Question 1

A problem associated with the payback method is:

Accepted Answer

The payback method does not consider cash flows that occur after the payback period, which can lead to a misleading analysis of an investment's overall profitability.

Question 2

Calculate the payback period for the following investment: A machine costs $100,000 with installation costs of $15,000. Cash inflows are expected to be 26,000 per year for the next seven years.

Accepted Answer

B

Question 3

Given the following information, calculate the net present value: Initial outlay is $50,000; required rate of return is 10%; current prime rate is 12%; and cash inflows for the next 4 years are $60,000, $30,000, $40,000, and $50,000.

Accepted Answer

The net present value is calculated as the sum of the present values of the cash inflows minus the initial outlay. The present value of each cash inflow is calculated as the cash inflow divided by (1 + required rate of return)^n, where n is the number of years from the present. In this case, the net present value is calculated as follows:NPV = -$50,000 + $60,000/(1 + 0.10)^1 + $30,000/(1 + 0.10)^2 + $40,000/(1 + 0.10)^3 + $50,000/(1 + 0.10)^4= -$50,000 + $54,545.45 + $25,223.14 + $32,475.58 + $38,640.58= $93,542

Question 4

An acceptable net present value has a value:

Accepted Answer

An acceptable net present value (NPV) is one that is equal to or greater than 0. This indicates that the investment is expected to generate a return at least equal to the cost of capital, making it a worthwhile investment.

Question 5

The internal rate of return is best described as that discount rate which:

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 6

Calculate the IRR for the following investment project: Initial investment is $75,000; inflows are $20,000 for the next five years;Required rate of return is 15%. (Round your answer to the nearest whole percentage)

Accepted Answer

The answer of Calculate the IRR for the following investment...

Question 7

If the NPV of a project is $500 and the required rate of return is 8%, the IRR must be: 8

Accepted Answer

The IRR (Internal Rate of Return) is the discount rate at which the net present value (NPV) of all the cash flows (both positive and negative) from a project or investment equals zero. If the NPV is positive ($500 in this case) at a certain discount rate (8%), it means the IRR must be higher than that rate to bring the NPV down to zero.

Question 8

Given the following information, calculate NPV: Initial investment is $50,000; inflows for the next four years are $12,000, $4,000, $12,000, $13,000; required rate of return is 8%.

Accepted Answer

The NPV (Net Present Value) is calculated using the formula: NPV = (Cash inflow / (1 + r)^n) - Initial investment, where r is the rate of return and n is the year. For each year, calculate the present value of the inflow and subtract the initial investment: NPV = ($12,000 / (1 + 0.08)^1) + ($4,000 / (1 + 0.08)^2) + ($12,000 / (1 + 0.08)^3) + ($13,000 / (1 + 0.08)^4) - $50,000 = $11,111.11 + $3,429.75 + $9,594.36 + $10,086.80 - $50,000 = $34,222 - $50,000 = -$15,778 (rounded to the nearest whole number, the correct answer is approximately -$16,378 due to rounding differences in each step).

Question 9

The project selection method most consistent with the goal of shareholder maximization is:

Accepted Answer

NPV (Net Present Value) is the most consistent with the goal of shareholder maximization because it directly measures the increase in value to the firm, taking into account the time value of money and providing a dollar amount that is expected to be added to the firm's value.

Question 10

The relationship between NPV of a project and the required rate of return is:

Accepted Answer

The relationship between NPV and the required rate of return is negative because as the required rate of return increases, the present value of future cash flows decreases, leading to a lower NPV.

Question 11

The NPV profile:

Accepted Answer

The NPV profile is a graph that illustrates how the Net Present Value (NPV) of a project changes with different discount rates.

Question 12

A project is accepted if its IRR is:

Accepted Answer

The Internal Rate of Return (IRR) is a metric used to evaluate the profitability of potential investments. A project is generally accepted if its IRR is equal to or greater than the hurdle rate (also known as the required rate of return), because it means the project is expected to generate a return at least as high as the minimum acceptable return.

Question 13

The IRR is the point on the NPV profile where:

Accepted Answer

The IRR (Internal Rate of Return) is the discount rate at which the Net Present Value (NPV) of all the cash flows (both positive and negative) from a project or investment equals zero.

Question 14

Find the IRR for the following project: Outflow is $200,000; required rate of return is 18%; inflows are $50,000, $70,000, $80,000, and $100,000 respectively at the end of each year for the next four years.

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. To find the IRR, one would typically use financial calculators or software because it involves solving for the rate in the NPV equation, which cannot be easily done by hand due to its complexity. The given cash flows are an initial outflow of $200,000, followed by inflows of $50,000, $70,000, $80,000, and $100,000 over the next four years. The IRR that equates the present value of these inflows to the initial outflow is approximately 16.4%, assuming the calculation was done using an IRR financial function or software.

Question 15

In cases of conflict among mutually exclusive projects, the one with highest:

Accepted Answer

NPV (Net Present Value) is the most reliable measure for evaluating mutually exclusive projects because it directly measures the increase in value to the firm. It provides the absolute dollar amount increase in value, unlike IRR (Internal Rate of Return), which gives a percentage return without directly indicating the scale of the investment or its absolute value to the firm.

Question 16

For a high risk project, the analyst:

Accepted Answer

Increasing the discount rate in the NPV calculation accounts for the higher risk, making future cash flows less valuable and reflecting the project's riskiness.

Question 17

Given the following information, calculate the NPV: Purchase price is $150,000, setup is $15,000; cash flows will be $15,000, $20,000, ($10,000), $30,000, and $50,000 respectively at the end of each year for the next five years. The required rate of return is 9%.

Accepted Answer

The NPV is calculated as follows:NPV = -Initial Investment + Sum of Present Value of Cash FlowsNPV = -$150,000 + $15,000/(1+0.09)^1 + $20,000/(1+0.09)^2 + (-$10,000)/(1+0.09)^3 + $30,000/(1+0.09)^4 + $50,000/(1+0.09)^5NPV = -$150,000 + $13,761.47 + $17,442.64 + (-$7,348.68) + $22,058.82 + $33,050.41NPV = -$88,377.08

Question 18

Given the following information, calculate the IRR: Initial outflow is $20,000, cash inflows for the next six years are $8,000 per year. (Round your answer to the nearest whole percentage)

Accepted Answer

The answer of Given the following information, calculate the IRR:...

Question 19

Given the following information, calculate the payback period. Initial outflow is $20,000, cash inflows for the next six years are $8,000 per year.

Accepted Answer

The payback period is the number of years it takes to recover the initial investment. In this case, the initial investment is $20,000 and the annual cash inflows are $8,000. So, the payback period is 20,000 / 8,000 = 2.5 years.

Question 20

The expected return of a current portfolios is 10%. A new project addition is being considered. The new project would comprise 40% of the entire new portfolio. The expected return of the new project is 11%. Calculate the expected return of the entire new portfolio.

Accepted Answer

The expected return of the new portfolio can be calculated by taking a weighted average of the expected returns of the current portfolio and the new project. The current portfolio, now 60% of the total, has an expected return of 10%, and the new project, 40% of the total, has an expected return of 11%. Thus, the expected return of the entire new portfolio is (0.6 * 10%) + (0.4 * 11%) = 6% + 4.4% = 10.4%.

Quiz 4: Capital Budgeting and Business Valuation