Question 1

Using the profitability index, which of the following projects would you choose if you have limited funds? 
A) Project 1
B) Project 2
C) Project 3
D) Project 4
E) Project 5

Accepted Answer

The answer of Using the profitability index, which of the...

Question 2

By definition, the net present value is equal to zero when the discount rate is equal to the:
A) Average account rate of return.
B) Rate used in the discounted payback formula.
C) Profitability index rate.
D) Internal rate of return.
E) Crossover rate.

Accepted Answer

The net present value (NPV) equals zero when the discount rate is equal to the project's internal rate of return (IRR). This is because the IRR is the discount rate at which the present value of a project's cash inflows equals the present value of its cash outflows, resulting in a net present value of zero.

Question 3

_______________ is the focus of corporate finance as it is concerned with making the optimal choice between project alternatives.
A) Capital budgeting.
B) Capital structure.
C) Payback period.
D) Short-term budgeting.
E) Capital Allocation.

Accepted Answer

Capital budgeting is the process in corporate finance that focuses on evaluating and selecting investments in long-term assets, which is essentially about making the optimal choice between project alternatives.

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.

Accepted Answer

The payback period is the length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment.

Question 5

Matt is analyzing two mutually exclusive projects of similar size and has prepared the following data. Both projects have 5 year lives.  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.

Accepted Answer

The answer of Matt is analyzing two mutually exclusive projects...

Question 6

Your firm's CFO presents you with two capital budgeting analyses: one that involves buying a new delivery truck to replace the existing truck and one that involves the purchase of a three-ton metal stamping press to replace the existing press on the plant floor. This is an example of a decision involving _______________.
A) Mutually exclusive projects.
B) Crossover projects.
C) Payback projects.
D) Independent projects.
E) Working capital projects.

Accepted Answer

This is an example of independent projects because the decision to invest in one does not affect the decision to invest in the other; they are separate and unrelated investments.

Question 7

The principle that an investment should be accepted if the difference between the investment's market value and its cost is positive and rejected if the difference is negative is referred to as the:
A) Average accounting return rule.
B) Internal rate of return rule.
C) Profitability index rule.
D) Discounted payback rule.
E) Net present value rule.

Accepted Answer

The Net Present Value (NPV) rule states that an investment should be accepted if the NPV is positive, which means the present value of its cash flows exceeds its cost, and rejected if the NPV is negative. This principle directly relates to the difference between an investment's market value and its cost being positive or negative.

Question 8

You need to borrow $2,000 quickly, and the local pawn shop will give it to you if you promise to repay them $200.92 monthly over the next year.

Suppose the pawn shop has more customers than funds. Which capital budgeting technique would allow it to rank potential customers in order to maximize current wealth?
A) AAR
B) Payback period
C) Profitability index
D) NPV
E) Discounted payback

Accepted Answer

The Profitability Index (PI) is a capital budgeting technique that helps rank investment opportunities by comparing the present value of cash inflows to the initial investment. It is useful for maximizing current wealth when funds are limited, as it allows the pawn shop to prioritize customers who offer the highest return per dollar invested.

Question 9

Corey is considering two projects both of which have an initial cost of $20,000 and total cash inflows of $25,000. The cash inflows of project A are $3,000, $5,000, $8,000, and $9,000 over the next four years, respectively. The cash inflows for project B are $9,000, $8,000, $5,000, and $3,000 over the next four years, respectively. Which one of the following statements is correct if Corey requires a 10 % rate of return and has a required discounted payback period of 3 years?
A) Both projects should be accepted.
B) Both projects should be rejected.
C) Project A should be accepted and project B should be rejected.
D) Project A should be rejected and project B should be accepted.
E) You should be indifferent to accepting either or both projects.

Accepted Answer

Neither project meets the required discounted payback period of 3 years at a 10% rate of return.

Question 10

Ilona is considering two projects both of which have an initial cost of $17,000 and total cash inflows of $21,000. The cash inflows of project A are $6,000, $5,000, $5,000, and $5,000 over the next four years, respectively. The cash inflows for project B are $9,000, $7,000, $3,000 and $2,000 over the next four years, respectively. Which one of the following statements is correct if Ilona requires a 12 % rate of return and has a required discounted payback period of 3.5 years?
A) Both projects should be accepted.
B) Neither project ever pays back.
C) Project A should be accepted and Project B should be rejected.
D) Project A should be rejected and Project B should be accepted.
E) Both projects should be rejected even though Project B does pay back.

Accepted Answer

The discounted payback period for both projects exceeds 3.5 years, but Project B does pay back within its lifetime. However, since neither meets the required discounted payback period, both should be rejected.

Question 11

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.

Accepted Answer

Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time. It is used to assess the profitability of an investment or project.

