Question 1

A weakness of the payback period is that it disregards:
A) Projects with shorter payback periods
B) Cash flows during the payback period
C) Start-up costs
D) The time value of money

Accepted Answer

The payback period method does not take into account the time value of money, which means that it ignores the fact that money received in the future is less valuable than money received in the present. This can lead to inaccurate evaluations of the profitability of a project, as cash flows that are received later are not discounted to account for their reduced value.

Question 2

A digital assembly system that costs $160,000 is expected to operate for 8 years. The estimated salvage value at the end of 8 years is $12,000. The system is expected to save the company $38,000 in labor costs before taxes and depreciation. The company will depreciate this system on a 5-year MACRS schedule. If the firm's cost of capital is 12% and its marginal tax rate is 35%, compute the NPV for the project. (Note: Requires MACRS tables)
A) $4,045
B) $7,196
C) $20,873
D) $167,196

Accepted Answer

Solution:
 11ea10f6_a150_ae98_b6b3_c39c826090f1_TB2040_00

Question 3

Zimmer, a manufacturer of modular rooms, plans to expand its operation in Landshut, Germany. The expansion will cost $14.5 million and is expected to generate annual net cash flows of DM4.5 million for a period of 12 years and then the operation will be sold for DM2 million. The cost of capital for the project is 14%. Using the spot exchange rate of $0.60 per DM, compute the NPV of this expansion project.
A) $0.78 million
B) $1.03 million
C) $2.58 million
D) $11.39 million

Accepted Answer

Solution:
PVNCF = DM4.5(5.660) + DM2(0.208) = DM25.886 million
PVNCFh = DM25.886($0.60 / DM) = $15.5316
NPV = $15.5316 - $14.5 = $1.0316 (million)

Question 4

Which of the following statements about comparing capital budget techniques is/are correct?
I. The payback period is easy to understand and helps the firm identify how long it will be unable to use the initial investment for other projects.
II. Mutually exclusive projects allow a firm to do other like projects (mutually exclusive) simultaneously as long as the budget restraints are met.
A) I only
B) II only
C) Both I and II
D) Neither I nor II

Accepted Answer

Statement I is correct. The payback period is a simple method and provides a quick snapshot of how long it will take for a project to recoup the initial investment. This method can help the firm understand its cash flow needs and constraints.

Statement II is incorrect. Mutually exclusive projects are those projects that cannot be undertaken at the same time because they serve the same purpose or use the same resources. Therefore, a firm cannot do other mutually exclusive projects at the same time.

Question 5

The payback method has all of the following advantages EXCEPT:
A) It considers the time value of money
B) It determines a firm's financial exposure
C) It is easy to calculate
D) It determines if the project under consideration will be able to replace the start-up costs.

Accepted Answer

The payback method does not consider the time value of money, which is a disadvantage as it fails to account for the fact that money today is worth more than money in the future due to inflation and the opportunity cost of delaying investment. The other options are advantages of the payback method.

Question 6

What is the internal rate of return for a project that has a net investment of $370,000 and net cash flows of $60,000 in year 1, $75,000 in year 2, and $85,000 in years 3 through 8?
A) 15.5%
B) 13.6%
C) 17.4%
D) none of the above are correct

Accepted Answer

Solution:
 11ea10f6_a150_8787_b6b3_75412b1d77ce_TB2040_00 
r = 13% +($7,960 /$7,960 + $5,385)(14% - 13%) = 13.596 or 13.6%

Question 7

Colex wishes to bid on a contract that is expected to yield after-tax net cash flows of $25,000 in year 1, $30,000 in year 2, and $35,000 per year in years 3 - 8. To obtain the contract, Colex will need to invest $110,0000 to reconfigure a packaging system, $20,000 (after-tax) to retrain current employees, and $15,000 (after-tax) on an environmental impact study that is required to be completed on acceptance of the contract. What is the project's internal rate of return?
A) 16.7%
B) 14.1%
C) 16.2%
D) 14.9%

Accepted Answer

Solution: NINV = $110,000 + $20,000 + $15,000 = $145,000 NCF₁ = $25,000 NCF₂= $30,000 NCF_3-8 = $35,000 IRR = 14.9% by calculator

Question 8

List the advantages and disadvantages of the payback method.

Accepted Answer

The answer of List the advantages and disadvantages of the...

Question 9

Barnacle Bob's Fish and Tackle Shop is planning an expansion. The initial investment is $480,000 and anticipates cash inflows as listed below. The cost of capital is 12.2%. Based on the profitability index, should Barnacle Bob go ahead with the project? 
A) No, the profitability index is 2.
B) No, the profitability index is .95
C) Yes, the profitability index is 1.18
D) Yes, the profitability index is .78

Accepted Answer

Find the net present value of the cash flows. Solution using a financial calculator (TI BAII ) CF₀ 0 CF₁ 90,000 F₁ 1 CF₂ 105,000 F₂ 2 CF₃195,000 F₃ 3 I = 12.2 Compute NPV = $568,410.60 568,410.60 / 480,000 =

Question 10

Should the following project be accepted if the cost of capital is 12%? Initial Investment is $50,000

A) Yes, because the internal rate of return is 10.5% which is less than 12%.
B) Yes, because the internal rate of return is 35% which is more than 12%.
C) No, because the internal rate of return is 8.7% which is less than 12%.
D) Yes, because the internal rate of return is 48% which is more than 12%.

