Finance Exam 3

The net present value is best defined as the difference between an investment’s: market value and its cost
The process of valuing an investment by discounting its future cash flows is called: discounted cash flow valuation.
The period of time it takes an investment to generate sufficient cash flows to recover its initial cost is called the: payback period
Which one of the following correctly defines the average accounting return? average net income divided by average book value
The internal rate of return is the: discount rate that causes the net present value of a project to equal zero.
The net present value profile is a graphical relationship of an investment’s: discount rate and its net present value.
The possibility that more than one discount rate can cause the net present value of a project to equal zero is referred to as: multiple rates of return.
A mutually exclusive investment decision is defined as a situation where: an investment in project A prohibits you from investing in project B.
The present value of an investment’s cash inflows divided by the investment’s initial cost is called the profitability index.
Which of the following indicate that a project will produce a return equal to or greater than the required rate of return for that project? I. a positive NPVII. an NPV of zero
The net present value rule states that you should accept a project if the NPV: is positive
The net present value: I. is highly dependent upon the discount rate applied to an investmentIII. is a measure of the value created by undertaking an investment.
Of the following methods used to evaluate investments, the overall best method is the: net present value
Net present value is: equal to zero when the discount rate used is the IRR.
A net present value of zero implies that an investment: has no expected impact on shareholders.
A project has a net present value of $2,500 and an initial cash outlay of $2,500. This project’s: required return is less than its internal rate of return.
The president of a firm is most concerned with creating value for the firm’s shareholders. Given this concern, the best method he or she should use to evaluate all proposed projects is: net present value.
Which one of the following statements is correct concerning the payback rule? The rule is flawed because it ignores all cash flows after some arbitrary point in time.
The payback rule works best in evaluating which one of the following? low cost project which pays back rapidly
The payback rule: I. is biased towards short-term projects.II. helps limit possible losses.IV. is biased towards liquidity.
Payback ignores the: time value of money.
Which one of the following methods can be applied without the use of an interest rate? payback
Which one of the following methods is biased towards liquidity and requires an arbitrary cutoff date? payback
Which one of the following methods has the least value from a financial point of view? average accounting return
Angie is evaluating a proposed project and wants to answer two questions. First, what is the market value of the project? Second, how much profit will the project produce in relation to its book value? To answer these two questions, Angie should use which one of the following sets of investment analysis methods net present value and average accounting return
The average accounting return: II. ignores time value.
Which one of the following methods is based on net income rather than cash flows? accounting rate of return
The _____ can be interpreted as the breakeven financing rate that leads to a profitable project. internal rate of return
The internal rate of return can lead to faulty decisions: IV. if two projects are mutually exclusive.
You are considering a project which has an internal rate of return that is equal to the required return. This means that the: project is returning the minimal amount that is acceptable to you.
The internal rate of return is: the minimal rate that produces an accept decision given the net present value rule.
If a project has an internal rate of return that exceeds the required discount rate, then the project: should be accepted because the net present value is positive
The internal rate of return is best used to evaluate a project with all positive cash inflows after the initial cash outlay.
If a project has conventional cash flows and a net present value equal to 1.0, then the internal rate of return _____ the required rate of return. must be greater than
Which one of the following best expresses two mutually exclusive investments? building either a gas station or a restaurant on a corner lot
When evaluating two mutually exclusive investments, the best method to use is the: net present value.
You are using a net present value profile to compare two projects. At the point where the net present value of the two projects intersect, the: relevant discount rate is called the crossover rate.
For a project with conventional cash flows, a profitability index greater than 1.0 means that the: net present value is positive
If managers only invest in projects that have a profitability index greater than 1.0, the: firm will increase in value.
If a project with conventional cash flows has a profitability index equal to 1.0, the project: I. will pay back during the life of the project.II. will have an internal rate of return that equals the project’s required rate of return.