Question 12

Your firm needs to buy a metal stamping press. The CFO presents you with two analyses: one for a press that is automated, requiring little labour to operate, and another that is manual, requiring a significant amount of labour. This is an example of a decision involving ______________.
A) Independent projects.
B) Working capital projects.
C) Positive NPV projects.
D) Crossover projects.
E) Mutually exclusive projects.

Accepted Answer

This is an example of a decision involving mutually exclusive projects, where choosing one option (automated press) precludes the selection of the other (manual press).

Question 13

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.

Accepted Answer

The discounted payback rule considers the time value of money, but it may still reject projects with positive net present value if they do not recover their costs within the specified payback period.

Question 14

Which capital investment evaluation technique is described by the following characteristics? (1) Easy to understand; (2) Biased towards liquidity; (3) Requires an arbitrary cutoff point; (4) Ignores the time value of money.
A) NPV
B) IRR
C) Profitability index
D) Payback period
E) Discounted payback

Accepted Answer

The Payback Period method is described by the characteristics mentioned: it is simple and easy to understand, focuses on how quickly the initial investment can be recovered (hence, biased towards liquidity), requires a decision on an arbitrary cutoff point by which the investment should be paid back, and does not take into account the time value of money, unlike methods such as NPV or Discounted Payback.

Question 15

The internal rate of return is defined as the:
A) Average annual rate of return on a project.
B) Average annual rate of return divided by the average book value of a project's fixed assets.
C) Rate of return which yields a net present value equal to the initial investment in a project.
D) Rate of return which causes the net present value of a project to equal zero.
E) Rate of return which a cost-cutting, non-revenue generating project returns in an average year.

Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.

Question 16

The following values have been computed for various independent projects which have a required payback period of 3 years, a required discount rate of 14.5 %, and a required accounting return of 11 %. Which one of these values indicates an accept decision?
A) Net present value of ($1,200).
B) Accounting rate of return of 10 %.
C) Profitability index of 1.02.
D) Internal rate of return of 13.6 %.
E) Payback period of 3.2 years.

Accepted Answer

The profitability index of 1.02 indicates an accept decision because it is greater than 1, meaning the present value of future cash flows is greater than the initial investment, indicating a positive return on investment.

Question 17

The length of time required for an investment's discounted cash flows to equal its initial cost is the:
A) Net present value.
B) Internal rate of return.
C) Payback period.
D) Profitability index.
E) Discounted payback period.

Accepted Answer

The discounted payback period is the length of time required for an investment's discounted cash flows to equal its initial cost. This method takes into account the time value of money by discounting the cash flows at a particular rate before calculating the payback period.

Question 18

The difference between the market 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.

Accepted Answer

Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time, essentially representing the difference between the market value of an investment and its cost.

Question 19

As the required rate of return increases, the:
A) Net present value increases.
B) Payback period decreases.
C) Profitability index decreases.
D) Discounted payback period decreases.
E) Average accounting return decreases.

Accepted Answer

As the required rate of return increases, the present value of future cash flows decreases, leading to a lower profitability index. The profitability index is calculated as the present value of future cash flows divided by the initial investment, so as the discount rate (or required rate of return) increases, the denominator stays the same but the numerator decreases, thus decreasing the profitability index.

Question 20

The New Blues Co. is considering two projects. Project A consists of building a wholesale book outlet on lot #169 of the Minglewood Retail Center. Project B consists of building a sit-down restaurant on lot #169 of the Minglewood Retail Center. When trying to 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.

Accepted Answer

The Net Present Value (NPV) method is the most reliable for making investment decisions because it considers the time value of money, providing a clear estimate of the project's profitability by comparing the present value of cash inflows to the present value of cash outflows.

Quiz 9: Net Present Value and Other Investment Criteria

Using the profitability index, which of the following projects would you choose if you have limited funds?

By definition, the net present value is equal to zero when the discount rate is equal to the:

_______________ is the focus of corporate finance as it is concerned with making the optimal choice between project alternatives.

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

Matt is analyzing two mutually exclusive projects of similar size and has prepared the following data. Both projects have 5 year lives. Matt has been asked for his best recommendation given this information. His recommendation should be to accept:

The principle that an investment should be accepted if the difference between the investment's market value and its cost is positive and rejected if the difference is negative is referred to as the:

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

Your firm needs to buy a metal stamping press. The CFO presents you with two analyses: one for a press that is automated, requiring little labour to operate, and another that is manual, requiring a significant amount of labour. This is an example of a decision involving ______________.

The discounted payback rule may cause:

Which capital investment evaluation technique is described by the following characteristics? (1) Easy to understand; (2) Biased towards liquidity; (3) Requires an arbitrary cutoff point; (4) Ignores the time value of money.

The internal rate of return is defined as the:

The following values have been computed for various independent projects which have a required payback period of 3 years, a required discount rate of 14.5 %, and a required accounting return of 11 %. Which one of these values indicates an accept decision?

The length of time required for an investment's discounted cash flows to equal its initial cost is the:

The difference between the market value of an investment and its cost is the:

As the required rate of return increases, the: