Week 6 Assignment (ch.

8) FIN315

1) What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if
the opportunity cost of capital is 14%?

A. $13,397.57
B. $14,473.44
C. $16,081.60
D. $33,748.58
Answer: C

2) The decision rule for net present value is to:

A. accept all projects with cash inflows exceeding the initial cost.
B. reject all projects with rates of return exceeding the opportunity cost of capital.
C. accept all projects with positive net present values.
D. reject all projects lasting longer than 10 years.
Answer: C

3) Given the various investment options listed, what investment criteria concept might make an
investor select Project B over other projects?

Project NPV Profitability Index

A $ 1.3 million 0.23
B $ 2.2 million 0.54
C $ 3.5 million 0.49
D $ 4.6 million 0.38

A. The Gold Standard

B. The Rate of Return rule
C. Capital rationing
D. Selection bias
Answer: C

4) If a project’s NPV is calculated to be negative what should a project manager do?

A. The discount rate should be decreased.

B. The profitability index should be calculated.
C. The present value of the project cost should be determined.
D. The project should be rejected.
Answer: D

5) Which one of the following changes will increase the NPV of a project?

A. A decrease in the discount rate

B. A decrease in the size of the cash inflows
C. An increase in the initial cost of the project
D. A decrease in the number of cash inflows
Answer: A

6) What is the maximum that should be invested in a project at time zero if the inflows are
estimated at $50,000 annually for 3 years, and the cost of capital is 9%?

A. $101,251.79
B. $109,200.00
C. $126,564.73
D. $130,800.00
Answer: C

7) When a manager does not accept a positive-NPV project, shareholders face an opportunity
cost in the amount of the:

A. project's initial cost.

B. project's NPV.
C. project's discounted cash inflows.
D. soft capital rationing budget.
Answer: B

8) What is the maximum amount a firm should pay for a project that will return $15,000 annually
for 5 years if the opportunity cost is 10%?

A. $24,157.65
B. $56,861.80
C. $62,540.10
D. $48,021.19
Answer: B
9) Which of the following projects would you feel safest in accepting? Assume the opportunity
cost of capital to be 12% for each project.

A. "A" has a small, but negative, NPV.

B. "B" has a positive NPV when discounted at 10%.
C. "C's" cost of capital exceeds its rate of return.
D. "D" has a zero NPV when discounted at 14%.
Answer: D

10) As the discount rate is increased, the NPV of a specific project will:

A. increase.
B. decrease.
C. remain constant.
D. decrease to zero, then remain constant.
Answer: B

11) A project requires an initial outlay of $10 million. If the cost of capital exceeds the project
IRR, then the project has a(n):

A. positive NPV.
B. negative NPV.
C. acceptable payback period.
D. positive profitability index.
Answer: B

12) Using the "gold standard" of investment criteria, which project should be selected?

Project NPV Investment

A $ 2.3 million $ 5.2 million
B $ 1.2 million $ 2.8 million
C $ 3.5 million $ 6.9 million
D $ 4.4 million $ 8.9 million

A. Project A
B. Project B
C. Project C
D. Project D
Answer: D
13) The internal rate of return is most reliable when evaluating:

A. a single project with alternating cash inflows and outflows over several years.
B. mutually exclusive projects of differing sizes.
C. a single project with only cash inflows following the initial cash outflow.
D. a single project with cash outflows at time 0 and the final year and inflows in all other time
periods.
Answer: C

14) Firms that make investment decisions based on the payback rule may be biased toward
rejecting projects:

A. with short lives.

B. with long lives.
C. with late cash inflows.
D. that have negative NPVs.
Answer: C

15) What is the IRR for a project that costs $100,000 and provides annual cash inflows of
$30,000 for 6 years starting one year from today?

A. 19.91%
B. 16.67%
C. 15.84%
D. 22.09%
Answer: C

16) Using the Profitability Index rule, which of the four projects is the best investment?

Project NPV Investment

A $ 2.3 million $ 5.2 million
B $ 1.2 million $ 2.8 million
C $ 3.5 million $ 6.9 million
D $ 4.4 million $ 8.9 million

A. Project A
B. Project B
C. Project C
D. Project D
Answer: B
17) An investment costs $100,000 and provides a cash inflow of $17,000 per year. If the
discount rate is 13.1%, how long must the cash inflows last for it to be an acceptable investment?

A. 24 years
B. 6 years
C. 10 years
D. 12 years
Answer: D

18) If the IRR for a project is 15%, then the project's NPV would be:

A. negative at a discount rate of 10%.

B. positive at a discount rate of 20%.
C. negative at a discount rate of 20%.
D. positive at a discount rate of 15%.
Answer: C

19) A project can have as many different internal rates of return as it has:

A. cash inflows.
B. cash outflows.
C. periods of cash flow.
D. changes in the sign of the cash flows.
Answer: D

20) What is the NPV for the following project cash flows at a discount rate of 15%? C0 = −
$1,000, C1 = $700, C2 = $700.

A. −$308.70
B. −$138.00
C. $138.00
D. $308.70
Answer: C

21) What is the IRR of a project with the following cash flows: C0 = −$200, C1 = $ 110, C2 =
$121?

A. Zero
B. 10%
C. 18%
D. 5%
Answer: B

22) A project costing $20,000 generates cash inflows of $9,000 annually for the first 3 years,
followed by cash outflows of $1,000 annually for 2 years. At most, this project has ________
IRR(s).

A. one
B. two
C. three
D. five
Answer: B

23) When projects are mutually exclusive, you should choose the project with the:
A. longer life.
B. larger initial size.
C. highest IRR.
D. highest NPV.
Answer: D

24) A firm plans to use the profitability index to select between two mutually exclusive
investments. If no capital rationing has been imposed, which of the following statements is
correct?

A. Select the project with the higher profitability index

B. Select the project with the lower profitability index
C. Without capital rationing, both projects can be selected
D. Without capital rationing, the NPV method must be used instead
Answer: D

25) When managers cannot determine whether to invest now or wait until costs decrease later,
the rule should be to:

A. postpone until costs reach their lowest level.

B. invest now to maximize the NPV.
C. postpone until the opportunity cost reaches its lowest level.
D. invest at the date that provides the highest NPV today.
Answer: D
26) Which mutually exclusive project would you select, if both are priced at $1,000 and your
required return is 15%: Project A with three annual cash flows of $1,000; or Project B, with 3
years of zero cash flow followed by 3 years of $1,500 annually?

A. Project A
B. Project B
C. You are indifferent since the NPVs are equal.
D. Neither project should be selected.
Answer: B

27) Soft capital rationing is imposed upon a firm by _____________, while hard capital
rationing is imposed by _____________.

A. management; the capital market

B. the capital market; management
C. the government; the capital market
D. the capital market; the government
Answer: A

28) What is the possible cost of capital rationing?

A. The firm may have excess fixed assets.

B. The firm is likely to take too many risky projects.
C. The firm may miss out on positive NPV opportunities.
D. The firm may have too high a cost of capital.
Answer: C

29) In simple cases when hard capital rationing exists, projects may be evaluated by:

A. the payback period.

B. mutually exclusive IRRs.
C. a profitability index.
D. the modified internal rate of return.
Answer: C

30) The profitability index selects projects based on the:

A. highest net discounted value at time zero.

B. highest internal rate of return.
C. largest dollar investment per rate of return.
D. largest return per dollar invested.
Answer: D

31) When calculating a project's payback period, cash flows are:

A. discounted at the opportunity cost of capital.

B. discounted at the internal rate of return.
C. discounted at the risk-free rate of return.
D. not discounted at all.
Answer: D

32) Which of the following statements is true for a project with a $20,000 initial cost, cash
inflows of $6,667 per year for 6 years, and a discount rate of 15%?

A. Its payback period is 3 years.

B. Its NPV is $2,094.
C. Its IRR is 17.85%.
D. Its profitability index is 0.104.
Answer: C

33) The "gold standard" of investment criteria refers to the:

A. net present value rule.

B. internal rate of return rule.
C. payback rule.
D. profitability index rule.
Answer: A

34) Which of the following investment decision rules tends to improperly reject long-lived
projects?

A. Net present value

B. Internal rate of return
C. Payback period
D. Profitability index
Answer: C

35) The ratio of net present value to initial investment is known as the:

A. net present value.

B. internal rate of return.
C. payback period.
D. profitability index.
Answer: D

36) The opportunity cost of capital is equal to:

A. the discount rate that makes the project NPV equal zero.
B. the return that shareholders could expect by investing their money in the financial markets.
C. a project's internal rate of return.
D. the average rate of return for a firm's projects.
Answer: B

37) Occasionally projects may have positive initial cash flows. Such projects:

A. are like lending money.

B. are like borrowing money.
C. have no IRR.
D. their IRR increases as the cost of capital increases.
Answer: A

38) If a project's expected rate of return exceeds its opportunity cost of capital, one would expect
the:

A. profitability index to be negative.

B. opportunity cost of capital to be too low.
C. project to have a positive NPV.
D. NPV to be zero.
Answer: C

39) Which one of the following should be assumed about a project that requires a $100,000
investment at time zero, then returns $20,000 annually for 5 years?
A. The NPV is negative.
B. The NPV is zero.
C. The profitability index is 1.0.
D. The IRR is negative.
Answer: A

40) What is the minimum cash flow that could be received at the end of year 3 to make the
following project "acceptable"? Initial cost = $100,000; cash flows at end of years 1 and 2 =
$35,000; opportunity cost of capital = 10%.

A. $29,494
B. $30,000
C. $39,256
D. $52,250
Answer: C

41) According to the NPV rule, all projects should be accepted if NPV is positive when
discounted at the:

A. internal rate of return.

B. opportunity cost of capital.
C. risk-free interest rate.
D. accounting rate of return.
Answer: B

42) If a project's IRR is 13% and the project provides annual cash flows of $15,000 for 4 years,
how much did the project cost?

A. $44,617.07
B. $52,208.18
C. $41,909.29
D. $49,082.11
Answer: A

43) A polisher costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount
rate is 10% and the polisher will last for 5 years, what is the equivalent annual cost of the tool?

A. $17,163.04
B. $22,187.84
C. $22,637.97
D. $19,411.15
Answer: C

44) Selecting the project(s) with the highest NPV(s) is not the correct decision rule when:

A. there is capital rationing.

B. there are mutually exclusive projects.
C. projects are long-lived.
D. projects are independent.
Answer: A

45) The investment timing problem arises when:

A. cash flows may occur at the beginning or end of each time period.
B. there is a choice between using the payback or NPV rules.
C. the project has a positive initial cash flow.
D. investment can occur now or at some future point.
Answer: D

46) What happens to the equivalent annual cost of a project as the opportunity cost of capital
decreases?

A. It increases.
B. It decreases.
C. It is not affected.
D. It depends on whether or not the projects are mutually exclusive.
Answer: B

47) A currently used machine costs $10,000 annually to run. What is the maximum that should
be paid to replace the machine with one that will last 3 years and cost only $4,000 annually to
run? The opportunity cost of capital is 12%.

A. $15,209.84
B. $9,607.33
C. $14,410.99
D. $10,338.56
Answer: A
48) Because of its age, your car costs $4,000 annually in maintenance expense. You could
replace it with a newer vehicle with a purchase price of $8,000. Both vehicles would be expected
to last 4 more years, at which point they will be valueless. If your opportunity cost is 8%, by how
much must maintenance expense decrease on the newer vehicle to justify its purchase?

A. $1,625.40
B. $1,584.63
C. $1,469.08
D. $1,409.54
Answer: A

49) You can continue to use your less efficient machine at a cost of $8,000 annually.
Alternatively, you can purchase a more efficient machine for $12,000 plus $5,000 annual
maintenance. If the new machine lasts 5 years and the cost of capital is 15%, you should:

A. buy the new machine and save $600 in equivalent annual costs.
B. buy the new machine and save $388 in equivalent annual costs.
C. keep the old machine and save $388 in equivalent annual costs.
D. keep the old machine and save $580 in equivalent annual costs.
Answer: B