Which one of the following will reveal the amount of cash in today’s dollars that a project will return for each dollar originally invested profitability index
Project selection ambiguity can arise if you rely on the internal rate of return instead of the net present value when: there are multiple internal rates of return
Rank the following decision rules from best to worst in terms of their overall usefulness in capital budgeting analysis for a project with conventional cash flows. IV, I, II, IIInet present value, internal rate of return, payback and average accounting rate of return
Which one of the following methods is most appropriate for a low-level manager, who has no financial training, to use when evaluating small projects? payback
The payback method of analysis is the most beneficial in which one of the following situations? A firm has free cash which can be invested but must be returned in time to meet a bond obligation two years from now.
Which one of the following is correct concerning the rules related to project analysis? The internal rate of return can lead to faulty decisions if two mutually exclusive projects are of different sizes.
The incremental cash flows of a project can best be defined as the difference between a firm’s _____ with and without the project. future cash flows
The stand-alone principle is the assumption that the evaluation of a project may be based on the project’s: incremental cash flows.
A cost that has already been incurred and cannot be recouped is referred to as a(n) _____ cost. sunk
An opportunity cost is defined as: the most valuable alternative that is given up if a particular investment is undertaken.
A reduction in the sales of a current product whenever a new product is introduced by a firm is called: erosion
A pro forma financial statement is a financial statement which: projects future years’ operations.
The depreciation tax shield is defined as D × T.
A U.S. depreciation system which allows for more rapid depreciation under various classifications is called the _____ system. accelerated cost recovery
Forecasting risk can be defined as the possibility that _____ will lead to incorrect decisions. errors in projected cash flows
The analysis of the effects that what-if questions have on a project is referred to as _____ analysis scenario
The analysis of the effect that a single variable has on the net present value of a project is called _____ analysis. sensitivity
The opportunities to change the way a product is priced, manufactured, or advertised in the future are referred to as: managerial options.
Contingency planning is the consideration of the: managerial options implicit in a project.
The options that a company has to expand their business into related products are referred to as _____ options strategic
The situation a firm faces when it has positive net present value projects but cannot obtain financing for those projects is referred to as: capital rationing.
Soft rationing is best defined as the situation that exists when: the units within a business are allotted a fixed amount of money for their annual capital spending
When a firm cannot raise financing for a project under any circumstances, the firm is facing a situation known as: hard rationing.
The Shoe Co. is considering adding a new line of sandals to their product line-up. Which of the following are relevant cash flows for this project? II. the additional revenue generated from the new line of sandalsIV. the commission paid to a salesperson for selling the new sandals
ABC Plastics currently produces plastic plates. The company is considering expanding their production to include plastic silverware. Payment for which of the following are relevant to this project? I. the plastic used to make the silverwareII. the labor involved in making the silverwareIV. the plastic needed to produce the additional plates they expect to sell if they expand their product offerings
Lauer’s have decided to expand their retail shop by building on a vacant lot they own. The company will build a new building at an estimated cost of $1.8 million. The firm will spend another $400 thousand on the parking and access roads. The land was purchased ten years ago at a cost of $900 thousand. Today, that land is worth 2.8 million. What is the cost of this expansion project? d. $5.0 million
Alfsonso and Sons purchased a new grinding machine 2 years ago at a cost of $390,000. Last year, some revolutionary developments occurred making their machine virtually worthless as it cannot produce products which meet the higher quality standards of the newer machines. If Alfsonso and Sons continues using their current machine, they will lose all their customers. They have not found anyone willing to purchase the machine even at a deeply discounted price. The best description of this machine today is that it is a(n) _____ cost. sunk
The Siverly Hill Billies are discussing their old truck. Which one of the following items from their discussion represents a sunk cost? new fuel tank they put on last week
Freley Enterprises is considering two different development plans for an old building they own and want to restore. The building was purchased five years ago for $237,500. The first plan is to create an executive resort and conference centre at an estimated cost of $2.1 million. The second plan is to develop luxury apartments with a total cost of $3.4 million. Of course, there is always the third option, and that is to take the offer they just received of $275,000 and sell the property. Which one of the following values represents the opportunity cost of this project? $275,000
Mercy Motors owns a small engine repair shop. The company is trying to determine whether or not they should update the shop. To modernize the shop, Mercy estimates will require $350,000 in new machines and equipment and $120,000 in building improvements. The building was purchased in 1961 for $48,000. Since then, $329,000 worth of improvements have been added to create the existing structure, which is currently valued at $380,000. What is the opportunity cost of modernizing the shop? $380,000
Kate’s Store is considering three mutually exclusive options for the use of the new addition to her facility. Kate can either expand the women’s clothing section, add a new footwear section, or expand into home linens. She estimates annual profits of either $120,000 from the clothing, $104,000 from the footwear, or $98,000 from the home linens section should that section be chosen for the expansion. What is the opportunity cost of her most profitable option? $104,000
Jeff’s Sporting Goods sells fishing, hunting, and camping equipment. Jeff is contemplating greatly expanding the selection and variety of his hunting equipment. If he does this, he expects his fishing and hunting sales will increase and his camping related sales will decrease. Which one of the following expresses the erosion cost of this expansion project? Only the change in the camping equipment sales is an erosion effect.
Lakeside Amusement Park is adding a new thriller roller coaster to their park. They expect this addition to increase their overall ticket sales. On individual rides, they expect the ridership of their old roller coaster to increase along with the use of their bungee jumping facility. They expect fewer people to ride their creeper ride, but more to eat at their restaurant. Which of these changes represent the effect of erosion? the change in the ridership of the creeper ride
The Brick and Mortar Book Shop has decided to sell books on-line. Currently, their greatest sellers are young children’s books. On-line, they expect to sell primarily fiction to teenagers. Which one of the following would be an erosion cost related to this decision? less in-store sales because of the convenience of on-line shopping
The net working capital invested in a project is generally: recouped at the end of the project.
A proposed project will reduce the amount of inventory a firm must keep on hand. This effect is an initial cash inflow that should be included in the analysis.
The effects that projects have on the current accounts of a firm are captured in the: net working capital cash flows.
Compiling pro forma income statements for a project can allow the financial managers of a firm to see: I. the dollar changes in the sales revenue over a period of time.II. the effect that depreciation has on the net income for each time period.III. the difference between EBIT and net income.IV. a comparison of fixed versus variable costs.
Operating cash flow is equal to: EBIT minus taxes plus depreciation.
Operating cash flow includes: all of the cash expenses of a firm except interest expense.
The operating cash flow of a taxable firm: can be computed using the tax shield approach.
The tax shield approach computes the operating cash flow of a firm using the formula (Sales − Costs) × (1 – T) + (D × T).
Using the tax shield approach, a(n) _____ will increase the operating cash flow increase in depreciation
Which one of the following can be completely ignored when analyzing a project sunk cost
Which one of the following statements is correct concerning MACRS? A fixed asset classified as 5-year property is depreciated to a zero book value over 6 years.
Scenario analysis asks questions such as: What is the best outcome that is reasonably possible for this project?
Scenario analysis can be thought of as the: means of answering “What if?” questions that affect multiple variables simultaneously
Sensitivity analysis: helps identify the variable within a project that presents the greatest forecasting risk
Which of the following are examples of managerial options? I. changing the price of a productII. discontinuing the production of a productIII. waiting for a period of time before commencing a projectIV. changing the production process by which a product is manufactured
Ignoring the option to expand: underestimates the net present value of a project.
If a manager ignores the option of scaling back a project, he or she: misses something of value when analyzing a project.
The postponement of a project until conditions are more favorable: I. is a valuable option.III. could cause a negative net present value project to become a positive net present value project.
Under soft rationing, it would be common to find that division managers within a firm: compete to increase their capital allocation.
Which one of the following rates of return expresses the required return for a firm facing hard rationing? a rate so large that no project has a positive net present value

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