CHAPTER 12 CAPITAL BUDGETING: DECISION CRITERIA (Difficulty: E = Easy, M = Medium, and T = Tough) True-False Easy: Capital budget Diff:

E Answer: b

1. A firm should never undertake an investment if accepting the project would cause an increase in the firm's cost of capital. a. b. True False PV of cash Diff: E flows Answer: b

2. Because present value refers to the value of cash flows that occur at different points in time, present values cannot be added to determine the value of a capital budgeting project. a. b. True False Ranking methods Diff: E Answer: b

3. Given two mutually exclusive projects and a zero cost of capital, the payback method and NPV method of selecting investments will always lead to the same decision on which project to undertake. a. b. True False Payback period Diff: E Answer: a

4. One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a rough measure of a project's liquidity and risk. a. b. True False NPV 5. Assuming whose in in a. True b. False Chapter 12 - Page 1 IRR Diff: E more slowly. cash that flows the total the cash flows rapidly than rate are is is equal, more the NPV the sensitive of a NPV to of accrue relatively discount Answer: a whose cash changes flows come b Diff: E

project

project

Answer:

6. The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs) with the present value of the cash inflows. a. b. True False IRR Diff: E Answer: a

7. Under certain conditions, a particular project may have more than one IRR. One condition under which this situation can occur is if, in addition to the initial investment at time = 0, a negative cash flow occurs at the end of the project's life. a. b. True False IRR Diff: 8. Answer: E b

Other things held constant, an increase in the cost of capital discount rate will result in a decrease in a project's IRR.

a. b.

True False IRR 9. and NPV If be a project's NPV exceeds the project's IRR, then Answer: the b Diff: E

project

should

accepted.

a. b.

True False Multiple Diff: E IRRs Answer: b

10. a. b.

The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects which have different lives are being compared. True False Modified Diff: E IRR Answer: b

11. a. b.

The modified IRR (MIRR) method has wide appeal to professors, but most business executives prefer the NPV method to either the regular or modified IRR. True False Modified Diff: E IRR Answer: b

12. The modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method. A.True B.False

Chapter 12 - Page 2 Mutually exclusive Diff: E 13.

projects

Answer:

Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV. a. b. True False Reinvestment 14. The cost flows to a. b. Replacement 15. The two the True False chain replacement projects chain, with or common life, lives approach are is differing mutually Answer: applicable exclusive b Diff: E or rate NPV of are IRR assumption method's capital is reinvested method. assumption more at the that IRR. cash than This the IRR's the makes NPV inflows assumption method that reasonable Answer: are cash a Diff: at E

reinvested

the

preferable

whether

independent. a. b. True False

Medium: Ranking 16. methods Any itself capital cash should budgeting flows not and be investment the affected by rule managers' should cost of tastes, forecasted opportunity Answer: depend capital. the choice a solely The of Diff: M on rule

accounting a. b. True False Ranking 17. methods

method,

or

the

profitability

of

other

independent

projects.

Answer:

Diff:

A decrease in the firm's discount rate (r) will increase NPV, could change the accept/reject decision for a potential project. However, such a change would have no impact on the project's IRR, hence on the accept/reject decision under the IRR method.

which

a. b.

True False Mutually Diff: M exclusive projects Answer: b

18. a. b.

When considering two mutually exclusive projects, the financial manager should always select that project whose internal rate of return is the highest provided the projects have the same initial cost. True False

Chapter 12 - Page 3 NPV 19. Normal zero. Therefore, Project a. b. True False NPV 20. Project Project At the NPVs. Other preferred a. b. True False IRR and Diff: M NPV Answer: b S L Now things to S. has has a a cost suppose held pattern longer of of life, normal rates high cash with Projects and this flows S in and L its cash have will early flows large money Answer: life, late a while in its life. Diff: M R Projects we will Q know have a and R that greater have Q at NPV the has all than Q. same NPV larger discount when early rates However, Project Answer: the cash greater b Diff: rate than M is R. zero, discount flows than

current

capital, interest

identical decline. L to become cause

costs

generally

constant,

change

21. If the IRR of normal Project X is greater than the IRR of mutually exclusive Project Y (also normal), we can conclude that the firm will select X rather than Y if X has a NPV > 0. a. b. True False NPV versus Diff: M IRR Answer: b

22. The main reason that the NPV method is regarded as being conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist. a. b. True False NPV versus Diff: M IRR Answer: b

23. The NPV and IRR methods, when used to evaluate an independent project, will lead to different accept/reject decisions unless the IRR is greater than the cost of capital. a. b. True False

NPV profile Diff: M 24.