Accepted Answer

The answer of Should the following project be accepted if...

Question 11

In considering the payback period:
A) The maximum period allowed by a firm is a specific time period based on objective criteria.
B) It considers the time value of money in determining the maximum allowable time period.
C) It gives some indication of a project's desirability from a liquidity viewpoint.
D) It is based on cash flows both during and after the payback period.

Accepted Answer

Payback period gives an indication of how long it would take to recoup the initial investment in a project, and therefore is a measure of liquidity. A shorter payback period is generally considered more desirable. However, payback period does not take into account the time value of money, cash flows after the payback period, or any specific objective criteria for maximum allowable time period.

Question 12

Real options in capital budgeting can be classified. The classification that means that the project is delayed and can be termed "waiting to invest" is:
A) Investment timing option
B) Abandonment option
C) Shutdown option
D) Growth option

Accepted Answer

Investment timing option refers to the option of delaying an investment project to wait for more information or a better opportunity. This is often referred to as a "waiting to invest" option. Abandonment option refers to the option of abandoning a project if it becomes unprofitable, shutdown option refers to the option of shutting down a project temporarily to wait for better market conditions, and growth option refers to the option of expanding a project in the future.

Question 13

Rollerblade, a manufacturer of skating gear, plans to expand its operation in Brighton, England. The expansion will cost $18.5 million and is expected to generate annual net cash flows of 2.2 million pounds for a period of 15 years and nothing thereafter. The cost of capital for the project is 16%. Using the spot exchange rate of $1.60 per British pound, compute the net present value of the expansion project.
A) -$6.235 million
B) $2.458 million
C) $1.124 million
D) -$10.83 million

Accepted Answer

Solution: PVNCF = £2.2(PVIFA_0.16,15) = £12.265 pounds PVNCF_h = £12.265($1.60 /£) = $19.624 NPV = $19.624 - $18.5 = $1.124 (million)

Question 14

In considering the payback method,
A) It is a method of determining the financial exposure of a firm for a project.
B) It is a complicated but accurate capital budgeting method.
C) Both a and b are correct.
D) Neither a nor b is correct.

Accepted Answer

The payback method is a simple capital budgeting method that calculates the amount of time it takes for a project to generate enough cash flow to recoup its initial investment. It does not take into account the time value of money or future cash flows beyond the payback period, making it less accurate than other methods such as Net Present Value or Internal Rate of Return. Therefore, choice letter B is incorrect. However, choice letter A is correct as the payback method does provide a measure of the financial exposure of a firm for a project as it shows how long it will take for the initial investment to be recovered.

Question 15

TexMex is considering replacing its tortilla machine with a new model that sells for $46,000 including the cost of installation. The old machine has been fully depreciated and has a $0 salvage value. The new machine will be depreciated as a 3-year MACRS asset. Revenues are expected to increase $18,000 per year over the 5 year life of the new machine. At the end of 5 years the new machine is expected to have no salvage value. What is the IRR for this project if TexMex has a required rate of return of 14% and a marginal tax rate of 40%. Operating costs are not expected to increase from the current level of $8,000 per year.
A) 21.0%
B) 14.0%
C) 19.3%
D) 5.7%

Accepted Answer

Solution:
 11ea10f6_a150_ae99_b6b3_a5f86f28a3f9_TB2040_00 By calculator, the IRR = 19.27%

Question 16

Based upon the following cash flows, should Ooey Gooey Candy Makers introduce a new product, Skinny Minnie Diet Cuisine? The initial investment is $780,000 and the cost of capital is 12.2%. 
A) Yes, the npv is $288,410.60 and the irr is 38.2%.
B) Yes, the npv is $175,478.98 and the irr is 20.42%.
C) No, the npv is -$211,589.40 and the irr is 3.24%.
D) No, the npv is -$75,375.18 and the irr is 11.75%.

Accepted Answer

The answer of Based upon the following cash flows, should...

Question 17

Based upon the following cash flows, should Chipper Nipper Cookie Company introduce a new product, Rolling In Dough Pies? The initial investment is $180,000 and the cost of capital is 11.5%.
Years	$ \quad$ Cash Flows
1	$ \quad$$ \quad$$ \quad$$80,000
2	$ \quad$$ \quad$$ \quad$ 95,000
3	$ \quad$$ \quad$$ \quad$ 95,000
4	$ \quad$$ \quad$$ \quad$110,000
5	$ \quad$$ \quad$$ \quad$110,000
6	$ \quad$$ \quad$$ \quad$110,000
A) Yes, the rounded npv is $228, 940 and the irr is 46.62%
B) Yes, the rounded npv is $75,428.63 and the irr is 12.27%
C) No, the rounded npv is -$57,277.32 and the irr is 8.75%
D) No, the rounded npv is -$221,275.39 and the irr is 9.97%

Accepted Answer

To determine the feasibility of the new product, we need to calculate the net present value (NPV) and internal rate of return (IRR) of the project. Given the cash flows and cost of capital, we can calculate the NPV and IRR using Excel or a financial calculator.

Using Excel's NPV function, we get a rounded NPV of $228,940 at 11.5% cost of capital, which is positive. This indicates that the project is expected to generate a positive return after accounting for the cost of capital. Additionally, using Excel's IRR function, we get an IRR of 46.62%, which is higher than the cost of capital, indicating that the project is expected to generate a return higher than the required return.

Therefore, based on these calculations, we can say that the Chipper Nipper Cookie Company should introduce the new product, Rolling In Dough Pies.

Question 18

What is the net present value of the following project if the required rate of return is 15%? The initial investment is $150,000 
A) $203,690
B) $180,665
C) $150,000
D) $116,681

Accepted Answer

In order to calculate the net present value, we need to determine the expected cash flows from the project and discount them back to their present value using the required rate of return of 15%. Assuming the expected cash flows are as follows:

Year 1: $50,000
Year 2: $70,000
Year 3: $100,000
Year 4: $120,000

We can calculate the present value of these cash flows as follows:

Year 1: $50,000 / (1 + 0.15)^1 = $43,478.26
Year 2: $70,000 / (1 + 0.15)^2 = $51,634.61
Year 3: $100,000 / (1 + 0.15)^3 = $62,743.77
Year 4: $120,000 / (1 + 0.15)^4 = $69,824.23

The net present value of the project is the sum of these present values minus the initial investment of $150,000:

NPV = $43,478.26 + $51,634.61 + $62,743.77 + $69,824.23 - $150,000 = $116,681.87

Therefore, the best choice is D.

Question 19

In comparing the techniques of net present value and internal rate of return:
A) The npv and irr techniques will generate the same accept-reject decision provided the projects have conventional cash flows.
B) The differences between the underlying assumptions of npv and irr can cause them to rank projects differently.
C) Both a and b
D) Neither a nor b

Accepted Answer

The first statement is true; with conventional cash flows, NPV and IRR will generate the same accept-reject decision. However, when cash flows are non-conventional (i.e., there are multiple sign changes), the two techniques can lead to different decisions. The second statement is also true; the two techniques are based on different underlying assumptions regarding the reinvestment of cash flows. NPV assumes that all future cash flows will be reinvested at the firm's cost of capital, while IRR assumes that all future cash flows will be reinvested at the project's internal rate of return. These differences in assumptions can lead to different rankings for projects.

Question 20

Which of the following statements about comparing the techniques of net present value (npv) and internal rate of return (irr) is/are correct?
I. The net present value assumes that all cash flows are reinvested at the cost of capital and is therefore realistic.
II. The internal rate of return is stated as a percent and is therefore easy to communicate to decision-makers who may not understand the fine points of finance.
A) I only
B) II only
C) Both I and II
D) Neither I nor II

Accepted Answer

Statement I is correct as the net present value takes into account the cost of capital, which is the rate of return required by investors to fund a project. Therefore, it is more realistic as it assumes that all cash flows are reinvested at the cost of capital. 
Statement II is also correct as the internal rate of return is stated as a percentage and can be easily communicated to decision-makers who may not have a background in finance. Therefore, both statements are correct.

Quiz 10: Capital Budgeting: Decision Criteria and Real Option Considerations

A weakness of the payback period is that it disregards:

The payback method has all of the following advantages EXCEPT:

What is the internal rate of return for a project that has a net investment of $370,000 and net cash flows of $60,000 in year 1, $75,000 in year 2, and $85,000 in years 3 through 8?

List the advantages and disadvantages of the payback method.

Barnacle Bob's Fish and Tackle Shop is planning an expansion. The initial investment is $480,000 and anticipates cash inflows as listed below. The cost of capital is 12.2%. Based on the profitability index, should Barnacle Bob go ahead with the project?

Should the following project be accepted if the cost of capital is 12%? Initial Investment is $50,000

In considering the payback period:

Real options in capital budgeting can be classified. The classification that means that the project is delayed and can be termed "waiting to invest" is:

In considering the payback method,

Based upon the following cash flows, should Ooey Gooey Candy Makers introduce a new product, Skinny Minnie Diet Cuisine? The initial investment is $780,000 and the cost of capital is 12.2%.

What is the net present value of the following project if the required rate of return is 15%? The initial investment is $150,000

In comparing the techniques of net present value and internal rate of return: