Question 1

When the present value of the cash inflows exceeds the initial cost of a project, then the project should be: 
A) accepted because the payback period is less than the required time period. 
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 positive.

Accepted Answer

When the present value of the cash inflows exceeds the initial cost of a project, it means the profitability index (PI) is greater than 1. The PI is calculated as the present value of future cash flows divided by the initial investment. A PI greater than 1 indicates that the project is expected to generate more value than its cost, making it a financially viable option.

Question 2

Two mutually exclusive projects have an initial cost of $47,500 each. Project A produces cash inflows of $25,300, $37,100, and $22,000 for Years 1 through 3, respectively. Project B produces cash inflows of $43,600, $19,800 and $10,400 for Years 1 through 3, respectively. The required rate of return is 14.7 percent for Project A and 14.9 percent for Project B. Which project(s) should be accepted and why?
A) Project A, because it has the higher required rate of return.
B) Project A, because it has the larger NPV.
C) Project B, because it has the largest cash inflow in Year 1.
D) Project B, because it has the higher required rate of return.
E) Project B, because it has the larger NPV

Accepted Answer

To determine which project should be accepted, we need to compare their NPVs. NPV of Project A = -$47,500 + $25,300/(1+0.147) + $37,100/(1+0.147)^2 + $22,000/(1+0.147)^3 = $2,757.58. NPV of Project B = -$47,500 + $43,600/(1+0.149) + $19,800/(1+0.149)^2 + $10,400/(1+0.149)^3 = $7,354.52. Since Project B has a larger NPV, it should be accepted.

Question 3

In actual practice, managers most frequently use which two types of investment criteria? 
A) Net present value and payback 
B) Average accounting return and internal rate of return 
C) Internal rate of return and net present value 
D) Internal rate of return and payback 
E) Net present value and profitability index

Accepted Answer

In actual practice, managers most frequently use internal rate of return (IRR) and net present value (NPV) as investment criteria. IRR represents the actual return on the investment, while NPV shows the dollar amount of value created by the investment. These two methods are complementary, as IRR measures the viability of the investment, while NPV measures the profitability of the investment. Therefore, managers usually use both IRR and NPV to evaluate investment opportunities.

Question 4

You are considering a project with conventional cash flows, an IRR of 11.63 percent, a PI of 1.04, an NPV of $987, and a payback period of 2.98 years. Which one of the following statements is correct given this information?
A) The discounted payback period must be greater than 2.98 years.
B) The break-even discount rate must be less than 11.63 percent.
C) The discount rate used in computing the net present value was less than 11.63 percent.
D) The AAR is equal to the IRR/PI.
E) The project should be rejected based on its PI value.

Accepted Answer

The discount rate used in computing the net present value (NPV) was less than 11.63 percent. This is because the NPV is positive, indicating that the project's cash inflows exceed its outflows, which only occurs when the discount rate used to calculate the NPV is less than the project's IRR. Therefore, we know that the discount rate is less than 11.63 percent. Choices A, B, D, and E are all incorrect.

Question 5

Which one of the following methods of analysis provides the best information on the cost-benefit aspects of a project? 
A) Net present value 
B) Payback 
C) Internal rate of return 
D) Average accounting return
E) Profitability index

Accepted Answer

The answer of Which one of the following methods of...

Question 6

The profitability index is most closely related to which one of the following? 
A) Payback 
B) Discounted payback 
C) Average accounting return 
D) Net present value 
E) Modified internal rate of return

Accepted Answer

The profitability index (PI) is calculated as the present value of future cash flows divided by the initial investment. This ratio represents the value created per dollar of investment. Net present value (NPV) is calculated in a similar way, as the difference between the present value of cash inflows and the present value of cash outflows. Thus, the profitability index is most closely related to NPV, as both measures consider the time value of money and focus on the economic value of a project or investment. Payback, discounted payback, average accounting return, and modified internal rate of return do not explicitly account for the time value of money and are less comprehensive measures of project profitability.

Question 7

The final decision on which one of two mutually exclusive projects to accept ultimately depends upon which one of the following? 
A) Initial cost of each project 
B) Timing of the cash inflows 
C) Total cash inflows of each project 
D) Net present value 
E) Length of each project's life

Accepted Answer

The final decision on which project to accept depends on the net present value (NPV). NPV is calculated by subtracting the initial investment from the present value of all expected cash inflows. The project with a higher NPV is more beneficial as it generates more cash than the initial investment. Therefore, the project with a higher NPV should be accepted.

Question 8

A project will produce cash inflows of $5,400 a year for 3 years with a final cash inflow of $2,400 in Year 4. The project's initial cost is $13,400. What is the net present value if the required rate of return is 14.2 percent?
A) −$311.02
B) $505.92
C) −$165.11
D) $218.98
E) $668.02

Accepted Answer

The answer of A project will produce cash inflows of...

