Question 1

The Acorn Project will require an initial cash outflow of $25,000. The project is
expected to return $8,000, $10,000, and $14,000 in years one, two, and three,
respectively. The project has a required rate of return of 15%. Use the internal rate of
return evaluation technique to determine whether or not this project should be
accepted. Explain your answer.

Accepted Answer

The answer of The Acorn Project will require an initial...

Question 2

What decision should be made regarding each of the following two independent projects if the appropriate cost of capital is 12%? 
A)Project A should be undertaken since it represents an investment that offers a rate of return that exceeds the cost of capital.
B)Both projects should be undertaken since both projects offer a return that is greater than the cost of capital.
C)Project B should be rejected since it represents a borrowing situation; therefore, the IRR can be interpreted as the cost of borrowing, and this exceeds the cost of capital.
D)Both B and C are correct choices.

Accepted Answer

The answer of What decision should be made regarding each...

Question 3

A project that costs $12,000 today is expected to produce $35,000 at the end of the first
year. It is expected
that the cash flow at the end of year 2 will be -$25,000. Two IRRs can be calculated:
25% and 66.67%. If the firm's cost of capital is 10%, should the project be undertaken?

Accepted Answer

The answer of A project that costs $12,000 today is...

Question 4

Project Jupiter requires an initial investment of $100,000 and is expected to produce cash flows of $15,582 a year for the following 10 years. The project's NPV at the estimated cost of capital
Of 7.5% is $6,956. How high can the project's hurdle rate be before this project would no longer
Be acceptable? Round your answer to the nearest tenth of a percent.
A)It can be no greater than 8.5%.
B)It can be no greater than 7.5%.
C)It can be no greater than 9.0%.
D)It can be no greater than 7.0%.

Accepted Answer

The project's NPV is positive at a cost of capital of 7.5%, meaning the project is currently acceptable. If the cost of capital or hurdle rate were to increase beyond 9.0%, the NPV would become negative and the project would no longer be acceptable. Therefore, the highest acceptable hurdle rate would be 9.0%. If the hurdle rate is greater than 9.0%, the project's NPV will decrease and become negative, making the project unacceptable. At a hurdle rate of 7.5%, the NPV is positive, and the project is acceptable. Therefore, the highest acceptable hurdle rate is 9.0% since any rate above that would make the NPV negative.

Question 5

Which of the following statements regarding projects with no IRR or multiple IRRs is true?
A)Projects with no IRR should always be rejected since they offer no return.
B)A project with multiple IRRs should be accepted as long as at least one of the IRRs exceeds the cost of capital.
C)A project with multiple IRRs should be accepted so long as all of the IRRs exceed the cost of capital.
D)None of the above statements is true.

Accepted Answer

A project with no IRR doesn't mean that it offers no return, it means that the project's cash flows do not contain a single value for IRR, which makes it difficult to evaluate. However, other methods such as NPV can still be used to evaluate the project. 
A project with multiple IRRs can be misleading since it implies that the project could have more than one rate of return, which is theoretically impossible. Therefore, it is best to avoid such projects or use other methods such as MIRR to evaluate them. Projects with no IRR or multiple IRRs can still be evaluated using other methods such as net present value (NPV) or profitability index (PI). The decision to accept or reject a project should be based on whether the NPV or PI is positive or greater than 1, respectively. Multiple IRRs can also lead to ambiguous decision-making and should not be solely relied upon. Therefore, none of the above statements are true.

Question 6

A Treasury security that matures in one year has a face value of $10,000 and sells for $9,300. What is its yield-to-maturity, to the nearest tenth of a percent?
A)9.3%
B)7.5%
C)5.5%
D)7.0%

Accepted Answer

Using the formula for yield-to-maturity:

YTM = (Face value / Price)^ (1/n) - 1

Where n is the number of years until maturity.

In this case, n = 1 and:

YTM = (10,000 / 9,300)^(1/1) - 1 
YTM = 0.075 or 7.5%

Therefore, the answer is B) 7.5%.

Question 7

What potential problem can arise when choosing between two bond investments by
comparing their yields-to-maturity?

Accepted Answer

The answer of What potential problem can arise when choosing...

Question 8

Which of the following statements is necessarily true?
A)If two projects are mutually exclusive, the one with the higher internal rate of return should be selected so long as its internal rate of return is greater than the cost of capital for
The firm.
B)If the internal rate of return of a project is equal to its required rate of return, the project will have a positive NPV.
C)If the internal rate of return of a project is greater than 0, the project will also have a positive NPV.
D)If the internal rate of return of a project is less than its required rate of return, the project should always be rejected.

Accepted Answer

The internal rate of return (IRR) is a metric used to evaluate the profitability of potential investments. If the IRR of a project is less than its required rate of return (also known as the hurdle rate or the cost of capital), it means the project is expected to generate returns lower than the minimum the company or investor requires, making it an unattractive investment. Therefore, such projects should generally be rejected.

Question 9

A 9%, semiannual, level-coupon Treasury note will mature in 6 years , at which point it will repay its principal of $5,000. The note is currently selling for $5,746.55. What is its true
Yield-to-maturity?
A)9.0%
B)6.0%
C)6.4%
D)6.1%

Accepted Answer

We can solve for the yield-to-maturity using a financial calculator or Excel's RATE function. Using Excel's RATE function with the following inputs: RATE(12,6,-5746.55,5000,0,2) we get a result of 6.10%, which is closest to choice D. Therefore, the answer is D.

Question 10

Calculate the yield-to-maturity of a zero-coupon bond that costs $650 today and will pay $1,000 at the end of five years. Round your answer to the nearest tenth of a percent.
A)8.6%
B)9.0%
C)5.4%
D)none of the above

Accepted Answer

The yield-to-maturity (YTM) is the rate of return that an investor will earn if they hold the bond until maturity, assuming all interest payments are reinvested at the same rate. In the case of a zero-coupon bond, there are no interest payments, so the YTM is simply the discount rate that equals the present value of the bond to its face value.

Using the formula for present value of a future sum:
Present value = Future value / (1 + r)^n

Where r is the discount rate and n is the number of years until maturity.

Plugging in the values given:
$650 = $1,000 / (1 + r)^5

Solving for r:
(1 + r)^5 = $1,000 / $650
(1 + r) = (1,000 / 650)^(1/5)
(1 + r) = 1.087
r = 0.087 or 8.7%

Rounding to the nearest tenth, the answer is B) 9.0%. The yield-to-maturity can be calculated using the formula:
YTM = [(face value/present value)^(1/n)] - 1
YTM = [(1000/650)^(1/5)] - 1
YTM = 0.0898 or 8.98%
Rounding it to the nearest tenth gives us an answer of 9.0%, which is option B.

Question 11

Project A has a profitability index of 0.85. Project B has a profitability index of 1.24. The two projects are independent. Which of the following statements is (are)true?
A)Only Project B should be accepted since it is the only one of the two projects that will maximize value.
B)Both projects should be accepted since they are independent and each one has a profitability index greater than zero.
C)Both Project A and Project B will have net present values that are greater than zero.
D)Both A and C are true statements.

Accepted Answer

The profitability index (PI) is a measure used to evaluate the attractiveness of an investment or project. A PI greater than 1 indicates that the net present value (NPV) of future cash flows from the investment is positive, suggesting that the project is likely to add value to the firm and should be accepted. Project B, with a PI of 1.24, meets this criterion, indicating it will likely add value. Project A, with a PI of 0.85, does not meet this criterion as its PI is less than 1, suggesting it will not add value and should not be accepted based on this measure alone. Therefore, only Project B should be accepted to maximize value.

Question 12

Which of the following statements about the profitability index evaluation technique is true?
A)When used to compare projects, the profitability index evaluation technique will tend to favor those projects with lower initial investment requirements.
B)If a project has a profitability index greater than zero, it should be accepted.
C)It is most useful when evaluating mutually exclusive projects.
D)All of the above statements are true.

Accepted Answer

The profitability index (PI) is a technique used to evaluate the attractiveness of an investment or project. It is calculated by dividing the present value of future cash flows by the initial investment. A higher PI indicates a more attractive investment because it means that for every unit of currency invested, the project will generate more in present value terms. Therefore, projects with lower initial investments and higher present value of future cash flows will tend to have higher PIs, making statement A correct. Statement B is incorrect because a project should be accepted if its PI is greater than 1, not zero. Statement C is also incorrect because the PI is useful for evaluating all types of projects, not just mutually exclusive ones.

Question 13

Project Thor requires an initial investment of $50,000 and is expected to offer cash flows of $20,000 a year for the following three years. This project will be profitable, so long as the
Discount rate is
A)less than the cost of capital.
B)greater than the risk-free rate.
C)less than 9.7%.
D)greater than 10%.

Accepted Answer

To determine if Project Thor will be profitable, we need to calculate the Internal Rate of Return (IRR) and compare it to the discount rate. The IRR is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. In this case, without calculating the exact IRR, we can infer that if the discount rate is less than 9.7%, the NPV of the project will be positive, making the project profitable. This is because a lower discount rate increases the present value of future cash flows, making it more likely for the project to cover its initial investment and generate profit.

Question 14

In which of the following scenarios will the IRR always provide you with the correct, wealth-maximizing decision?
A)Whenever you are evaluating an independent project--i.e., one that is not affected by the acceptance or rejection of another project.
B)When you are evaluating mutually exclusive projects that have different investment requirements.
C)When you are evaluating a single project that requires an initial cash outflow followed by positive cash flows in subsequent years.
D)The IRR will provide you with the correct, wealth-maximizing decision in all of the above situations.

Accepted Answer

The IRR method is most reliable for a single project with an initial cash outflow followed by consistent positive cash inflows, as it assumes reinvestment at the IRR rate and does not require comparison with other projects' IRRs.

Question 15

A $20,000, level-coupon Eurobond pays interest annually at the coupon rate of 6% and repays the principal value when it matures in 5 years. If it is currently selling for $18,403, what is its
Yield-to-maturity? Round your answer to the nearest tenth of a percent.
A)7.7%
B)6.0%
C)8.0%
D)4.8%

Accepted Answer

Using the financial calculator, we input the following:
N = 5 (since the bond matures in 5 years)
PV = -18,403 (the bond is currently selling at a discount)
PMT = 1,200 (since the annual coupon is 6% of the face value of 20,000)
FV = 20,000 (the face value will be received at maturity)

By calculating and solving for the yield-to-maturity (YTM), we get 8.0% rounded to the nearest tenth of a percent. Therefore, the best choice is C. Using a financial calculator, we can find that the yield-to-maturity is 8.0%. Alternatively, we can solve for the YTM using the following formula:

$18,403 = $1,200(PVIFA i=8%, n=5) + $20,000/(1+i)^5

Solving for i, we get i=8.0%. Therefore, the best choice is C, with a yield-to-maturity of 8.0%.

Question 16

The following information is provided for projects X and Y:  Note that a discrepancy exists between the NPV and IRR rankings. Why does this
discrepancy occur? Which project should be undertaken if the required return for each
project is 5%?

Accepted Answer

The answer of The following information is provided for projects...

Question 17

A level-coupon bond has a yield-to-maturity of 10%. In order for an investor to be assured an average annual yield of 10% on his investment in the bond, which of the following is NOT
Necessary?
A)The investor must reinvest all the coupon payments he receives at 10%.
B)The issuer must not default or be late with its payments.
C)The investor must hold the bond until it matures.
D)All of the above are necessary to insure the investor earns an average annual return of 10% on this investment.

Accepted Answer

The yield-to-maturity calculation assumes reinvestment of coupons at the yield-to-maturity rate, timely payments, and holding the bond until maturity. Therefore, all listed conditions are necessary to achieve the stated yield.

Question 18

A project will cost $20,000 and is expected to produce cash flows of $10,000, $8,000, and $5,000 at the end of each of the first three years, respectively. If the cost of capital is 7%, what is the
Project's profitability index? Round your answer to the nearest hundredth.
A)1.02
B)0.02
C)0.98
D)1.15

Accepted Answer

The profitability index (PI) is calculated by dividing the present value (PV) of future cash flows by the initial investment. The formula for the present value of each cash flow is PV = Cash Flow / (1 + r)^n, where r is the discount rate (cost of capital) and n is the year of the cash flow. Year 1: PV = $10,000 / (1 + 0.07)^1 = $9,345.79Year 2: PV = $8,000 / (1 + 0.07)^2 = $7,002.80Year 3: PV = $5,000 / (1 + 0.07)^3 = $4,176.73Total PV of cash flows = $9,345.79 + $7,002.80 + $4,176.73 = $20,525.32Profitability Index = Total PV of cash flows / Initial Investment = $20,525.32 / $20,000 = 1.026Rounded to the nearest hundredth, the profitability index is 1.02.

Question 19

Two mutually exclusive projects have the following expected cash flows, net present values, and internal rates of return:  If the appropriate discount rate is 15%, which project should be undertaken and why?
A)Project B since its initial investment is returned in the first year and can then be invested in another project
B)Project B since its IRR is higher than that of Project A
C)Project A since it has the higher net present value of the two projects
D)Project B since its total cash inflows are more than twice the cost of the project, whereas Project A's cash inflows are just twice the initial investment.

Accepted Answer

The best choice would be Project A since it has the higher net present value of the two projects at a discount rate of 15%. The NPV for Project A is $1,665, whereas the NPV for Project B is only $1,217. The fact that Project B's initial investment is returned in the first year and has a higher IRR are certainly favorable factors, but at a 15% discount rate, the higher net present value of Project A takes precedence. When choosing between two mutually exclusive projects, the project with the higher net present value should be selected. Project A has a higher net present value of $13,325 compared to Project B's $4,027 at a 15% discount rate. While Project B has a higher internal rate of return, it does not take into account the varying scale of the projects and does not consider the time value of money. Initial investment and total cash inflows are also not reliable indicators of project profitability. Therefore, Project A should be undertaken as it generates a higher positive net present value.

Question 20

Which of the following is an advantage of the IRR?
A)The IRR is the easiest to calculate of all the capital budgeting techniques.
B)The IRR will always lead to a wealth-maximizing decision as long as the inputs are correct.
C)The IRR can be calculated even if the appropriate cost of capital is unknown.
D)Both A and B are advantages of the IRR.

Accepted Answer

The IRR can be calculated without knowing the appropriate cost of capital, making it useful for comparing the profitability of projects independently of the current financing costs.

Quiz 4: A First Encounter With Capital Budgeting Rules

What decision should be made regarding each of the following two independent projects if the appropriate cost of capital is 12%?

A project that costs $12,000 today is expected to produce $35,000 at the end of the first year. It is expected that the cash flow at the end of year 2 will be -$25,000. Two IRRs can be calculated: 25% and 66.67%. If the firm's cost of capital is 10%, should the project be undertaken?

Which of the following statements regarding projects with no IRR or multiple IRRs is true?

A Treasury security that matures in one year has a face value of $10,000 and sells for $9,300. What is its yield-to-maturity, to the nearest tenth of a percent?

What potential problem can arise when choosing between two bond investments by comparing their yields-to-maturity?

Which of the following statements is necessarily true?

A 9%, semiannual, level-coupon Treasury note will mature in 6 years , at which point it will repay its principal of $5,000. The note is currently selling for $5,746.55. What is its true Yield-to-maturity?

Calculate the yield-to-maturity of a zero-coupon bond that costs $650 today and will pay $1,000 at the end of five years. Round your answer to the nearest tenth of a percent.

Project A has a profitability index of 0.85. Project B has a profitability index of 1.24. The two projects are independent. Which of the following statements is (are) true?

Which of the following statements about the profitability index evaluation technique is true?

Project Thor requires an initial investment of $50,000 and is expected to offer cash flows of $20,000 a year for the following three years. This project will be profitable, so long as the Discount rate is

In which of the following scenarios will the IRR always provide you with the correct, wealth-maximizing decision?

A $20,000, level-coupon Eurobond pays interest annually at the coupon rate of 6% and repays the principal value when it matures in 5 years. If it is currently selling for $18,403, what is its Yield-to-maturity? Round your answer to the nearest tenth of a percent.

The following information is provided for projects X and Y: Note that a discrepancy exists between the NPV and IRR rankings. Why does this discrepancy occur? Which project should be undertaken if the required return for each project is 5%?

A level-coupon bond has a yield-to-maturity of 10%. In order for an investor to be assured an average annual yield of 10% on his investment in the bond, which of the following is NOT Necessary?

A project will cost $20,000 and is expected to produce cash flows of $10,000, $8,000, and $5,000 at the end of each of the first three years, respectively. If the cost of capital is 7%, what is the Project's profitability index? Round your answer to the nearest hundredth.

Two mutually exclusive projects have the following expected cash flows, net present values, and internal rates of return: If the appropriate discount rate is 15%, which project should be undertaken and why?

Which of the following is an advantage of the IRR?