,{0) FO, l rn~. $24,{0) ~ I I= 8 NPV CPT

39,094.65

PI _ 39,094.65 ~ t02 {l,- $38.500

Prnjeci B; CF11 $ 0

co, $10.000 FO 1 CO;z $40.000 FO~ I = 8 NPVCPT $43,552.8.1

Pl = $43,552.81 ~ t.04 El 42,000

Because lhe projects. .are independent and the~r P]s. exceed 1.0. boll1 p:rojoclS shoo ld be accepted.

30,000 $37,000 . -PVinfl»w .. - 1 + ., ~ NPV1n~:::::::: $57,8:.11.24

o.1u) u.tur CFB $ 0 CU, $3-0 ,UOO FD, l c~ $37,000 ro~ l l = 10 rpy CPT

$57.851.24

PI = $57~85 l.24 ;;::: L05 $55J)(10

YoU :dmuld n: je~:.; i rhe pmjed ' i nee mihc PI uf 1.05 i.o; 1 css mhun Vi ci.uriSIJ. ' rL'1-JJUircmc n I of I. W. Tm i ' W~\ni h meniiuning rih:ai ihe NPV n.f ilrli:o.; pmjec'i 1s

79.

&0.

$2$5 1.24 nrtd mhc IRR i"i 13.71 pen.-eni, lbumh Elf \.\1hich wnuld llt)!imully irrulic:a!le pmjeci uccepiunce, Hnwe\ler, neiiher illt NPV llt)f rhe mR meei mhe re~1ui remeill~ ~lf rei urning $ I , I 0 fur c\'try $ I spen l.

$2 600- I 400 P;t \obl•c k periud = J + ' ' , :::::::: I .86 ve:a;r.;

- ~t4100 .

P \.~. k ' d 3 $4,300 - $.550- . 970 - $2,600 3 3 . ::l")'IU&.LC' • pcno !: + = _ 6 ye,ars

$500

81.

P ~,. k "od 3 ( 4 200 + $ ~.5-00) - $1.200 -

a,....>ac .. pe:n . =- + $1 ,750

S3. The prtlj c..-c r ne\<'er i(lJl ) '' hack un " di M:oU n1cd. ha!i.i . .

ss.

OCF $2,600 .$4,900 1500 $ _ _ = (I+ _07)' + (I+ .07)1 + 0 + .07) ~ ncF!: 7,934.20, wl·nch IS le·s HJ:m llle

initial cost of $8.500

Year I 2

4

Discounted cash t1ow $825.69 $757.5 I $6~4.97 $637.58

D- .. _..II l k 3 $2~800- $825.69 - $757.51 - $694.97 1soounLUI pav )ac · = . + ;;:::; 3.82 years

Ye:u-1 2 3 4

~ .$637.58 ~

C.• ·h n~ ... w Di:scnunled c::Jsh lltlW

$ 0$ 0.00 $35,000$:!8,925 .62 $55,000$41·1,322.3 ~ $75,000$51 ,126.0 I

0- d b k

3 .$120,000- o -.$28,925.62-$41,322.31

1SCoume pay oc = + $5

~ .226~01 = 3.97 years

Ginny sho uM rejec t the project since the payba.ck pcrh:xl of 3.97 years exceeds the required 3 years..

87.

88.

8.9.

9 0.

9L

A AR .06 X $240~000 _

, ~ : AAR = 9.93 percem; T1le proJect shoo1d be. a.cc-eptect .5 X ( 290,000 + 0)

AAR ($ 1,000+$1,200 + 1 ,500+ .~ 1,700) -:-4

= == 7. 11 poetrccnt .5x ($3 8,000+ 0)

AAR ($9,500 + ~ 2,500 -+ $ ~ 5,500) -;. 3

~ . = 9.60 ifk-"'t'Cem .5 X (.~260,400+0)

2,~ 00 AAR = = 6.46 pc~·ccnl

.5 X ($65,000 + 0) The finn sh t ruld reje.£·l tbe proj oct hase.d on lhe J\A R.

AAR ($9,500 + $79,500 + $44,500 + $34,.500) + 4 13 08 - = . pel'Cf!lll

.5 X ($642,000 + 0)

Y car Proj cct A Cash Row 0 -$8.4.500 l $19.000 2 $40,000 3 $:27,000

CFo -$7.600 co, $4,000 FO, ] co~ $5,000 'FO, l co, $] ,000 Hl ·~ 3

LRRCPT I 7 .t~99 percent ;;; ] 7 _ 9%

Ptrojc:ct B Cash Flow ~$76.~ $2.5,(0) $35.~ $26JJOO

D ~ffcrcncc -$7,600 $4,000 $5,000 $],000

92.

93.

Year Project A Cash Jrlow l~rojcct H Cash flow Difference 0 -$75.000 -$60,lKl.l -$15,utl!l J $30.00U $2:5J.K.IO $ :5,000 2 $35.01JU $30.m.IO $ :5.000 3 $3.S.OOU $2:5J100 $10,000

Cash tlows. for (A·B : Cash t1mvs for A: Cash tlows for B: CF0 -$15.000 CF 11 .. $75.~ CF0 -$60,000 co, $ 5.01JU co, 30,000 co, $25 .000 toll, 1 FO, 1 FO 1 C{):! $ s.ooo cn1 ""35,000 C{)2 $30 000 FO~ :l fU! I Jolh ]

co~ $10.000 co:} ~35.000 C<h $25 000 FOJ ] ru~ I JoUJ ]

IRRCPT ] =d5 I ::::; IS. 13 .~4 percent PV CI)T NPVCFr

$565.05 $861.35

'lrhc cros.rovcr rate ~s. l3.94 pe~·cc nt. At a. Tate higher thant!r.c cro~soverr m.te, such as. IS. percent, Pmject B 'i.v.iU have t!hc higher Nt>V and should be acrcptcd

PV _ $46~200 + $&7 300 + 4 l,OOO + 39.000 ; PVirdt.>v.~ = irl '-"" (1 + .0~5) 1 (1 + .085)2 (1 + .0~5)3 (1 + .085)<1

l76.978.72

CFn col FO, CO:t; FOz co, ~ m F04

0 $46..200 ]

$87.300 ]

$41.000 ]

$39.000 ]

l= 8.5 NPVCPT

l76,978.72

I $176,Y78.72 .

P = ;;;; 1.05; You s.hould accept beca.l!.ltse the PI 1s greater than L 169,0()0 .

94.

J

95.

96.

cr:;ll -$169,(0) co1 - 5,200 FOI I C(h S7,300 FO! l c~ J .• ooo FO~ co4 39,000 ro4 I IRRCPT 10.75 pen:~om y t.lU should [lt.:Ccpt h ct.' !.lUSC llrtc IR R nr I 0.75 p¢Tt.:C"!Ilt c ;(Cc¢<ls mh~ rcq~1red rei um elf s.so pL"l'(;C n'l .

C n

col f0 1

-$169,000 6.200

co, f01

co1 FO ... c~ f-04 l

PVCPI $7,97&.72

~ .• 000

39.000

You should accept because the PV is posiLi\1e.

I . k . 2 J 6CJ.OOO - $46.200 - 87,300 2 07 1.'aybac penod = + ::: .o yc:ars 4 ~,000

Bared on payback, rl1e project should he :rejocled because [])e B)a.ybad:: pe.l'lo.dl of 2.87 years exceeds. rlle :requ1 i'e.d period of 2.5 yeai's.

97.

9&.

99.

r PV = - 75,000 + 19,000 + $48,000 + .~ 12.000 . . PV A = -$9,042.07 l\ (J + .l0)1 0 +- .) 0)-z (1.10)3

•

. J 0,000 16,000 $72ll00 . ' . PVB = -$70,000 + I + l + l . NPV h ... S-1.279.52

Cash flows for A; CF{} -$7 5,001) co, 19,000 F01 l co1. S4s.ooo fU1 I C11 12,000 Flh 1 l= 10

PVCPT -$9 ,042.07

( 1 + .13) ( 1 + .13) (I . I 3)

Casb t1o'>vs ·for B; CFfl 70.000 co, $10,000 FO I col $t6.ooo ro~ 1 0)3 $72.000 FO, ·1 [ = n NPVCPT $] ,279.52

Project IB should be accepted and project A s.loou[d be rcj cctcd.

Beca!JJr~c lhe~c arc mutually e.xdusi vc projects. IJbe [RR n~lc should! not be applicdl. ID· -L- k ,

00 ,

2 $75,000- J 9,000- 48,000

2 67 .oa)'uuC • pen tor A = + ~ . · years 12,000

- $70 000 - $1 0~000 - $16~000 Payback penod forB - 2 + :::: 2.61 year '

$7~000 -either project pays back within 2 years. tnu s.. the. y shouLd both be rejected.

HMJ Becau se these are mutuaJ iy e:-:dusivc proJects.. the PI mle s.hould not be. applied_

., 01 . Tbc AAR c-an not be computed because the oct ~nco1.nc. '!.vas. not pm,~ded

102. NPV = ($27.50/1.1) • · 25JJO = $U

103. l~ayback Period;;; ($5.t.M.l.l + .S.S .OOO + $:5.500;::; ~ 5500 for 3 years~ remai!llder $20.utM.I $ l :5.:500 == 4..500. $4.500/$5.500 = . 818 ! 8 ;;; .82) ;;; Payback Period ;;; 3 .81 years

'104. Dis.<'04mted I>:J.~back: A.1.n;::: $"15.00JJ$5,utM.I = 3. PM.Ir;;; l PV=-3 FV;:::Q Jl/YJR:;:::;IO N=~3.75

HJ5. $7:5/1. ~ 2 = $66.96, I :25/L t 22 == W .65. $1 OWL 123 = $71..18, $:5011.124 = $3 L 78 3 yr. CF~ $2:50- $66.%- $99.65 - 7 l . I 8 = $U.21 +Fraction= $12.211$31.78 = .38 Dis.<"oontcill P·a~back: 3 + .. 38 == 3. 3 8 years.

I 06. $-2001 U 0 ;;; $-181.82: $-181 .82 + l 500 ;;; $ ·1.318 . 18~ Cash tlow 0 = $-1 .000: Cash li1ow ~ ;;; $1.318. I 8