**CHAPTER 9**

*Net Present Value and Other Investment
Criteria*

**I. DEFINITIONS**

**NET**** PRESENT VALUE**

a 1. The difference between
the present value of an investment and its cost is the:

a. net present value.

b. internal rate of
return.

c. payback period.

d. profitability index.

e. discounted payback
period.

**DISCOUNTED
CASH FLOW
VALUATION**

b 2. The process of valuing
an investment by determining the present value of its future

cash
flows is called (the):

a. constant dividend
growth model.

b. discounted cash flow
valuation.

c. average accounting
valuation.

d. expected earnings
model.

e. Capital Asset Pricing
Model.

**NET**** PRESENT VALUE RULE**

c 3. Which one of the
following statements concerning net present value (NPV) is correct?

a. An investment should be
accepted if, and only if, the NPV is exactly equal to zero.

b. An investment should be
accepted only if the NPV is equal to the initial cash flow.

c. An investment should be
accepted if the NPV is positive and rejected if it is negative.

d. An investment with
greater cash inflows than cash outflows, regardless of when the cash flows
occur, will always have a positive NPV and therefore should always be accepted.

e. Any project that has
positive cash flows for every time period after the initial investment should
be accepted.

**PAYBACK**

c 4. The length of time
required for an investment to generate cash flows sufficient to recover the
initial cost of the investment is called the:

a. net present value.

b. internal rate of
return.

c. payback period.

d. profitability index.

e. discounted cash period.

**PAYBACK RULE**

a 5. Which one of the
following statements is correct concerning the payback period?

a. An investment is
acceptable if its calculated payback period is less than some pre-specified period
of time.

b. An investment should be
accepted if the payback is positive and rejected if it is negative.

c. An investment should be
rejected if the payback is positive and accepted if it is negative.

d. An investment is
acceptable if its calculated payback period is greater than some pre-specified period
of time.

e. An investment should be
accepted any time the payback period is less than the discounted payback
period, given a positive discount rate.

**DISCOUNTED
PAYBACK**

e 6. The length of time
required for a project’s discounted cash flows to equal the initial cost of the
project is called the:

a. net present value.

b. internal rate of
return.

c. payback period.

d. discounted profitability
index.

e. discounted payback
period.

**DISCOUNTED
PAYBACK RULE**

d 7. The discounted payback
rule states that you should accept projects:

a. which have a discounted
payback period that is greater than some pre-specified period of time.

b. if the discounted
payback is positive and rejected if it is negative.

c. only if the discounted
payback period equals some pre-specified period of time.

d. if the discounted
payback period is less than some pre-specified period of time.

e. only if the discounted
payback period is equal to zero.

**AVERAGE
ACCOUNTING RETURN**

c 8. An investment’s average
net income divided by its average book value defines the average:

a. net present value.

b. internal rate of
return.

c. accounting return.

d. profitability index.

e. payback period.

**AVERAGE
ACCOUNTING RETURN RULE**

b 9. An investment is acceptable
if its average accounting return (

a. is less than a target

b. exceeds a target

c. exceeds the firm’s
return on equity (ROE).

d. is less than the firm’s
return on assets (ROA).

e. is equal to zero and
only when it is equal to zero.

**INTERNAL RATE OF RETURN**

b. 10. The discount rate that makes the
net present value of an investment exactly equal to

zero
is called the:

a. external rate of
return.

b. internal rate of
return.

c. average accounting
return.

d. profitability index.

e. equalizer.

**INTERNAL RATE OF RETURN RULE**

d 11. An investment is acceptable if its
IRR:

a. is exactly equal to its
net present value (NPV).

b. is exactly equal to
zero.

c. is less than the
required return.

d. exceeds the required
return.

e. is exactly equal to 100
percent.

**MULTIPLE RATES
OF RETURN**

e 12. The possibility that more than one
discount rate will make the NPV of an investment equal to zero is called the
_____ problem.

a. net present value
profiling

b. operational ambiguity

c. mutually exclusive
investment decision

d. issues of scale

e. multiple rates of
return

**MUTUALLY
EXCLUSIVE PROJECTS**

c 13. A situation in which accepting one
investment prevents the acceptance of another investment is called the:

a. net present value
profile.

b. operational ambiguity
decision.

c. mutually exclusive
investment decision.

d. issues of scale problem.

e. multiple choices of
operations decision.

**PROFITABILITY
INDEX**

d. 14. The present value of an
investment’s future cash flows divided by the initial cost of the investment is
called the:

a. net present value.

b. internal rate of
return.

c. average accounting
return.

d. profitability index.

e. profile period.

**PROFITABILITY
INDEX RULE**

a 15. An investment is acceptable if the
profitability index (PI) of the investment is:

a. greater than one.

b. less than one.

c. greater than the
internal rate of return (IRR).

d. less than the net
present value (NPV).

e. greater than a
pre-specified rate of return.

**II. CONCEPTS**

**CAPITAL
BUDGETING DECISIONS**

a 16. Capital budgeting decisions
generally:

a. have long-term effects
on a firm.

b. are of short-duration.

c. are easy to revise once
implemented.

d. focus solely on whether
or not a particular asset should be purchased.

e. have minimal effects on
a firm’s operations.

**CAPITAL
BUDGETING DECISIONS**

e 17. Which of the following are capital
budgeting decisions?

II. deciding which product
markets to enter

IV. determining which, if any, new
products should be produced

a. I only

b.

c. II and IV only

d. I,

e. II,

**NET**** PRESENT VALUE**

d 18. All else constant, the net present
value of a project increases when:

a. the discount rate
increases.

b. each cash inflow is
delayed by one year.

c. the initial cost of a
project increases.

d. the rate of return
decreases.

e. all cash inflows occur during
the last year of a project’s life instead of

periodically
throughout the life of the project.

**NET**** PRESENT VALUE**

a 19. The primary reason that company
projects with positive net present values are

considered
acceptable is that:

a. they create value for
the owners of the firm.

b. the project’s rate of
return exceeds the rate of inflation.

c. they return the initial
cash outlay within three years or less.

d. the required cash
inflows exceed the actual cash inflows.

e. the investment’s cost
exceeds the present value of the cash inflows.

**NET**** PRESENT VALUE**

d 20. If a project has a net present
value equal to zero, then:

II. the project produces a rate
of return that just equals the rate required to accept the

project.

IV. any delay in receiving the
projected cash inflows will cause the project to have a negative
net present value.

a. II and

b. II and IV only

c. I, II, and IV only

d. II,

e. I, II, and

**NET**** PRESENT VALUE**

b 21. When computing the net present
value of a project, the net amount received from

salvaging
the fixed assets used in the project is:

a. subtracted from the
initial cash outlay.

b. included in the final
cash flow of the project.

c. excluded from the
analysis since it occurs only when the project ends.

d. subtracted from the
original cost of the assets.

e. added to the net
present value of the project to determine if the project is

acceptable.

**NET**** PRESENT VALUE**

d 22. Net present value:

is
implemented.

II. is highly independent of the
rate of return assigned to a particular project.

estimates.

IV. is affected by the timing of each
and every cash flow related to a project.

a. I only

b.

c. II and IV only

d.

e. I,

**NET**** PRESENT VALUE**

b 23. Net present value:

a. cannot be used when
deciding between two mutually exclusive projects.

b. is more useful to
decision makers than the internal rate of return when comparing

different
sized projects.

c. is easy to explain to
non-financial managers and thus is the primary method of analysis

used
by the lowest levels of management.

d. is computed the same as
present value when using excel spreadsheets to analyze a

project.

e. is very similar in its
methodology to the average accounting return.

**PAYBACK**

c 24. Payback is frequently used to
analyze independent projects because:

a. it considers the time
value of money.

b. all relevant cash flows
are included in the analysis.

c. the cost of the
analysis is less than the potential loss from a faulty decision.

d. it is the most
desirable of all the available analytical methods from a financial

perspective.

e. it produces better
decisions than those made using either NPV or IRR.

**PAYBACK**

c 25. The advantages of the payback
method of project analysis include the:

II. bias towards liquidity.

IV. arbitrary cutoff point.

a. I and II only

b. I and

c. II and

d. II and IV only

e. II,

**PAYBACK**

d 26. Under the payback method of
analysis:

a. the initial cash outlay
is ignored.

b. the cash flow in year 3
is ignored if the required payback period is 4 years.

c. a project’s initial cost
is discounted.

d. the cash flow in year 2
is valued just as highly as the cash flow in year 1 as long as the required
payback period is 3 years or more.

e. a project will be
acceptable whenever the payback period exceeds the pre-specified

number
of years.

**PAYBACK**

d 27. All else equal, the payback period
for a project will decrease whenever the:

a. initial cost increases.

b. required return for a
project increases.

c. assigned discount rate
decreases.

d. cash inflows are moved
forward in time.

e. duration of a project
is lengthened.

**DISCOUNTED
PAYBACK**

e 28. Discounted payback is used less
frequently than payback because:

a. the methodology is less
desirable from a financial perspective.

b. it is so simple to
calculate.

c. it requires an
arbitrary cutoff point.

d. it is biased towards
liquidity.

e. it includes time value
of money calculations.

**DISCOUNTED
PAYBACK**

d 29. The discounted payback period of a
project will decrease whenever the:

a. discount rate applied
to the project is increased.

b. initial cash outlay of
the project is increased.

c. time period of the
project is increased.

d. amount of each project
cash flow is increased.

e. costs of the fixed
assets utilized in the project increase.

**DISCOUNTED
PAYBACK**

a 30. The discounted payback rule may
cause:

a. some positive net
present value projects to be rejected.

b. the most liquid
projects to be rejected in favor of less liquid projects.

c. projects to be
incorrectly accepted due to ignoring the time value of money.

d. projects with negative
net present values to be accepted.

e. some projects to be
accepted which would otherwise be rejected under the payback

rule.

**AVERAGE
ACCOUNTING RETURN**

e 31. The average accounting rate of
return:

a. is actually based more
on financial values than on accounting values.

b. measures net income
against the market value of a firm.

c. is highly recommended
by financial professionals as one of the two best methodologies

used
in the analysis of independent projects.

d. is the primary
methodology used in analyzing independent projects.

e. is similar to the
return on assets ratio.

**AVERAGE
ACCOUNTING RETURN**

d 32. Assuming that straight line
depreciation is used, the average accounting return for a

project
is computed as the average:

a. net income of a project
divided by the average total assets of a firm.

b. book value of a project
multiplied by the average profit margin of the project.

c. book value of a project
divided by the average net income of the project.

d. net income of a project
divided by the average investment in the project.

e. net income of the firm
divided by the average investment in a project.

**AVERAGE
ACCOUNTING RETURN**

d 33. Which of the following are
disadvantages associated with the average accounting

return?

II. exclusion of time value of
money considerations

IV. the accounting basis of the values
used in the computation

a. I and IV only

b. II and

c. I, II, and

d. II,

e. I, II, and IV only

**AVERAGE
ACCOUNTING RETURN**

b 34. The average accounting return:

a. reflects the projected
net effect of the cash flows from a project on the overall firm.

b. is comparable to the
return on assets and thus provides a similar measure of

performance.

c. reflects the
anticipated net impact of a project on the shareholders of the firm.

d. rule, when applied,
guarantees that only projects that increase shareholder wealth will

be
accepted.

e. ignores all income
produced by a project after an arbitrarily assigned cutoff point.

**INTERNAL
RATE OF RETURN**

b 35. The internal rate of return (IRR):

accepted.

II. is the rate generated solely
by the cash flows of an investment.

IV. can effectively be used to analyze
all investment scenarios.

a. I and IV only

b. II and

c. I, II, and

d. II,

e. I, II, III, and IV

**INTERNAL
RATE OF RETURN**

e 36. The internal rate of return method
of analysis:

II. may lead to incorrect
decisions when comparing mutually exclusive projects.

IV. works best for independent projects
with conventional cash flows.

a. I and II only

b.

c. I,

d. I, II, and IV only

e. I, II,

**INTERNAL
RATE OF RETURN**

a 37. The internal rate of return for a
project will increase if:

a. the initial cost of the
project can be reduced.

b. the total amount of the
cash inflows is reduced.

c. each cash inflow is
moved such that it occurs one year later than originally projected.

d. the required rate of
return is reduced.

e. the salvage value of
the project is omitted from the analysis.

**INTERNAL
RATE OF RETURN**

c 38. The internal rate of return is:

a. more reliable as a
decision making tool than net present value whenever you are

considering
mutually exclusive projects.

b. equivalent to the
discount rate that makes the net present value equal to one.

c. difficult to compute
without the use of either a financial calculator or a computer.

d. dependent upon the
interest rates offered in the marketplace.

e. a better methodology
than net present value when dealing with unconventional cash

flows.

**INTERNAL
RATE OF RETURN**

d 39. Which of the following are elements
of the internal rate of return method of analysis?

II. the cutoff point after which
any future cash flows are ignored

IV. the initial cost of an investment

a. I and II only

b.

c. I, II, and

d. I,

e. II,

**INTERNAL
RATE OF RETURN**

a 40. The internal rate of return tends
to be:

a. easier for managers to
comprehend than the net present value.

b. extremely accurate even
when cash flow estimates are faulty.

c. ignored by most
financial analysts.

d. used primarily to
differentiate between mutually exclusive projects.

e. utilized in project
analysis only when multiple net present values apply.

**CROSSOVER
POINT**

e 41. You are trying to determine whether
to accept project A or project B. These projects

are
mutually exclusive. As part of your analysis, you should compute the crossover

point
by determining:

a. the internal rate of
return for the cash flows of each project.

b. the net present value
of each project using the internal rate of return as the discount

rate.

c. the discount rate that
equates the discounted payback periods for each project.

d. the discount rate that
makes the net present value of each project equal to 1.

e. the internal rate of
return for the differences in the cash flows of the two projects.

**CROSSOVER
POINT**

c 42. You are comparing two mutually
exclusive projects. The crossover point is 9 percent.

You
determine that you should accept project A if the required return is 6 percent.
This

implies
that you should:

** **

II. always accept project A and
always reject project B.

IV. accept project A any time the
discount rate is less than 9 percent.

a. I and II only

b.

c. I,

d. I, II, and IV only

e. I, II, III, and IV

**CROSSOVER
POINT**

b 43. Graphing the crossover point helps
explain:

a. why one project is
always superior to another project.

b. how decisions
concerning mutually exclusive projects are derived.

c. how the duration of a
project affects the decision as to which project to accept.

d. how the net present
value and the initial cash outflow of a project are related.

e. how the profitability
index and the net present value are related.

**PROFITABILITY
INDEX**

d 44. The profitability index is closely
related to:

a. payback.

b. discounted payback.

c. the average accounting
return.

d. net present value.

e. mutually exclusive
projects.

**PROFITABILITY
INDEX**

b 45. Analysis using the profitability
index:

a. frequently conflicts
with the accept and reject decisions generated by the application of

the
net present value rule.

b. is useful as a decision
tool when investment funds are limited.

c. is useful when trying
to determine which one of two mutually exclusive projects

should
be accepted.

d. utilizes the same basic
variables as those used in the average accounting return.

e. produces results which
typically are difficult to comprehend or apply.

**PROFITABILITY
INDEX**

e 46. If you want to review a project
from a benefit-cost perspective, you should use the

_____
method of analysis.

a. net present value

b. payback

c. internal rate of return

d. average accounting
return

e. profitability index

**PROFITABILITY
INDEX**

b 47. When the present value of the cash
inflows exceeds the initial cost of a project, then

the
project should be:

a. accepted because the
internal rate of return is positive.

b. accepted because the
profitability index is greater than 1.

c. accepted because the
profitability index is negative.

d. rejected because the
internal rate of return is negative.

e. rejected because the net
present value is negative.

**MUTUALLY
EXCLUSIVE PROJECTS**

c 48. Which one of the following is the
best example of two mutually exclusive projects?

a. planning to build a
warehouse and a retail outlet side by side

b. buying sufficient
equipment to manufacture both desks and chairs simultaneously

c. using an empty
warehouse for storage or renting it entirely out to another firm

d. using the company sales
force to promote sales of both shoes and socks

e. buying both inventory
and fixed assets using funds from the same bond issue

**MUTUALLY
EXCLUSIVE PROJECTS**

d 49. The Liberty Co. is considering two
projects. Project A consists of building a wholesale

book
outlet on lot #169 of the

a
sit-down restaurant on lot #169 of the

decide
whether or build the book outlet or the restaurant, management should rely

most
heavily on the analysis results from the _____ method of analysis.

a. profitability index

b. internal rate of return

c. payback

d. net present value

e. accounting rate of
return

**MUTUALLY
EXCLUSIVE PROJECTS**

c 50. When two projects both require the
total use of the same limited economic resource,

the
projects are generally considered to be:

a. independent.

b. marginally profitable.

c. mutually exclusive.

d. acceptable.

e. internally profitable.

**MUTUALLY
EXCLUSIVE PROJECTS**

b 51. The final decision on which one of
two mutually exclusive projects to accept

ultimately
depends upon the:

a. initial cost of each
project.

b. required discount rate.

c. total cash inflows of
each project.

d. assigned payback period
of each project.

e. length of each
project’s life.

**MUTUALLY
EXCLUSIVE PROJECTS**

c 52. Matt is analyzing two mutually
exclusive projects of similar size and has prepared the

following
data. Both projects have 5 year lives.

__Project
A__ __Project
B__

Net
present value $15,090 $14,693

Payback
period 2.76
years 2.51
years

Average
accounting return 9.3
percent 9.6
percent Required
return 8.3
percent 8.0
percent

Required

Matt
has been asked for his best recommendation given this information. His
recommendation should be to accept:

a. project B because it
has the shortest payback period.

b. both projects as they
both have positive net present values.

c. project A and reject
project B based on their net present values.

d. project B and reject
project A based on their average accounting returns.

e. project
B and reject project A based on both the payback period and the average

accounting
return.

**INVESTMENT
ANALYSIS**

a 53. Given that the net present value (NPV)
is generally considered to be the best method

of
analysis, why should you still use the other methods?

a. The other methods help
validate whether or not the results from the net present value analysis
are reliable.

b. You need to use the
other methods since conventional practice dictates that you only

accept
projects after you have generated three accept indicators.

c. You need to use other
methods because the net present value method is unreliable when
a project has unconventional cash flows.

d. The average accounting
return must always indicate acceptance since this is the best

method
from a financial perspective.

e. The discounted payback
method must always be computed to determine if a project

returns
a positive cash flow since NPV does not measure this aspect of a project.

**INVESTMENT
ANALYSIS**

e 54. In actual practice, managers
frequently use the:

I.

II. IRR because the results are
easy to communicate and understand.

IV. net present value because it is considered
by many to be the best method of analysis.

a. I and

b. II and

c. I,

d. II,

e. I, II,

**INVESTMENT
ANALYSIS**

a 55. No matter how many forms of
investment analysis you do:

a. the actual results from
a project may vary significantly from the expected results.

b. the internal rate of
return will always produce the most reliable results.

c. a project will never be
accepted unless the payback period is met.

d. the initial costs will
generally vary considerably from the estimated costs.

e. only the first three
years of a project ever affect its final outcome.

**INVESTMENT
ANALYSIS**

b 56. Which of the following may have
contributed to the change in the primary methods

used
by chief financial officers to evaluate projects over the past forty years?

II. an increased availability of
computers and financial calculators to handle the more

complex
computations

executives

IV. an increasing emphasis by financial
executives on accounting values rather than

financial
values

a. I and II only

b. II and

c.

d. I, II, and IV only

e. II,

**INVESTMENT
ANALYSIS**

b 57. Which of the following methods of
project analysis are biased towards short-term

projects?

I. internal rate of return

II. accounting rate of return

IV. discounted payback

a. I and II only

b.

c. II and

d. I and IV only

e. II and IV only

**INVESTMENT
ANALYSIS**

a 58. If a project is assigned a required
rate of return equal to zero, then:

a. the timing of the
project’s cash flows has no bearing on the value of the project.

b. the project will always
be accepted.

c. the project will always
be rejected.

d. whether the project is
accepted or rejected will depend on the timing of the cash flows.

e. the project can never
add value for the shareholders.

**DECISION
RULES**

e 59. You are considering a project with
the following data:

Internal
rate of return 8.7 percent

Profitability
ratio
.98

Net
present value
-$393

Payback
period
2.44 years

Required
return 9.5
percent

Which
one of the following is correct given this information?

a. The discount rate used
in computing the net present value must have been less than 8.7

percent.

b. The discounted payback
period will have to be less than 2.44 years.

c. The discount rate used
to compute the profitability ratio was equal to the internal rate of
return.

d. This project should be
accepted based on the profitability ratio.

e. This project should be
rejected based on the internal rate of return.

**DECISION
RULES**

c 60. Which of the following statements
are correct?

I. A positive net present
value signals an accept decision.

II. Projects should be accepted
when the profitability index is less than 1.

IV. When the internal rate of return
exceeds the required return, a project should be

accepted.

a. I and

b. II, III, and IV only

c. I,

d. I, II, and

e. I, II,

**III****. PROBLEMS**

**NET**** PRESENT VALUE**

b 61. What is the net present value of a
project with the following cash flows and a required

return
of 12 percent?

__Year Cash Flow__

0
-$28,900

1
$12,450

2
$19,630

3
$ 2,750

a. -$287.22

b. -$177.62

c. $177.62

d. $204.36

e. $287.22

**NET**** PRESENT VALUE**

a 62. What is the net present value of a
project that has an initial cash outflow of $12,670

and
the following cash inflows? The required return is 11.5 percent.

__Year Cash Inflows__

1 $4,375

2 $ 0

3 $8,750

4 $4,100

a. $218.68

b. $370.16

c. $768.20

d. $1,249.65

e. $1,371.02

**NET**** PRESENT VALUE**

b 63. A project will produce cash inflows
of $1,750 a year for four years. The project

initially
costs $10,600 to get started. In year five, the project will be closed and as a

result
should produce a cash inflow of $8,500. What is the net present value of this project
if the required rate of return is 13.75 percent?

a. -$5,474.76

b. -$1,011.40

c. -$935.56

d. $1,011.40

e. $5,474.76

**NET**** PRESENT VALUE**

a 64. You are considering the following two
mutually exclusive projects. The required rate of
return is 11.25 percent for project A and 10.75 percent for project B. Which
project

should
you accept and why?

__Year__ __Project
A__ __Project
B__

0 -$48,000 -$126,900

1
$18,400
$ 69,700

2
$31,300
$ 80,900

3
$11,700
$
0

a. project A; because its
NPV is about $335 more than the NPV of project B

b. project A; because it
has the higher required rate of return

c. project B; because it
has the largest total cash inflow

d. project B; because it
returns all its cash flows within two years

e. project B; because it
is the largest sized project

**NET**** PRESENT VALUE**

a 65. You are considering two mutually
exclusive projects with the following cash flows.

Will
your choice between the two projects differ if the required rate of return is 8

percent
rather than 11 percent? If so, what should you do?

__Year__ __Project
A__ __Project
B__

0 -$240,000 -$198,000

1
$
0
$110,800

2
$
0
$ 82,500

3
$325,000
$ 45,000

a. yes; Select A at 8
percent and B at 11 percent.

b. yes; Select B at 8
percent and A at 11 percent.

c. yes; Select A at 8
percent and select neither at 11 percent.

d. no; Regardless of the
required rate, project A always has the higher NPV.

e. no; Regardless of the
required rate, project B always has the higher NPV.

**INTERNAL
RATE OF RETURN**

b 66. What is the internal rate of return
on an investment with the following cash flows?

__Year__ __Cash
Flow__

0 -$123,400

1
$ 36,200

2
$ 54,800

3
$ 48,100

a. 5.93 percent

b. 5.96 percent

c. 6.04 percent

d. 6.09 percent

e. 6.13 percent

**INTERNAL
RATE OF RETURN**

a 67. An investment has the following
cash flows. Should the project be accepted if it has

been
assigned a required return of 9.5 percent? Why or why not?

__Year__ __Cash
Flow__

0 -$24,000

1
$ 8,000

2
$12,000

3
$ 9,000

a. yes; because the IRR
exceeds the required return by about 0.39 percent

b. yes; because the IRR is
less than the required return by about 3.9 percent

c. yes; because the IRR is
positive

d. no; because the IRR exceeds the required
return by about 3.9 percent

e. no; because the IRR is 9.89 percent

**INTERNAL
RATE OF RETURN AND NET
PRESENT VALUE**

e 68. You are considering two independent
projects with the following cash flows. The

required
return for both projects is 10 percent. Given this information, which one of

the
following statements is correct?

__Year__ __Project
A__ __Project
B__

0 -$950,000 -$125,000

1
$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 project A because

you
can not accept both projects.

b. You should accept
project A because it has the lower NPV and reject project B.

c. You should accept
project A because it has the higher NPV and you can not 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.

**INTERNAL
RATE OF RETURN**

e 69. You are considering an investment
with the following cash flows. If the required rate

of
return for this investment is 13.5 percent, should you accept it based solely
on the internal
rate of return rule? Why or why not?

__Year__ __Cash
Flow__

0 -$12,000

1
$ 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 rate of return

e. You can not apply the
IRR rule in this case because there are multiple IRRs.

**PROFITABILITY
INDEX**

d 70. What is the profitability index for
an investment with the following cash flows given a

9
percent required return?

__Year__ __Cash
Flow__

0 -$21,500

1
$ 7,400

2
$ 9,800

3
$ 8,900

a. .96

b. .98

c. 1.00

d. 1.02

e. 1.04

**PROFITABILITY
INDEX**

e 71. Based on the profitability index (PI)
rule, should a project with the following cash

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

__Year__ __Cash
Flow__

0
-$18,600

1
$10,000

2
$ 7,300

3
$ 3,700

a. yes; because the PI is
1.008

b. yes; because the PI is
.992

c. yes; because the PI is
.999

d. no; because the PI is
1.008

e. no; because the PI is
.992

**PROFITABIILITY
INDEX**

c 72. You are considering two independent
projects both of which have been assigned

a
discount rate of 8 percent. Based on the profitability index, what is your

recommendation
concerning these projects?

Project
A Project
B

__Year Cash Flow__ __Year Cash Flow__

0
-$38,500 0
-$42,000

1
$20,000 1 $10,000

2
$24,000 2 $40,000

a. You should accept both projects
since both of their PIs are positive.

b. You should accept
project A since it has the higher PI.

c. You should accept both projects
since both of their PIs are greater than 1.

d. You should only accept
project B since it has the largest PI and the PI exceeds 1.

e. Neither project is
acceptable.

**PROFITABILITY
INDEX**

d 73. You would like to invest in the
following project.

__Year__ __Cash Flow__

0
-$55,000

1
$30,000

2
$37,000

Victoria,
your boss, insists that only projects that can return at least $1.10 in today’s

dollars
for every $1 invested can be accepted. She also insists on applying a 10
percent

discount
rate to all cash flows. Based on these criteria, you should:

a. accept the project
because it returns almost $1.22 for every $1 invested.

b. accept the project
because it has a positive PI.

c. accept the project
because the NPV is $2,851.

d. reject the project
because the PI is 1.05.

e. reject the project
because the IRR exceeds 10 percent.

**PAYBACK
PERIOD**

c 74. It will cost $2,600 to acquire a
small ice cream cart. Cart sales are expected to be

$1,400
a year for three years. After the three years, the cart is expected to be
worthless

as
that is the expected remaining life of the cooling system. What is the payback
period

of
the ice cream cart?

a. .86 years

b. 1.46 years

c. 1.86 years

d. 2.46 years

e. 2.86 years

**PAYBACK
PERIOD**

e 75. You are considering a project with
an initial cost of $4,300. What is the payback

period
for this project if the cash inflows are $550, $970, $2,600, and $500 a year
over

the
next four years, respectively.

a. 2.04 years

b. 2.36 years

c. 2.89 years

d. 3.04 years

e. 3.36 years

**PAYBACK
PERIOD**

d 76. A project has an initial cost of
$1,900. The cash inflows are $0, $500, $900, and $700

over
the next four years, respectively. What is the payback period?

a. 2.71 years

b. 2.98 years

c. 3.11 years

d. 3.71 years

e. never

**PAYBACK
PERIOD**

e 77. Jack is considering adding toys to
his general store. He estimates that the cost of

inventory
will be $4,200. The remodeling expenses and shelving costs are estimated at

$1,500.
Toy sales are expected to produce net cash inflows of $1,200, $1,500, $1,600,

and
$1,750 over the next four years, respectively. Should Jack add toys to his
store if

he
assigns a three-year payback period to this project?

a. yes; because the
payback period is 2.94 years

b. yes; because the
payback period is 2.02 years

c. yes; because the
payback period is 3.80 years

d. no; because the payback
period is 2.02 years

e. no; because the payback
period is 3.80 years

**DISCOUNTED
PAYBACK PERIOD**

e 78. A project has an initial cost of
$8,500 and produces cash inflows of $2,600, $4,900, and
$1,500 over the next three years, respectively. What is the discounted payback

period
if the required rate of return is 7 percent?

a. 2.13 years

b. 2.33 years

c. 2.67 years

d. 2.91 years

e. never

**DISCOUNTED
PAYBACK PERIOD**

c 79. Yancy is considering a project
which will produce cash inflows of $900 a year for 4

years.
The project has a 9 percent required rate of return and an initial cost of
$2,800. What
is the discounted payback period?

a. 3.11 years

b. 3.18 years

c. 3.82 years

d. 4.18 years

e. never

**DISCOUNTED
PAYBACK PERIOD**

e 80. Ginny Trueblood is considering an
investment which will cost her $120,000. The

investment
produces no cash flows for the first year. In the second year the cash

inflow
is $35,000. This inflow will increase to $55,000 and then $75,000 for the

following
two years before ceasing permanently. Ginny requires a 10 percent rate of

return
and has a required discounted payback period of three years. Ginny should

_____
this project because the discounted payback period is _____

a. accept; 2.03 years.

b. accept; 2.97 years.

c. accept; 3.97 years.

d. reject; 3.03 years.

e. reject; 3.97 years.

**DISCOUNTED
PAYBACK PERIOD**

e 81. Tim is considering two projects
both of which have an initial cost of $12,000 and total

cash
inflows of $15,000. The cash inflows of project A are $1,000, $2,000, $4,000,
and

$8,000
over the next four years, respectively. The cash inflows for project B are

$8,000,
$4,000, $2,000 and $1,000 over the next four years, respectively. Which one of

the
following statements is correct if Tim requires a 10 percent rate of return and
has a

required
discounted payback period of 3 years?

I. Tim should accept
project A because it has a payback period of 2.65 years.

II. Tim should reject project A
because it never pays back at a 10 percent rate.

IV. Tim should accept project B because
it has a discounted payback period of 2.95 years.

a. I and

b. I and IV only

c. II and

d. II and IV only

e. II,

**AVERAGE
ACCOUNTING RETURN**

e 82. Larry’s Lanterns is considering a
project which will produce sales of $240,000 a year

for
the next five years. The profit margin is estimated at 6 percent. The project
will

cost
$290,000 and be depreciated straight-line to a book value of zero over the life
of

the
project. Larry’s has a required accounting return of 8 percent. This project
should be
_____ because the AAR
is _____

a. rejected; 4.14 percent.

b. rejected; 6 percent.

c. rejected; 8.28 percent.

d. accepted; 8.28 percent.

e. accepted; 9.93 percent.

**AVERAGE
ACCOUNTING RETURN**

d 83. A project has an initial cost of
$38,000 and a four-year life. The company uses straight-line
depreciation to a book value of zero over the life of the project. The

projected
net income from the project is $1,000, $1,200, $1,500, and $1,700 a year for the
next four years, respectively. What is the average accounting return?

a. 3.55 percent

b. 4.13 percent

c. 4.28 percent

d. 7.11 percent

e. 14.21 percent

**AVERAGE
ACCOUNTING RETURN**

d 84. A project produces annual net
income of $9,500, $12,500, and $15,500 over the three

years
of its life, respectively. The initial cost of the project is $260,400. This
cost is

depreciated
straight-line to a zero book value over three years. What is the average

accounting
rate of return if the required discount rate is 7 percent?

a. 4.80 percent

b. 7.32 percent

c. 8.97 percent

d. 9.60 percent

e. 10.27 percent

**AVERAGE
ACCOUNTING RETURN**

d 85. A project has average net income of
$2,100 a year over its 4-year life. The initial cost

of
the project is $65,000 which will be depreciated using straight-line
depreciation to a

book
value of zero over the life of the project. The firm wants to earn a minimal

average
accounting return of 8.5 percent. The firm should _____ the project based on

the
AAR of _____

a. accept; 6.46 percent.

b. accept; 9.69 percent.

c. accept; 12.92 percent.

d. reject; 6.46 percent.

e. reject; 12.92 percent.

**AVERAGE
ACCOUNTING RETURN**

a 86. Martin is analyzing a project and
has gathered the following data. Based on this data,

what
is the average accounting rate of return? The firm depreciates it assets using

straight-line
depreciation to a zero book value over the life of the asset.

__Year__ __Cash
Flow__ __Net
Income__

0 -$642,000
n/a

1
$170,000 $ 9,500

2
$240,000 $79,500

3
$205,000 $44,500

4
$195,000 $34,500

a. 13.08 percent

b. 15.77 percent

c. 21.83 percent

d. 26.17 percent

e. 31.54 percent

**CROSSOVER
RATE**

e 87. You are analyzing the following two
mutually exclusive projects and have developed

the
following information. What is the crossover rate?

Project
A Project
B

__Year__ __Cash
Flow__ __Cash
Flow__

0 -$84,500 -$76,900

1
$29,000
$25,000

2
$40,000
$35,000

3
$27,000
$26,000

a. 11.113 percent

b. 13.008 percent

c. 14.901 percent

d. 16.750 percent

e. 17.899 percent

**CROSSOVER
RATE**

b 88. The Winston Co. is considering two
mutually exclusive projects with the following

cash
flows. The crossover rate is _____ and if the required rate is higher than the

crossover
rate then project _____ should be accepted.

Project
A Project
B

__Year__ __Cash
Flow__ __Cash
Flow__

0 -$75,000 -$60,000

1
$30,000
$25,000

2
$35,000
$30,000

3
$35,000
$25,000

a. 13.94 percent; A

b. 13.94 percent; B

c. 15.44 percent; A

d. 15.44 percent; B

e. 15.86 percent; A

**Use
the following information to answer questions 89 through 92.**

You
are analyzing a project and have prepared the following data:

__Year__ __Cash flow__

0 -$169,000

1 $
46,200

2 $
87,300

** ** 3 $ 41,000

4 $ 39,000

Required
payback period 2.5 years

Required
AAR 7.25
percent

Required
return 8.50
percent

**PROFITABILITY
INDEX**

b 89. Based on the profitability index of
_____ for this project, you should _____ the

project.

a. .97; accept

b. 1.05; accept

c. 1.18; accept

d. .97; reject

e. 1.05; reject

**INTERNAL
RATE OF RETURN**

b 90. Based on the internal rate of
return of _____for this project, you should _____ the

project.

a. 8.95 percent; accept

b. 10.75 percent; accept

c. 8.44 percent; reject

d. 9.67 percent; reject

e. 10.33 percent; reject

**NET**** PRESENT VALUE**

c 91. Based on the net present value of
_____for this project, you should _____ the

project.

a. -$2,021.28; reject

b. -$406.19; reject

c. $7,978.72; accept

d. $9,836.74; accept

e. $12,684.23; accept

**PAYBACK
PERIOD**

c 92. Based on the payback period of
_____for this project, you should _____ the

project.

a. 1.87 years; accept

b. 2.87 years; accept

c. 2.87 years; reject

d. 3.13 years; reject

e. 3.87 years; reject

**Use
the following information to answer questions 93 through 97.**

** **You
are considering the following two mutually exclusive projects. Both projects
will be

depreciated
using straight-line depreciation to a zero book value over the life of the
project.

Neither
project has any salvage value.

** **

** ** Project A Project B

__Year Cash Flow__ __Year Cash Flow__

0 -$75,000 0 -$70,000

1
$19,000 1
$10,000

2
$48,000 2
$16,000

3
$12,000 3
$72,000

Required
rate of return 10
percent 13
percent

Required
payback period 2.0 years 2.0
years

Required
accounting return 8 percent 11 percent

**NET**** PRESENT VALUE**

c 93. Based on the net present value
method of analysis and given the information in the

problem,
you should:

a. accept both project A
and project B.

b. accept project A and
reject project B.

c. accept project B and
reject project A.

d. reject both project A
and project B.

e. accept whichever one
you want as they represent equal opportunities.

**INTERNAL
RATE OF RETURN**

e 94. Based upon the internal rate of return
(IRR) and the information provided in the

problem,
you should:

a. accept both project A
and project B.

b. reject both project A
and project B.

c. accept project A and
reject project B.

d. accept project B and
reject project A.

e. ignore the IRR rule and
use another method of analysis.

**PAYBACK
PERIOD**

b 95. Based upon the payback period and
the information provided in the problem, you

should:

a. accept both project A
and project B.

b. reject both project A
and project B.

c. accept project A and
reject project B.

d. accept project B and
reject project A.

e. require that management
extend the payback period for project A since it has a higher initial
cost.

**PROFITABILITY
INDEX**

e 96. Based upon the profitability index
(PI) and the information provided in the problem,

you
should:

a. accept both project A
and project B.

b. accept project A and
reject project B.

c. accept project B and
reject project A.

d. reject both project A
and project B.

e. disregard the PI method
in this case.

**AVERAGE
ACCOUNTING RETURN**

e 97. Based upon the average accounting
return (AAR) and the information provided in the

problem,
you:

a. should accept both
project A and project B.

b. should accept project A
because the AAR exceeds the required rate.

c. should accept project A
because the AAR is less than the required rate.

d. should accept whichever
project you prefer as they are equivalent from an AAR

perspective.

e. can not compute the AAR
of either project.

**ESSAYS**

**NPV
AND FIRM
VALUE**

98. According to the text, the NPV rule
states that, “An investment should be accepted if the net present value [NPV] is
positive and rejected if it is negative.” What does an NPV of zero mean? If you
were a decision-maker faced with a project with a zero NPV (or very close to
zero) what would you do? Why?

Although
the possibility of a zero NPV is remote, it makes for an interesting question
and tests the student’s understanding of the underlying theory. In strict
economic terms, one should be indifferent to the project; however, many
projects require further considerations. A key point in the student’s answer
should be that they stress the project provides a return just equal to the
firm’s required return. This question provides a good lead-in to the two
capital budgeting chapters that follow.

**INTERNAL
RATE OF RETURN**

99. List and briefly discuss the
advantages and disadvantages of the internal rate of return (IRR)

rule.

The
advantages of the rule are its close relationship with NPV and the ease with
which it is understood and communicated. The two disadvantages are that there
may be multiple solutions and the rule may lead to a ranking conflict in
evaluating mutually exclusive investments. The student should add a brief
explanation demonstrating their understanding of each.

**NPV
VS. PI**

100. Explain the differences and similarities
between net present value (NPV) and the

profitability
index (PI).

The
NPV and PI are basically the same calculation, and both rules lead to the same
accept/reject decision. The main difference between the two is that the PI may
be useful in determining which projects to accept if funds are limited;
however, the PI may lead to incorrect decisions in considering mutually
exclusive investments.

**NPV
AND PROJECT VALUE**

101. Given the goals of firm value and shareholder
wealth maximization, we have stressed the importance of net present value (NPV).
And yet, many financial decision-makers at some of the most prominent firms in
the world continue to use less desirable measures such as the payback period
and the average accounting return (AAR). Why do you think this is the case?

This
is an open-ended question which allows the creative student to speculate on the
value of non-discounted cash flow evaluation measures. We use it as a
springboard to stress that even rational financial managers sometimes find it
expedient to use a group of measures. For example, firms may rely on the IRR because
it is easier to explain to board members than NPV. Also, for large projects,
AAR provides shareholders with some insights as to the project’s impact on net
income and earnings per share.