Finance-3120 Exam 3 TB-Chapter 10

A) increase the present value of the NCFs. The capital budgeting manager for XYZ Corporation, a very profitable high technology company, completed her analysis of Project A assuming 5-year depreciation. Her accountant reviews the analysis and changes the depreciation method to 3-year depreciation. This change willA) increase the present value of the NCFs.B) decrease the present value of the NCFs.C) have no effect on the NCFs because depreciation is a non-cash expense.D) only change the NCFs if the useful life of the depreciable asset is greater than 5 years.
C) the IRR of Project W will increase. Project W requires a net investment of $1,000,000 and has a payback period of 5.6 years. You analyze Project W and decide that Year 1 free cash flow is $100,000 too low, and Year 3 free cash flow is $100,000 too high. After making the necessary adjustments,A) the payback period for Project W will be longer than 5.6 years.B) the payback period for Project W will be shorter than 5.6 years.C) the IRR of Project W will increase.D) the NPV of Project W will decrease.
A) Both projects have a positive net present value (NPV). Project Alpha has an internal rate of return (IRR) of 15 percent. Project Beta has an IRR of 14 percent. Both projects have a required return of 12 percent. Which of the following statements is MOST correct?A) Both projects have a positive net present value (NPV).B) Project Alpha must have a higher NPV than Project Beta.C) If the required return were less than 12 percent, Project Beta would have a higher IRR than Project Alpha.D) Project Beta has a higher profitability index than Project Alpha.
C) The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the IRR. Which of the following statements is MOST correct?A) If a project’s internal rate of return (IRR) exceeds the required return, then the project’s net present value (NPV) must be negative.B) If Project A has a higher IRR than Project B, then Project A must 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 IRR.D) A project with a NPV = 0 is not acceptable.
D) 2.50 years DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI’s required rate of return is 8%. What is the payback period of this project?A) 4.00 yearsB) 3.09 yearsC) 2.91 yearsD) 2.50 years
A) $104,089 DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI’s required rate of return is 8%. What is the net present value of this project? A) $104,089B) $100,328C) $96,320D) $87,417
D) 15.13% DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI’s required rate of return is 8%. What is the internal rate of return of this project? A) 10.87%B) 11.57%C) 13.68%D) 15.13%
B) 11.57% DYI Construction Co. is considering a new inventory system that will cost $750,000. The system is expected to generate positive cash flows over the next four years in the amounts of $350,000 in year one, $325,000 in year two, $150,000 in year three, and $180,000 in year four. DYI’s required rate of return is 8%. What is the modified internal rate of return of this project? A) 10.87%B) 11.57%C) 13.68%D) 15.13%
B) $150,000 Project LMK requires an initial outlay of $400,000 and has a profitability index of 1.5. The project is expected to generate equal annual cash flows over the next twelve years. The required return for this project is 20%. What is project LMK’s net present value?A) $600,000B) $150,000C) $120,000D) $80,000
D) 26.12% Project LMK requires an initial outlay of $500,000 and has a profitability index of 1.4. The project is expected to generate equal annual cash flows over the next ten years. The required return for this project is 16%. What is project LMK’s internal rate of return?A) 19.88%B) 22.69%C) 24.78%D) 26.12%
D) greater than 15% A capital budgeting project has a net present value of $30,000 and a modified internal rate of return of 15%. The project’s required rate of return is 13%. The internal rate of return isA) greater than $30,000.B) less than 13%.C) between 13% and 15%.D) greater than 15%
D) $26,074. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. The firm’s required rate of return for these projects is 10%. The net present value for Project A isA) $12,358.B) $16,947.C) $19,458.D) $26,074.
B) $66,363. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. The net present value for Project B isA) $58,097.B) $66,363.C) $74,538.D) $112,000.
A) 1.27. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. The profitability index for Project A isA) 1.27.B) 1.22.C) 1.17.D) 1.12.
A) 1.55. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. The profitability index for Project B isA) 1.55.B) 1.48.C) 1.39.D) 1.33.
B) 29.42%. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. The internal rate of return for Project A isA) 31.43%.B) 29.42%.C) 25.88%.D) 19.45%.
C) 35.27%. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. The internal rate of return for Project B isA) 29.74%.B) 30.79%.C) 35.27%.D) 36.77%.
B) 24.18%. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%.The modified internal rate of return for Project A isA) 19.19%.B) 24.18%.C) 26.89%.D) 29.63%.
D) 22.80%. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. The modified internal rate of return for Project B isA) 17.84%.B) 18.52%.C) 19.75%.D) 22.80%.
D) all of the above The net present value methodA) is consistent with the goal of shareholder wealth maximization.B) recognizes the time value of money.C) uses all of a project’s cash flows.D) all of the above
B) they require detailed long-term forecasts of the incremental benefits and costs. Arguments against using the net present value and internal rate of return methods include thatA) they fail to use accounting profits.B) they require detailed long-term forecasts of the incremental benefits and costs.C) they fail to consider how the investment project is to be financed.D) they fail to use the cash flow of the project.
C) the IRR of a mutually exclusive project exceeds the required rate of return. All of the following are sufficient indications to accept a project EXCEPT (assume that there is no capital rationing constraint, and no consideration is given to payback as a decision tool)A) the net present value of an independent project is positive.B) the profitability index of an independent project exceeds one.C) the IRR of a mutually exclusive project exceeds the required rate of return.D) the NPV of a mutually exclusive project is positive and exceeds that of all other projects.
C) the IRR will always be a point on the horizontal axis line where NPV = 0. When reviewing the net present profile for a project,A) the higher the discount rate, the higher the NPV.B) the higher the discount rate, the higher the IRR.C) the IRR will always be a point on the horizontal axis line where NPV = 0.D) the IRR will always be a point on the horizontal axis equal to the required return.
C) 8.5% A project requires an initial investment of $389,600. The project generates free cash flow of $540,000 at the end of year 4. What is the internal rate of return for the project?A) 138.6%B) 38.6%C) 8.5%D) 6.9%
D) $447,292 Raindrip Corp. can purchase a new machine for $1,875,000 that will provide an annual net cash flow of $650,000 per year for five years. The machine will be sold for $120,000 after taxes at the end of year five. What is the net present value of the machine if the required rate of return is 13.5%. A) $558,378B) $513,859C) $473,498D) $447,292
A) $291,417 A machine that costs $1,500,000 has a 3-year life. It will generate after-tax annual cash flows of $700,000 at the end of each year. It will be salvaged for $200,000 at the end of year 3. If your required rate of return for the project is 13%, what is the NPV of this investment?A) $291,417B) $400,000C) $600,000D) $338,395
C) dividing the present value of the annual after-tax cash flows by the cash investment in the project. We compute the profitability index of a capital budgeting proposal byA) multiplying the internal rate of return by the cost of capital.B) dividing the present value of the annual after-tax cash flows by the cost of capital.C) dividing the present value of the annual after-tax cash flows by the cash investment in the project.D) multiplying the cash inflow by the internal rate of return.
B) 5.20 years What is the payback period for a project with an initial investment of $180,000 that provides an annual cash inflow of $40,000 for the first three years and $25,000 per year for years four and five, and $50,000 per year for years six through eight?A) 5.80 yearsB) 5.20 yearsC) 5.40 yearsD) 5.59 years
A) it can be used as a rough screening device to eliminate those projects whose returns do not materialize until later years. The advantages of NPV are all of the following EXCEPTA) it can be used as a rough screening device to eliminate those projects whose returns do not materialize until later years.B) it provides the amount by which positive NPV projects will increase the value of the firm.C) it allows the comparison of benefits and costs in a logical manner through the use of time value of money principles.D) it recognizes the timing of the benefits resulting from the project.
D) the IRR requires long, detailed cash flow forecasts. The disadvantage of the IRR method is thatA) the IRR deals with cash flows.B) the IRR gives equal regard to all returns within a project’s life.C) the IRR will always give the same project accept/reject decision as the NPV.D) the IRR requires long, detailed cash flow forecasts.
B) the discount rate that equates the present value of the cash inflows with the present value of the cash outflows. The internal rate of return isA) the discount rate that makes the NPV positive.B) the discount rate that equates the present value of the cash inflows with the present value of the cash outflows.C) the discount rate that makes NPV negative and the PI greater than one.D) the rate of return that makes the NPV positive.
C) it deals with accounting profits as opposed to cash flows. All of the following are criticisms of the payback period criterion EXCEPTA) time value of money is not accounted for.B) cash flows occurring after the payback are ignored.C) it deals with accounting profits as opposed to cash flows.D) None of the above; they are all criticisms of the payback period criteria.
C) 9.25% Your company is considering a project with the following cash flows:Initial Outlay = $3,000,000Cash Flows Year 1-8 = $547,000Compute the internal rate of return on the project.A) 6.38%B) 8.95%C) 9.25%D) 12.34%
D) greater than or equal to zero; greater than or equal to one For the net present value (NPV) criteria, a project is acceptable if NPV is ________, while for the profitability index a project is acceptable if PI is ________.A) greater than zero; greater than the required returnB) greater than or equal to zero; greater than zeroC) greater than one; greater than or equal to oneD) greater than or equal to zero; greater than or equal to one
B) must be greater than If the NPV (Net Present Value) of a project with one sign reversal is positive, then the project’s IRR (Internal Rate of Return) ________ the required rate of return.A) must be less thanB) must be greater thanC) could be greater or less thanD) The project’s IRR cannot be determined without actual cash flows.
B) 5.54% You are considering investing in a project with the following year-end after-tax cash flows:Year 1: $57,000Year 2: $72,000Year 3: $78,000If the initial outlay for the project is $185,000, compute the project’s internal rate of return.A) 3.98%B) 5.54%C) 11.89%D) 14.74%
C) tends to reduce firm risk because it favors projects that generate early, less uncertain returns. A significant advantage of the payback period is that itA) places emphasis on time value of money.B) allows for the proper ranking of projects.C) tends to reduce firm risk because it favors projects that generate early, less uncertain returns.D) gives proper weighting to all cash flows.
C) does not properly consider the time value of money. A significant disadvantage of the payback period is that itA) is complicated to explain.B) increases firm risk.C) does not properly consider the time value of money.D) provides a measure of liquidity.
B) 3.16 years Your firm is considering an investment that will cost $750,000 today. The investment will produce cash flows of $250,000 in year 1, $300,000 in years 2 through 4, and $100,000 in year 5. What is the investment’s discounted payback period if the required rate of return is 10%? A) 3.33 yearsB) 3.16 yearsC) 2.67 yearsD) 2.33 years
D) considers all of a project’s cash flows and their timing. A significant advantage of the internal rate of return is that itA) provides a means to choose between mutually exclusive projects.B) provides the most realistic reinvestment assumption.C) avoids the size disparity problem.D) considers all of a project’s cash flows and their timing.
A) produces a net present value that is greater than or equal to zero. An independent project should be accepted if itA) produces a net present value that is greater than or equal to zero.B) produces a net present value that is greater than the equivalent IRR.C) has only one sign reversal.D) produces a profitability index greater than or equal to zero.
C) $192,369 Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment’s net present value?A) $540,000B) $378,458C) $192,369D) $112,583
A) 1.21 Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment’s profitability index?A) 1.21B) 1.26C) 1.43D) 1.69
C) 20.53% Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment’s internal rate of return?A) 27.28%B) 21.26%C) 20.53%D) 15.98%
C) It fully considers the time value of money. Which of the following statements about the internal rate of return (IRR) is true?A) It has the most conservative and realistic reinvestment assumption.B) It never gives conflicting answers.C) It fully considers the time value of money.D) It is greater than the modified internal rate of return if the discount rate is higher than the IRR.
C) can result in multiple rates of return (more than one IRR). A significant disadvantage of the internal rate of return is that itA) does not fully consider the time value of money.B) does not give proper weight to all cash flows.C) can result in multiple rates of return (more than one IRR).D) is expressed as a percentage.
C) may have an unrealistic reinvestment assumption. A significant disadvantage of the internal rate of return is that itA) does not fully consider the time value of money.B) does not give proper weight to all cash flows.C) may have an unrealistic reinvestment assumption.D) is expressed as a percentage.
B) produces an internal rate of return that is greater than the firm’s discount rate. A one-sign-reversal project should be accepted if itA) generates an internal rate of return that is higher than the profitability index.B) produces an internal rate of return that is greater than the firm’s discount rate.C) results in an internal rate of return that is above a project’s equivalent annual annuity.D) results in a modified internal rate of return that is higher than the internal rate of return.
C) They are reinvested at the project’s internal rate of return. What is the internal rate of return’s assumption about how cash flows are reinvested?A) They are reinvested at the firm’s discount rate.B) They are reinvested at the required rate of return.C) They are reinvested at the project’s internal rate of return.D) They are only reinvested at the end of the project.
C) could be greater or less than If the NPV (Net Present Value) of a project with multiple sign reversals is positive, then the project’s required rate of return ________ its calculated IRR (Internal Rate of Return).A) must be less thanB) must be greater thanC) could be greater or less thanD) The required rate of return cannot be determined without actual cash flows.
D) the net present value is positive. A project would be acceptable ifA) the payback is greater than the discounted equivalent annual annuity.B) the equivalent annual annuity is greater than or equal to the firm’s discount rate.C) the profitability index is greater than the net present value.D) the net present value is positive.
C) capital rationing is not imposed. The net present value always provides the correct decision provided thatA) cash flows are constant over the asset’s life.B) the required rate of return is greater than the internal rate of return.C) capital rationing is not imposed.D) the internal rate of return is positive.