Answer:

The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zero. Also, the NPV of X is greater than the NPV of Y at the cost of capital. If the two projects are mutually exclusive, Project X should definitely be selected, and the investment made, provided we have confidence in the data. Put another way, it is impossible to draw NPV profiles that would suggest not accepting Project X. a. b. True False Chapter 12 - Page 4 Reinvestment 25. rate assumption Answer: a Diff: IRR M

In capital budgeting analyses, it is possible that NPV and both involve an assumption of reinvestment of the project's cash flows at the same rate. a. Tr ue b. Fa ls e

will

Small Diff:

business M

Answer:

26. Small businesses probably make less use of the DCF capital budgeting techniques than large businesses. This may reflect a lack of knowledge on the part of small firms' managers, but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for those firms. a. b. True False Replacement Diff: M 27. chain Answer: b

Although the replacement chain, or common life, approach is appealing for dealing with projects with different lives, it is not used in industry because there are no projects which meet the assumptions the method requires. a. b. True False Common life Diff: M 28. comparisons Answer: a

Extending projects with different lives to a common life for comparison purposes, while theoretically appealing, should be done only if there is a high probability that the projects will actually be replicated beyond their initial lives.

a. b.

True False Chapter 12 - Page 5 Multiple Choice: Conceptual Easy: Ranking methods Diff: E Answer: b

29. a. b.

Assume a project has normal cash flows (i.e., the initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct? All else equal, a project's IRR increases as the cost of capital declines. All else equal, a project's NPV increases as the cost of capital declines. c. All else equal, a project's MIRR is unaffected cost d. e. Ranking of a b capital. and and b c are are correct. correct. Answer: a Diff: E Answers Answers

by

changes in

the

conflicts

30.

Which a. The

of

the NPV of NPV free NPV of

following method capital method rate method capital

statements that the that IRR that the

is

most cash

correct? flows will assumes will will assumes be reinvestment be at the be reinvestment reinvested at at reinvested at IRR. reinvested at at the the the the the

assumes while assumes while the assumes while

cost IRR. b. c. The risk The cost d. e.

IRR cash method cash IRR

method flows assumes flows method

reinvestment

risk-free rate. The NPV method does not consider the inflation premium. The IRR method does not consider all relevant cash flows, and particularly cash flows beyond the payback period. Payback period Answer: e Diff: E A major disadvantage of the payback period method is that it

31. a. b. c. d. e.

Is useless as a risk indicator. Ignores cash flows beyond the payback period. Does not directly account for the time value All of the answers above are correct. Only answers b and c are correct. Chapter 12 - Page 6 NPV profiles Diff: E

of

money.

Answer:

Which a. b. c. d. e.

of

the

following

statements

is

most

correct?

Project A has the smaller cash flows in the later years. Project A has the larger cash flows in the later years. We require information on the cost of capital in order to determine which project has larger early cash flows. The NPV profile graph is inconsistent with the statement made in the problem. None of the statements above is correct. NPV 33. and IRR Which of the a. capital, positive. If Project A has a higher IRR than Project B, then Project also have a higher NPV. c. The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the cost of capital. Answers a and c are correct. None of the answers above is correct. NPV and Diff: E IRR Answer: a b. A must following If then a statements projects the is most correct? rate of return present (IRR) value exceeds (NPV) the cost must of be Answer: a Diff: E

internal net

projects

d. e.

34. a. b. c. d. e.

Project A has an internal rate of return (IRR) of 15 percent. Project B has an IRR of 14 percent. Both projects have a cost of capital of 12 percent. Which of the following statements is most correct? Both projects have a positive net present value (NPV). Project A must have a higher NPV than Project B. If the cost of capital were less than 12 percent, Project B would have a higher IRR than Project A. Statements a and c are correct. Statements a, b, and c are correct.

Chapter 12 - Page 7 Post-audit Diff: E 35. The post-audit is used to

Answer:

a. b. c. d. e.

Improve cash flow forecasts. Stimulate management to improve operations and bring results into line with forecasts. Eliminate potentially profitable but risky projects. All of the answers above are correct. Answers a and b are correct. Project selection Diff: E Answer: e

36. Your company has a cost of capital equal to 10%. If the following projects are mutually exclusive, and you only have the information that is provided, which should you accept? A Payback IRR NPV a. b. c. d. e. A B C B E IRR 37. Project percent. statements A has Both is an IRR of have 15 the percent. same risk. Project Which B projects most (Millions) (years) 1 18% $40 B 5 20% $75 C 2 20% $35 E 5 12% $100

and

Answer: has of

b an IRR

Diff: of

E 18

the

following

correct?

b. c. d. e.

If If If If

a. If the WACC is 10 percent, both projects will have a positive NPV, and the NPV of Project B will exceed the NPV of Project A. the WACC is 15 percent, the NPV of Project B will exceed the NPV of Project A. the WACC is less than 18 percent, Project B will always have a shorter payback than Project A. the WACC is greater than 18 percent, Project B will always have a shorter payback than Project A. the WACC increases, the IRR of both projects will decline. and MIRR Answer: b

NPV, IRR, Diff: E 38. a. b. c. d. e.

A project has an up-front cost of $100,000. The projects WACC is 12 percent and its net present value is $10,000. Which of the following statements is most correct? The project should be rejected since its return is less than the WACC. The projects internal rate of return is greater than 12 percent. The projects modified internal rate of return is less than 12 percent. All of the above answers are correct. None of the above answers is correct.

Chapter 12 - Page 8 Medium: NPV profiles Diff: M Answer: b

39. Projects L and S each have an initial cost of $10,000, followed by a series of positive cash inflows. Project L has total, undiscounted cash inflows of $16,000, while S has total undiscounted inflows of $15,000. Further, at a discount rate of 10 percent, the two projects have identical NPVs. Which project's NPV will be more sensitive to changes in the discount rate? (Hint: Projects with steeper NPV profiles are more sensitive to discount rate changes.) a. b. c. d. Project S. Project L. Both projects are equally sensitive to changes in the discount rate since their NPVs are equal at all costs of capital. Neither project is sensitive to changes in the discount rate, since both have NPV profiles which are horizontal. e. The solution cannot be determined unless the timing of the cash flows is known. NPV 40. profiles Two total, mutually exclusive cash cash projects flows flows each from from have Project Project a L S cost are of $15,000, while $13,000. total undiscounted Answer: a the Their NPV Diff: M

$10,000.

The

undiscounted

profiles following a. b. c.

cross statements

at best

discount describes this

rate

of

10 percent.

Which

of

the

situation?

The NPV and IRR methods will select the same project if the cost of capital is greater than 10 percent; for example, 18 percent. The NPV and IRR methods will select the same project if the cost of capital is less than 10 percent; for example, 8 percent. To determine if a ranking conflict will occur between the two projects piece d. e. Project a Project a of L S the cost be be of capital is needed at at any any cost cost as of of well capital, capital, as an because because additional it it has has information. should IRR. should IRR. selected selected

higher

higher

Chapter 12 - Page 9 NPV and IRR Diff: M 41. a. b. c. d. most correct?

Answer:

Assume that you are comparing two mutually exclusive projects. Which of the following statements is The NPV and IRR rules will always lead to the same decision unless one or both of the projects are "non-normal" in the sense of having only one change of sign in the cash flow stream, i.e., one or more initial cash outflows (the investment) followed by a series of cash inflows. If a conflict exists between the NPV and the IRR, the conflict can always be eliminated by dropping the IRR and replacing it with the MIRR. There will be a meaningful (as opposed to irrelevant) conflict only if the projects' NPV profiles cross, and even then, only if the cost of capital is to the left of (or lower than) the discount rate at which the crossover occurs. Statements a, b, and c are true. NPV and Diff: M 42. IRR Which a. b. c. d. e. of the a following project statements has is incorrect? cash flows, the NPV will be positive Answer: a

Assuming

normal

if the IRR is less than the cost of capital. If the multiple IRR problem does not exist, any independent project acceptable by the NPV method will also be acceptable by the IRR method. If IRR = r (the cost of capital), then NPV = 0. NPV can be negative if the IRR is positive. The NPV method is not affected by the multiple IRR problem. NPV, IRR, 43. a. and MIRR of the following with statements normal then the cash project is most correct? flows has must have an a IRR which NPV. exceeds the Answer: a Diff: M

Which If a

project of

cost

capital,

positive

b.

If the IRR of Project A exceeds the IRR of Project B, then Project A must also have a higher NPV. c. The modified internal rate of return (MIRR) can never exceed the IRR. d. Answers a and c are correct. e. None of the answers above is correct. NPV, IRR, Diff: M and the MIRR following statements is most correct? Answer: c

44. a. b. c. d. e.

Which

of

The MIRR method will always arrive at the same conclusion as the NPV method. The MIRR method can overcome the multiple IRR problem, while the NPV method cannot. The MIRR method uses a more reasonable assumption about reinvestment rates than the IRR method. Statements a and c are correct. All of the above statements are correct.

Chapter 12 - Page 10 NPV, IRR, and MIRR Diff: M 45. a. b.

Answer:

Assume a project has normal cash flows (that is, the initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct? All else equal, a project's IRR increases as the cost of capital declines. All else equal, a project's NPV increases as the cost of capital declines. c. All else equal, a project's MIRR is unaffected by Answers Answers NPV, 46. a b cost of capital. and b are correct. and c are correct. and payback X has net an internal of value. rate of of return 15 of 20 Which of rate return percent. the Both Answer: percent. projects statements following e Project is Diff: Y have M has a most

changes

in

the

d. e.

IRR, an

Project positive correct?

internal

present

a. b. c. d. e.

Project

must

have

higher

net

present

value

than

Project

Y.

If the two projects have the same WACC, Project X must have a higher net present value. Project X must have a shorter payback than Project Y. Both answers b and c are correct. None of the above answers is correct. IRR Diff: Answer: M internal rate of return of a capital investment e

47. a. b. c. d. e.

The

Changes when the cost of capital changes. Is equal to the annual net cash flows divided by one half of the project's cost when the cash flows are an annuity. Must exceed the cost of capital in order for the firm to accept the investment. Is similar to the yield to maturity on a bond. Answers c and d are correct. Modified 48. IRR Which (MIRR) of the following statements is most correct? Answer: The e Diff: modified M IRR

method:

b. c.

a. Always leads to the same ranking decision as NPV for independent projects. Overcomes the problem of multiple rates of return. Compounds cash flows at the cost of capital. d. Overcomes the problems of cash flow timing and project size lead to criticism of the regular IRR method. e. Answers b and c are correct.

that

Chapter 12 - Page 11 Ranking methods Diff: M 49. a. b. c. d. e. Which of the following statements is correct?

Answer:

Because discounted payback takes account of the cost of capital, a project's discounted payback is normally shorter than its regular payback. The NPV and IRR methods use the same basic equation, but in the NPV method the discount rate is specified and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found. If the cost of capital is less than the crossover rate for two mutually exclusive projects' NPV profiles, a NPV/IRR conflict will not occur. If you are choosing between two projects which have the same life, and if their NPV profiles cross, then the smaller project will probably be the one with the steeper NPV profile. If the cost of capital is relatively high, this will favor larger, longer-term projects over smaller, shorter-term alternatives because it is good to earn high rates on larger amounts over longer periods. Ranking methods Answer: e Diff: M 50. In comparing two mutually exclusive projects of equal size and equal life, which of the following statements is most correct? a. The project with the higher NPV may not always be the project with the higher IRR. b. The project with the higher NPV may not always be the project with the higher MIRR. c. The project with the higher IRR may not always be the project with the higher MIRR. All of the answers above are correct. Answers a and c are correct. Miscellaneous Diff: M concepts following is most correct? Answer: e

d. e.

51. a. b. c.

Which

of

the

The NPV and IRR rules will always lead to the same decision in choosing between mutually exclusive projects, unless one or both of the projects are non-normal in the sense of having only one change of sign in the cash flow stream. The Modified Internal Rate of Return (MIRR) compounds cash outflows at the cost of capital. Conflicts between NPV and IRR rules arise in choosing between two mutually exclusive projects (that each have normal cash flows) when the cost of capital exceeds the crossover point (that is, the point at which the NPV profiles cross). d. The discounted payback method overcomes the problems that the payback method has with cash flows occurring after the payback period. e. None of the statements above is correct.

Chapter 12 - Page 12 Miscellaneous concepts Diff: M 52. a. Which of the following statements is most correct?

Answer:

The IRR method is appealing to some managers because it produces a rate of return upon which to base decisions rather than a dollar amount like the NPV method. b. c. The with discounted the payback payback method. the decision the IRR method or to the accept or NPV method. reject will method solves all the problems associated

d. e.

For independent projects, always be the same using either All of the statements above are correct. Statements a and c are correct. Miscellaneous Diff: M concepts following statements is most

Answer: correct?

53. a.

Which

of

the

One of the disadvantages of choosing between mutually exclusive projects on the basis of the discounted payback method is that you might choose the project with the faster payback period but with the lower total return.

b. c. d. e.

Multiple IRRs can occur in cases when project cash flows are normal, but they are more common in cases where project cash flows are nonnormal. When choosing between mutually exclusive projects, managers should accept all projects with IRRs greater than the weighted average cost of capital. All of the statements above are correct. Two of the statements above are correct. Miscellaneous Diff: M concepts Answer: a

54. Normal projects C and D are mutually exclusive. Project C has a higher net present value if the WACC is less than 12 percent, whereas Project D has a higher net present value if the WACC exceeds 12 percent. Both projects have a positive NPV if the WACC is 12 percent. Which of the following statements is most correct? a. b. c. d. e. Project Project Project All of Answers D has a higher internal D is probably larger in C probably has a faster the statements above are a and c are correct. rate of return. scale than Project payback. correct. C.

Project selection Diff: M 55.

Answer:

A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept? a. Project A requires an up- front expenditure of $1,000,000 and generates a net present value of $3,200. Project B has a modified internal rate of return of 9.5 percent. Project C requires an up-front expenditure of $1,000,000 and generates a positive internal rate of return of 9.7 percent. Project D has an internal rate of return of 9.5 percent. None of the projects above should be accepted.

b. c. d. e.

Chapter 12 - Page 13 Tough: NPV profiles Diff: T 56. Answer: b

Your assistant has just completed an analysis of two mutually exclusive projects. You must now take her report to a board of directors meeting and present the alternatives for the board's consideration. To you with the Of with NPV the your profiles so following presentation, for you the do two not your know assistant which the also constructed However, line profiles, which she to one is forgot which most applies a to projects. regarding

help graph label project.

profiles,

statements

reasonable? If the two projects have the same investment cost, and if their NPV profiles cross once in the upper right quadrant, at a discount rate of 40 percent, this suggests that a NPV versus IRR conflict is not likely to exist. b. If the two projects' NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical sense (that is, a conflict which will affect the actual investment decision). c. If one of the projects has a NPV profile which crosses the X-axis twice, hence the project appears to have two IRRs, your assistant must have made a mistake. d. Whenever a conflict between NPV and IRR exist, then, if the two projects have the same initial cost, the one with the steeper NPV profile probably has less rapid cash flows. However, if they have identical probably e. If a in the cash has two flow the patterns, both have then a the single one with the steeper at profile t = 0, followed by lower initial cost. outlay if their the projects accepted if NPV should they were profiles be not cross a.

projects

series of the lower

positive cash inflows, and left quadrant, then one of and both would be

accepted, exclusive. NPV, IRR, and MIRR Which of the following

mutually

Answer: statements is most correct?

Diff:

57.

a. b.

d. e.

When dealing with independent projects, discounted payback (using a payback requirement of 3 or less years), NPV, IRR, and modified IRR always lead to the same accept/reject decisions for a given project. When dealing with mutually exclusive projects, the NPV and modified IRR methods always rank projects the same, but those rankings can conflict with rankings produced by the discounted payback and the regular IRR methods. c. Multiple rates of return are possible with the regular IRR method but not with the modified IRR method, and this fact is one reason given by the textbook for favoring MIRR (or modified IRR) over IRR. Statements a, b, and c are false. Statements a and c are true.

Chapter 12 - Page 14 NPV, IRR, and MIRR Diff: T 58. a. b. Which of the following statements is correct?

Answer:

There can never be a conflict between NPV and IRR decisions if the decision is related to a normal, independent project, i.e., NPV will never indicate acceptance if IRR indicates rejection. To find the MIRR, we first compound CFs at the regular IRR to find the TV, and then we discount the TV at the cost of capital to find the PV. c. The NPV and IRR methods both assume that cash flows are reinvested at the cost of capital. reinvestment at the MIRR itself. If you are choosing between two and IRR e. A if change NPV their has in and NPV more the its profiles of its cost IRR. T cross, cash of probably However, projects then flows coming which the in the would the have MIRR the method same with cost, the higher both a assumes

d.

project later normally

years. change

capital

project's

Choosing among mutually exclusive projects Answer: c Diff: 59. Project A has an internal rate of return of 18 percent, while Project B has an internal rate of return of 16 percent. However, if the companys cost of capital (WACC) is 12 percent, Project B has a higher net present value. Which of the following statements is most correct? a. b. c. d. e. The crossover rate for the two projects is less than 12 percent. Assuming the timing of the two projects is the same, Project A is probably of larger scale than Project B. Assuming that the two projects have the same scale, Project A probably has a faster payback than Project B. Answers a and b are correct. Answers b and c are correct.

Multiple Choice: Problems

Easy: Payback 60. period The through 10. cost the of capital is 10 year, 1/365th Seattle which $35,000 4, Corporation will per yield year This each cash in has flows Years 5 of will What been $30,000 9, flows is cost per and the through cash presented year firm occur the in $40,000 evenly payback in opportunity Answer: with Years 1 and the for firm's this Year today, period during b an Diff: E

investment

investment

$150,000

percent. day.

Assume

investment? a. b. c. d. e. 5.23 4.86 4.00 6.12 4.35 years years years years years

Chapter 12 - Page 15 NPV Diff: E

Answer:

61. As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows: Year 0 1 2 3 4 a. b. c. d. e. Neither Project Project Project Project NPV Diff: E project. X, since Z, since X, since Z, since Project Cash X Project Cash Z

Flow 50,000 40,000 30,000 10,000

Flow 10,000 30,000 40,000 60,000

-$100,000

-$100,000

If Denver's cost of capital is 15 percent, which project would you choose? it it it it has has has has the the the the higher higher higher higher IRR. NPV. NPV. IRR. Answer: a

62. Two projects being considered are mutually exclusive and have the following projected cash flows: Year 0 1 2 3 4 5 a. b. c. d. e. Project B because it Project B because it Project A because it Project A because it Neither, because both Chapter 12 - Page 16 Medium: Payback period Diff: M 63. has has has has have the higher the higher the higher the higher IRRs less NPV. IRR. NPV. IRR. than Project Cash A Project Cash B

Flow 15,625 15,625 15,625 15,625 15,625

Flow 0 0 0 0 99,500

-$50,000

-$50,000

If the required rate of return on these projects is 10 percent, which would be chosen and why?

the

cost

of

capital.

Answer:

Michigan Mattress Company is considering the purchase of land and the construction of a new plant. The land, which would be bought immediately (at t = 0), has a cost of $100,000 and the building, which would be erected at the end of the first year (t = 1), would cost $500,000. It is estimated that the firm's after-tax cash flow will be increased by $100,000 starting at the end of the second year, and that this incremental flow would increase at a 10 percent rate annually over the next 10 years. What is the approximate payback period? 2 4 6 8 10 years years years years years Answer: c

a. b. c. d. e.

Payback period Diff: M 64.

Haig Aircraft is considering a project which has an up-front cost paid today at t = 0. The project will generate positive cash flows of $60,000 a year at the end of each of the next five years. projects NPV is $75,000 and the companys WACC is 10 percent.

The What

is a. b. c. d. e. Discounted Diff: M 65.

the 3.22 1.56 2.54 2.35 4.16

projects years years years years years

simple,

regular

payback?

payback Enterprises has a project Year 0 1 2 3 4 5 which has the following Flow -$200,000 50,000 100,000 150,000 40,000 25,000 percent. What is the cash

Answer: flows:

Lloyd

Cash

The

cost

of

capital

is

10

project's

discounted

payback? a. b. c. d. e. 1.8763 2.0000 2.3333 years years years

2.4793 years 2.6380 years

Chapter 12 - Page 17 Discounted payback Diff: M 66. Polk Products is considering an investment project with the following cash flows: Year 0 1 2 3 4 The company has a 10 percent cost of Cash Flow 40,000 90,000 30,000 60,000 capital.

Answer:

-$100,000

What is

the

projects

discounted a. b. c. d. e. Discounted 67. 1.67 1.86 2.11 2.49 2.67

payback? years years years years years Answer: Corporation The projects to is corporation faced has an recover all with investment two policy costs independent which requires within 3 years. The d Diff: M

payback

Davis acceptable

investment

opportunities.

corporation projects for the and two

uses

the

discounted a are: discount

payback rate

method

to of

assess 10

potential percent. The cash flows

utilizes projects Year 0 1 2 3 4

Project Cash

Project Cash -$80,000 50,000 20,000 30,000 0 in?

Flow 40,000 40,000 40,000 30,000

Flow

-$100,000

Which a. b. c. d. Project Neither Project Project

investment

project(s)

does

the

company

invest

A only. Project A nor A and Project B only.

Project B.

B.

Chapter 12 - Page 18 NPV 68. The in and Seattle which 1 Year firm's Years in the Corporation will 10. cost of yield 4, This through $35,000 investment is 10 will cost percent. has end-of-year cash been flows per the of presented $30,000 in firm per year opportunity $40,000 Answer: with year 5 is through the NPV 9, for and this today, Years What d an Diff: M investment

$150,000

capital

investment? a.$135, 984 b. $ 18,023 c. $219,04 5 d. $ 51,138 e. $ 92,146 NPV 69. You $5,000 $2,000 of much are considering per per and you year year the be for the for cash Years purchase Years 9 flows to 1-5, and occur pay 10. at for the this end of an investment per If of you each that year require year, $3,000 Answer: would for a then how pay b you Years 14 6-8, percent and rate Diff: M

return, should

willing

investment?

a. $15,819.2 7 b. $21,937.2 6 c. $32,415.8 5 d. $38,000.0 0 e. $52,815.71 NPV 70. and payback Shannon cash flows: Year 0 1 Cash Flow ? $2,000 Industries is considering a project which Answer: has b Diff: M

the

following

2 3 4 projects net present value NPV? a. $ 577.68 b. $ 765.91 c. $1,049.8 0 d. $2,761.3 2 e. $3,765.9 1 Chapter 12 - Page 19 Modified 71. IRR Alyeska Valdez, provide firm's and considering. management the the Salmon Alaska, after-tax is has The Inc., a a new cash IRR 12 project annual modified firm of large automated has a flows with cost of the

3,000 3,000 1,500

The project has a payback of 2.5 years. The firms cost of capital is 12 percent. What is the

Answer: salmon production of IRR line $275,000 reinvestment canning project and is for firm it eight is

Diff: out

M of

operating to years. a

expected

$73,306

The cost of

uncomfortable

assumption You have calculated MIRR?

prefers for

approach. percent. What is the

capital a. b. c. d. e. MIRR 72. and 15.0% 14.0% 12.0% 16.0% 17.0% CAPM Below

project's

Answer: are the returns of Nulook Cosmetics and "the

Diff: over

M a

market"

three-year

period: Year 1 2 3 Nulook 9% 15 36 using Model premium cost at with the is today the only a 6 of end historical rate and next 3 percent. $2,028 of the beta is risk-free Market 6% 10 24 retained to 7 earnings, its and is will years. the evaluating provide What is a this estimated and it uses

Nulook the cost project cash of

finances Asset equity. market which inflows MIRR?

internally Pricing risk has of a $1,000 Currently,

Capital

determine percent, Nulook

estimated

project's a. b. c. d. e. Before-tax 73. has 12.4% 16.0% 17.5% 20.0% 22.9% cash an

flows Corporation's estimated new project of calls for 10 an investment The IRR of has $10,000. been life years.

Answer:

Diff: to

M It be

Scott

calculated

15 40

percent. percent,

If what is a

cash is the

flows

are

evenly before-tax cash flow each

distributed year?

and

the

tax

rate

is

annual

(Assume

depreciation a. b. c. d. e. $1,993 $3,321 $1,500 $4,983 $5,019

negligible

amount.)