Deck 6: Net Present Value and Other Investment Rules

Question 1

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.

Answer 1

internal rate of return.

Question 2

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.

Answer 2

accounting return.

Question 3

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.

Answer 3

greater than one.

Question 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.

Question 5

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.

Question 6

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%.

Question 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.

Question 8

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.

Question 9

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

Question 10

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 earlier in time.
E)duration of a project is lengthened.

Question 11

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.

Question 12

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.

Question 13

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)it is easy and quick to calculate.
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.

Question 14

If a project has a net present value equal to zero, then: I.the present value of the cash inflows exceeds the initial cost of the project.
II)the project produces a rate of return that just equals the rate required to accept the project.
III)the project is expected to produce only the minimally required cash inflows.
IV)any delay in receiving the projected cash inflows will cause the project to have a negative net.

A)II and III only.
B)II and IV only.
C)I, II, and IV only.
D)II, III, and IV only.
E)I, II, and III only.

Question 15

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.

Question 16

All else constant, the net present value of a typical investment 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.

Question 17

An investment is acceptable if its average accounting return (AAR):

A)is less than a target AAR.
B)exceeds a target AAR.
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.

Question 18

The advantages of the payback method of project analysis include the: I.application of a discount rate to each separate cash flow.
II)bias towards liquidity.
III)ease of use.
IV)arbitrary cut-off point.

A)I and II only.
B)I and III only.
C)II and III only.
D)II and IV only.
E)II, III, and IV only.

Question 19

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 management.
D)is not an as widely used tool as payback and discounted payback
E)is very similar in its methodology to the average accounting return.

Question 20

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)payback period.

Question 21

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.

Question 22

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.

Question 23

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.

Question 24

In actual practice, managers may use the: I.AAR because the necessary accounting numbers are readily available.
II)IRR because the results are easy to communicate and understand.
III)payback because of its simplicity.
IV)net present value because it is considered by many to be the best method of analysis.

A)I and III only.
B)II and III only.
C)I, III, and IV only.
D)II, III, and IV only.
E)I, II, III, and IV.

Question 25

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.

Question 26

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.

Question 27

Graphing the NPVs of mutually exclusive projects over different discount rates helps demonstrate:

A)how the incremental IRR varies with changes in the discount rate.
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 payback period and the initial cash outflow of a project are related.
E)how the profitability index and the net present value are related.

Question 28

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 incremental IRR 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.

Question 29

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.

Question 30

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

Question 31

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.

Question 32

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.

Question 33

The discounted payback rule may cause: I.some positive net present value projects to be rejected.
II)the most liquid projects to be rejected in favor of less liquid projects.
III)projects to be incorrectly accepted due to ignoring the time value of money.
IV)some projects with negative net present values to be accepted.

A)(I) correct only.
B)(II) correct only.
C)(III) correct only.
D)(IV) correct only.
E)(I) and (IV) correct only.

Question 34

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.

Question 35

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.

Question 36

The profitability index is closely related to:

A)payback.
B)discounted payback.
C)average accounting return.
D)net present value.
E)internal rate of return.

Question 37

The Liberty Co.is considering two projects.Project A consists of building a wholesale book outlet on lot #169 of the Englewood Retail Center.Project B consists of building a sit-down restaurant on
Lot #169 of the Englewood Retail Center.When trying to decide whether to 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

Question 38

The internal rate of return (IRR): I.rule states that a typical investment project with an IRR that is less than the required rate should
Be accepted.
II)is the rate generated solely by the cash flows of an investment.
III)is the rate that causes the net present value of a project to exactly equal zero.
IV)can effectively be used to analyze all investment scenarios.

A)I and IV only.
B)II and III only.
C)I, II, and III only.
D)II, III, and IV only.
E)I, II, III, and IV

Question 39

Which of the following methods of project analysis are biased towards short-term projects? I.internal rate of return
II)accounting rate of return
III)payback
IV)discounted payback

A)I and II only.
B)III and IV only.
C)II and III only.
D)I and IV only.
E)II and IV only.

Question 40

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)cannot be used to aid capital rationing.
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.

Question 41

If there is a conflict between mutually exclusive projects due to the IRR, one should:

A)drop the two projects immediately.
B)spend more money on gathering information.
C)depend on the NPV as it will always provide the most value.
D)depend on the AAR because it does not suffer from these same problems.
E)None of the above.

Question 42

The profitability index is the ratio of:

A)average net income to average investment.
B)internal rate of return to current market interest rate.
C)net present value of cash flows to internal rate of return.
D)net present value of cash flows to average accounting return.
E)present value of cash flows to initial investment cost.

Question 43

The payback period rule accepts all investment projects in which the payback period for the cash flows is:

A)equal to the cut-off point.
B)greater than the cut-off point.
C)less than the cut-off point.
D)positive.
E)None of the above.

Question 44

The internal rate of return may be defined as:

A)the discount rate that makes the NPV cash flows equal to zero.
B)the difference between the market rate of interest and the NPV.
C)the market rate of interest less the risk-free rate.
D)the project acceptance rate set by management.
E)None of the above.

Question 45

Using internal rate of return, a conventional project should be accepted if the internal rate of return is:

A)equal to the discount rate.
B)greater than the discount rate.
C)less than the discount rate.
D)negative.
E)equal to zero.

Question 46

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

Question 47

Which of the following does not characterize NPV?

A)NPV does not explicitly incorporate risk into the analysis.
B)NPV incorporates all relevant cash flow information.
C)NPV uses all of the project's cash flows.
D)NPV discounts all future cash flows.
E)Using NPV will lead to decisions that maximize shareholder wealth.

Question 48

A project will have more than one IRR if:

A)the IRR is positive.
B)the IRR is negative.
C)the NPV is zero.
D)the cash flow pattern exhibits more than one sign change.
E)the cash flow pattern exhibits exactly one sign change.

Question 49

The payback period rule is a convenient and useful tool because:

A)it provides a quick estimate of how rapidly the initial investment will be recouped.
B)results of a short payback rule decision will be quickly seen.
C)it does not have to take into account time value of money.
D)All of the above.
E)None of the above.

Question 50

The investment decision rule that relates average net income to average investment is the:

A)discounted cash flow method.
B)average accounting return method.
C)average payback method.
D)average profitability index.
E)None of the above.

Question 51

Internal rate of return: I.handles the the positive and negative cash flows throughout the life span of a project effectively.
II)requires the use of a discount rate.
III)does not require the use of a discount rate.

A)(I) correct only.
B)(II) correct only.
C)(III) correct only.
D)(I) and (II) correct only.
E)(I) and (III) correct only.

Question 52

The payback period rule:

A)discounts cash flows.
B)ignores initial cost.
C)always uses all possible cash flows in its calculation.
D)discounts cash flows, but does not ignore initial cost.
E)None of the above.

Question 53

The two fatal flaws of the internal rate of return rule are:

A)arbitrary determination of a discount rate and failure to consider initial expenditures.
B)arbitrary determination of a discount rate and failure to correctly analyze mutually
Exclusive investment projects.
C)arbitrary determination of a discount rate and the multiple rate of return problem.
D)failure to consider initial expenditures and failure to correctly analyze mutually exclusive
Investment projects.
E)failure to correctly analyze mutually exclusive investment projects and the multiple rate of
Return problem.

Question 54

The discounted payback period rule:

A)considers the time value of money.
B)discounts the cutoff point.
C)ignores uncertain cash flows.
D)is preferred to the NPV rule.
E)None of the above.

Question 55

The shortcoming(s) of the average accounting return (AAR) method is (are):

A)the use of net income instead of cash flows.
B)the pattern of income flows has no impact on the AAR.
C)there is no clear-cut decision rule.
D)All of the above.
E)None of the above.

Question 56

The payback period rule:

A) determines a cutoff point so that all projects accepted by the NPV rule will be accepted by
the payback period rule.
B) determines a cutoff point so that depreciation is just equal to positive cash flows in the
payback year.
C) requires an arbitrary choice of a cutoff point.
D) varies the cutoff point with the interest rate.
E) requires two cut-off points to control cash flows in each period.

Question 57

Accepting positive NPV projects benefits the shareholders because:

A)it is the most easily understood valuation process.
B)the present value of the expected cash flows are equal to the cost.
C)the present value of the expected cash flows are greater than the cost.
D)it is the most easily calculated.
E)None of the above.

Question 58

The problem of multiple IRRs can occur when:

A)there is only one sign change in the cash flows.
B)the first cash flow is always positive.
C)the cash flows decline over the life of the project.
D)there is more than one sign change in the cash flows.
E)None of the above.

Question 59

The average accounting return is determined by:

A)dividing the yearly cash flows by the investment.
B)dividing the average cash flows by the investment.
C)dividing the average net income by the average investment.
D)dividing the average net income by the initial investment.
E)dividing the net income by the cash flow.

Question 60

A mutually exclusive project is a project whose:

A)acceptance or rejection has no effect on other projects.
B)NPV is always negative.
C)IRR is always negative.
D)acceptance or rejection affects other projects.
E)cash flow pattern exhibits more than one sign change.

Question 61

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.

Question 62

A)-£287.22
B)-£177.62
C)£177.62
D)£204.36
E)£287.22

Question 63

A)yes; because the IRR exceeds the required return by about 0.39%.
B)yes; because the IRR is less than the required return by about 3.9%.
C)yes; because the IRR is positive.
D)no; because the IRR exceeds the required return by about 3.9%.
E)no; because the IRR is 9.89%.

Question 64

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.

Question 65

A)5.93%
B)5.96%
C)6.04%
D)6.09%
E)6.13%

Question 66

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% 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% .

Question 67

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 since both NPV's are >
0)

Question 68

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

Question 69

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.

Question 70

A)£218.68
B)£370.16
C)£768.20
D)£1,249.65
E)£1,371.02

Question 71

Which of the following statement is true?

A)One must know the discount rate to compute the NPV of a project but one can compute
The IRR without referring to the discount rate.
B)One must know the discount rate to compute the IRR of a project but one can compute the
NPV without referring to the discount rate.
C)Payback accounts for time value of money.
D)There will always be one IRR regardless of cash flows.
E)Average accounting return is the ratio of total assets to total net income.

Question 72

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%?

A)-€5,474.76
B)-€1,011.40
C)-€935.56
D)€1,011.40
E)€5,474.76

Question 73

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.

Question 74

Brounen, et al.(2006) found that ___ and ___ were the two most popular capital budgeting methods in the UK.

A)Internal Rate of Return; Payback Period
B)Internal Rate of Return; Net Present Value
C)Net Present Value; Payback Period
D)Modified Internal Rate of Return; Internal Rate of Return
E)Modified Internal Rate of Return; Net Present Value

Question 75

A).96
B).98
C)1.00
D)1.02
E)1.04

Question 76

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)0.86 year.
B)1.46 years.
C)1.86 years.
D)2.46 years.
E)2.86 years.

Question 77

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%?

A)2.13 years.
B)2.33 years.
C)2.67 years.
D)2.91 years.
E)never.

Question 78

A)yes; Select A at 8% and B at 11%.
B)yes; Select B at 8% and A at 11%.
C)yes; Select A at 8% and select neither at 11%.
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.

Question 79

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.

Question 80

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)None of the above.