D) the company’s stock price is at an historically high level. Capital rationing may be imposed because of all of the following EXCEPTA) capital market conditions are poor.B) management has a fear of debt.C) stockholder control problems prevent issuance of additional stock.D) the company’s stock price is at an historically high level.
C) If the firm is limited in the capital it has available (capital rationing). Under what condition would you NOT accept a project that has a positive net present value?A) If the project has a profitability index less than zero.B) If two or more projects are mutually inclusive.C) If the firm is limited in the capital it has available (capital rationing).D) If a project has more than one sign reversal.
C) $15,024. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. The equivalent annual annuity amount for project A isA) $12,989.B) $13,357.C) $15,024.D) $18,532.
B) Project 2 Your company is considering an investment in one of two mutually exclusive projects. Project 1 involves a labor intensive production process. Initial outlay for Project 1 is $1,495 with expected after-tax cash flows of $500 per year in years 1-5. Project 2 involves a capital intensive process, requiring an initial outlay of $6,704. After-tax cash flows for Project 2 are expected to be $2,000 per year for years 1-5. Your firm’s discount rate is 10%. If your company is not subject to capital rationing, which project(s) should you take on?A) Project 1B) Project 2C) Projects 1 and 2D) Neither project is acceptable.
A) $2,232 and $85 Your firm is considering investing in one of two mutually exclusive projects. Project A requires an initial outlay of $3,500 with expected future cash flows of $2,000 per year for the next three years. Project B requires an initial outlay of $2,500 with expected future cash flows of $1,500 per year for the next two years. The appropriate discount rate for your firm is 12% and it is not subject to capital rationing. Assuming both projects can be replaced with a similar investment at the end of their respective lives, compute the NPV of the two chain cycle for Project A and three chain cycle for Project B.A) $2,232 and $85B) $5,000 and $1,500C) $2,865 and $94D) $3,528 and $136
B) $8,520 Determine the five-year equivalent annual annuity of the following project if the appropriate discount rate is 16%.Initial Outflow = $150,000Cash Flow Year 1 = $40,000Cash Flow Year 2 = $90,000Cash Flow Year 3 = $60,000Cash Flow Year 4 = $0Cash Flow Year 5 = $80,000A) $7,058B) $8,520C) $9,454D) $9,872
D) It may be used to select among projects of different sizes. Which of the following statements about the net present value is true?A) It produces a percentage result that is easy to describe.B) It has an inadequate reinvestment assumption.C) It is likely that there will be more than one NPV for a project.D) It may be used to select among projects of different sizes.
C) a set of investment proposals perform essentially the same task. Mutually exclusive projects occur whenA) projects have uneven cash flows.B) more than one firm can use the projects.C) a set of investment proposals perform essentially the same task.D) projects are independent.
D) the equivalent annual annuity Which of the following methods of evaluating investment projects can properly evaluate projects of unequal lives?A) the net present valueB) the paybackC) the internal rate of returnD) the equivalent annual annuity
A) $52,377 Your firm is considering an investment that will cost $920,000 today. The investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the investment’s equivalent annual annuity?A) $52,377B) $42,923C) $41,387D) $40,399
A) Project B because its NPV is higher than Project A’s replacement chain NPV of $47,623 Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. Which project would you recommend using the replacement chain method to evaluate the projects with different lives?A) Project B because its NPV is higher than Project A’s replacement chain NPV of $47,623B) Project A because its replacement chain NPV is $76,652, which exceeds the NPV for Project BC) Project A because its replacement chain NPV is $45,642, which is less than the NPV for Project BD) Both projects will be valued the same since they are now both four year projects.
B) $20,936. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects is 10%. The equivalent annual annuity amount for project B, rounded to the nearest dollar, isA) $17,385.B) $20,936.C) $22,789.D) $26,551.
A) the size of investment outlays differ. Different discounted cash flow evaluation methods may provide conflicting rankings of investment projects whenA) the size of investment outlays differ.B) the projects are mutually exclusive.C) the accounting policies differ.D) the internal rate of return equals the cost of capital.
A) the firm’s discount rate; the internal rate of return The Net Present Value (or NPV) criteria for capital budgeting decisions assumes that expected future cash flows are reinvested at ________, and the Internal Rate of Return (or IRR) criteria assumes that expected future cash flows are reinvested at ________.A) the firm’s discount rate; the internal rate of returnB) the internal rate of return; the internal rate of returnC) the internal rate of return; the firm’s discount rateD) Neither criteria assumes reinvestment of future cash flows
C) They are reinvested at the firm’s discount rate. What is the net present value’s assumption about how cash flows are reinvested?A) They are reinvested at the IRR.B) They are reinvested at the APR.C) They are reinvested at the firm’s discount rate.D) They are reinvested only at the end of the project.

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