Question 9

Projects A and B are mutually exclusive and have an initial cost of $82,000 each. Project A provides cash inflows of $34,000 a year for three years while Project B produces a cash inflow of $115,000 in Year 3. Which project(s) should be accepted if the discount rate is 11.7 percent? What if the discount rate is 13.5 percent?
A) Accept A at both discount rates
B) Accept A at 11.7 percent and neither at 13.5 percent
C) Accept B at both discount rates
D) Accept both at 11.7 percent and neither at 13.5 percent
E) Accept B at 11.7 percent and neither at 13.5 percent

Accepted Answer

Project B has a higher NPV than Project A at both discount rates.

Question 10

Which one of the following indicates an accept decision for an independent project with conventional cash flows?
A) PI greater than 1.0
B) AAR lower than the required rate
C) Payback period that exceeds the requirement
D) Required discount rate greater than the IRR
E) Discounted payback period less than the payback period

Accepted Answer

A PI (profitability index) greater than 1.0 indicates that the project will generate more cash inflows than outflows, and will provide a return on investment. Therefore, an accept decision can be made for the project, assuming there are no other factors that would cause the project to be rejected.

Question 11

Roger's Meat Market is considering two independent projects. The profitability index decision rule indicates that both projects should be accepted. This result most likely does which one of the following? 
A) Conflicts with the results of the net present value decision rule 
B) Assumes the firm has sufficient funds to undertake both projects 
C) Agrees with the decision that would also apply if the projects were mutually exclusive 
D) Bases the accept/reject decision on the same variables as the average accounting return 
E) Fails to provide useful information as the firm must reject at least one of the projects

Accepted Answer

The profitability index assumes that the firm has sufficient funds to undertake both projects, as it calculates the ratio of present value of cash inflows to the initial investment. Therefore, the result of the profitability index decision rule indicates that the firm can invest in both projects without facing any financial constraints.

Question 12

A project has a required return of 12.6 percent, an initial cash outflow of $42,100, and cash inflows of $16,500 in Year 1, $11,700 in Year 2, and $10,400 in Year 4. What is the net present value?
A) −$11,748.69
B) −$10,933.52
C) −$11,208.62
D) −$10,457.09
E) −$12,006.13

Accepted Answer

Using the formula for Net Present Value (NPV), we get:
NPV = -Initial Cash Outflow + (Cash Inflow Year 1 / (1+Required Return)^1) + (Cash Inflow Year 2 / (1+Required Return)^2) + (Cash Inflow Year 4 / (1+Required Return)^4)
NPV = -42100 + (16500 / (1+0.126)^1) + (11700 / (1+0.126)^2) + (10400 / (1+0.126)^4)
NPV = -42100 + 14604.20 + 9328.57 + 715.85
NPV = -$11,748.69
Therefore, the best choice is A.

Question 13

Which two methods of project analysis are the most biased towards short-term projects?
A) Net present value and internal rate of return
B) Internal rate of return and profitability index 
C) Payback and discounted payback
D) Net present value and discounted payback 
E) Discounted payback and profitability index

Accepted Answer

Payback and discounted payback are both biased towards short-term projects as they focus on the amount of time it takes to recover the initial cash outlay. These methods do not take into account the time value of money and future cash flows beyond the payback period. The other methods listed, especially net present value, consider the timing and size of all cash flows, making them more suitable for long-term projects.

Question 14

Which one of the following statements would generally be considered as accurate given independent projects with conventional cash flows?
A) The internal rate of return decision may contradict the net present value decision. 
B) Business practice dictates that independent projects should have three distinct accept indicators before a project is actually implemented. 
C) The payback decision rule could override the net present value decision rule should cash availability be limited. 
D) The profitability index rule cannot be applied in this situation. 
E) The projects cannot be accepted unless the average accounting return decision ruling is positive.

Accepted Answer

The payback decision rule might be used over the NPV rule if a company has limited cash and needs to recover its investment quickly.

Question 15

A project has an initial cash outflow of $42,600 and produces cash inflows of $17,680, $19,920, and $15,670 for Years 1 through 3, respectively. What is the NPV at a discount rate of 12 percent?
A) $186.95
B) -$108.19
C) $219.41
D) $229.09
E) $311.16

Accepted Answer

The NPV is calculated by discounting each cash flow at 12% and summing them: NPV = -42600 + 17680/(1.12) + 19920/(1.12^2) + 15670/(1.12^3) = $219.41.

Question 16

Isaac has analyzed two mutually exclusive projects that have 3-year lives. Project A has an NPV of $81,406, a payback period of 2.48 years, and an AAR of 9.31 percent. Project B has an NPV of $82,909, a payback period of 2.57 years, and an AAR of 9.22 percent. The required return for Project A is 11.5 percent while it is 12 percent for Project B. Both projects have a required AAR of 9.25 percent. Isaac must make a recommendation and justify it in 15 words or less. What should his recommendation be? 
A) Accept both projects because both NPVs are positive 
B) Accept Project A because it has the shortest payback period 
C) Accept Project B and reject Project A based on the NPVs 
D) Accept Project A and reject Project B based on their AARs 
E) Accept Project A because it has the lower required return

Accepted Answer

Project B has the higher NPV, making it the better choice among mutually exclusive projects.

Question 17

Western Beef Exporters is considering a project that has an NPV of $32,600, an IRR of 15.1 percent, and a payback period of 3.2 years. The required return is 14.5 percent and the required payback period is 3.0 years. Which one of the following statements correctly applies to this project?
A) The net present value indicates accept while the internal rate of return indicates reject. 
B) Payback indicates acceptance. 
C) The payback decision rule could override the accept decision indicated by the net present value. 
D) The payback rule will automatically be ignored since both the net present value and the internal rate of return indicate an accept decision. 
E) The net present value decision rule is the only rule that matters when making the final decision.

Accepted Answer

The NPV indicates that the project should be accepted, while the IRR is greater than the required return which also indicates acceptance. However, the payback period is longer than the required period, which may cause concerns for liquidity or other reasons. Therefore, the payback decision rule could override the accept decision indicated by NPV and IRR in this case.

Question 18

Mutually exclusive projects are best defined as competing projects that: 
A) would need to commence on the same day. 
B) have the same initial start-up costs. 
C) both require the total use of the same limited resource. 
D) both have negative cash outflows at time zero. 
E) have the same life span.

Accepted Answer

Mutually exclusive projects are projects that cannot be undertaken simultaneously because they require the exclusive use of the same limited resource. This means that if one project is selected, the other project(s) cannot be undertaken. Therefore, the correct option is C, which states that mutually exclusive projects require the total use of the same limited resource. The other options (A, B, D, and E) are incorrect because they do not accurately describe mutually exclusive projects.

Question 19

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.

Accepted Answer

The profitability index is calculated by dividing the present value of future cash flows by the initial investment cost. This index is used to assess the attractiveness of an investment.

Question 20

Kristi wants to start training her most junior assistant, Amy, in the art of project analysis. Amy has just started college and has no experience or background in business finance. To get her started, Kristi is going to assign the responsibility for all projects that have initial costs less than $1,000 to Amy to analyze. Which method is Kristi most apt to ask Amy to use in making her initial decisions?
A) Discounted payback 
B) Profitability index
C) Internal rate of return
D) Payback 
E) Average accounting return

Accepted Answer

Given Amy's lack of experience in business finance, Kristi is likely to assign a method that is simple and straightforward for initial project analysis. The payback method, which calculates the time it takes for an investment to generate an amount of cash equal to the initial investment, is the simplest and requires the least financial knowledge, making it the most suitable choice for Amy.

Quiz 9: Net Present Value and Other Investment Criteria

When the present value of the cash inflows exceeds the initial cost of a project, then the project should be:

In actual practice, managers most frequently use which two types of investment criteria?

You are considering a project with conventional cash flows, an IRR of 11.63 percent, a PI of 1.04, an NPV of $987, and a payback period of 2.98 years. Which one of the following statements is correct given this information?

Which one of the following methods of analysis provides the best information on the cost-benefit aspects of a project?

The profitability index is most closely related to which one of the following?

The final decision on which one of two mutually exclusive projects to accept ultimately depends upon which one of the following?

A project will produce cash inflows of $5,400 a year for 3 years with a final cash inflow of $2,400 in Year 4. The project's initial cost is $13,400. What is the net present value if the required rate of return is 14.2 percent?

Which one of the following indicates an accept decision for an independent project with conventional cash flows?

Roger's Meat Market is considering two independent projects. The profitability index decision rule indicates that both projects should be accepted. This result most likely does which one of the following?

A project has a required return of 12.6 percent, an initial cash outflow of $42,100, and cash inflows of $16,500 in Year 1, $11,700 in Year 2, and $10,400 in Year 4. What is the net present value?

Which two methods of project analysis are the most biased towards short-term projects?

Which one of the following statements would generally be considered as accurate given independent projects with conventional cash flows?

A project has an initial cash outflow of $42,600 and produces cash inflows of $17,680, $19,920, and $15,670 for Years 1 through 3, respectively. What is the NPV at a discount rate of 12 percent?

Western Beef Exporters is considering a project that has an NPV of $32,600, an IRR of 15.1 percent, and a payback period of 3.2 years. The required return is 14.5 percent and the required payback period is 3.0 years. Which one of the following statements correctly applies to this project?

Mutually exclusive projects are best defined as competing projects that:

The present value of an investment's future cash flows divided by the initial cost of the investment is called the: