Question 1

If a project has a profitability index greater than 1,

Accepted Answer

If the profitability index is greater than 1, the present value of future cash flows is expected to exceed the amount invested in the project. This indicates a positive net present value, and also implies that the project's internal rate of return (IRR) must be higher than the required rate of return in order to achieve this level of profitability. Therefore, all of the above options are correct.

Question 2

A project has an initial outlay of $4,000. It has a single payoff at the end of Year 4 of $6,996.46. What is the IRR for the project (round to the nearest percent)?

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. The IRR for this project can be found using the formula for NPV = 0: $0 = -$4,000 + $6,996.46 / (1 + IRR)^4. Solving for IRR gives an approximate rate of 15%, hence option D is correct.

Question 3

Dieyard Battery Recyclers is considering a project with the following cash flows
Initial outlay = $13,000
Cash flows: Year 1 = $5,000
Year 2 = $3,000
Year 3 = $9,000
If the appropriate discount rate is 15%, compute the NPV of this project.

Accepted Answer

The answer of Dieyard Battery Recyclers is considering a project...

Question 4

Equipment should be replaced whenever replacement results in a positive NPV.

Accepted Answer

This statement is true. NPV (Net Present Value) is a financial metric used to evaluate the profitability of an investment by comparing the present value of cash inflows to the present value of cash outflows over a defined period of time. If the NPV of replacing equipment is positive, it means that the benefits of the new equipment outweigh the costs and the investment is profitable, making it a wise decision to replace the equipment.

Question 5

Your company is considering a project with the following cash flows: Initial outlay = $1,748.80
Cash flows Years 1-6 = $500
Compute the IRR on the project.

Accepted Answer

To calculate the IRR, we need to solve for the discount rate that sets the net present value (NPV) of the cash flows equal to zero. Using a financial calculator or Excel, we can find that the IRR for this project is 18%. This is the discount rate at which the present value of the cash inflows equals the present value of the initial outlay. Since this IRR is higher than the company's required rate of return, the project is considered attractive and should be accepted.

Question 6

The required rate of return represents the cost of capital for a project.

Accepted Answer

The required rate of return is the minimum rate of return that an investor expects to receive from an investment to compensate for the risk and opportunity cost of capital. It represents the cost of capital from the investor's perspective.

Question 7

When charting a project's NPV profile, the curve will cross the horizontal axis at

Accepted Answer

The NPV profile plots the net present value of a project at different discount rates. The curve crosses the horizontal axis when NPV equals 0, which represents the project's break-even point. At this point, the project isn't generating any profit or loss. If we move to the left of the break-even point on the curve, the NPV is positive, indicating that the project is profitable. When we move to the right of the break-even point, the NPV is negative, indicating that the project is not-profitable. The intersection of the curve and the horizontal axis represents the project's IRR, which is the discount rate that makes the NPV equal to zero. Therefore, all of the above choices are correct.

Question 8

Compute the payback period for a project with the following cash flows, if the company's discount rate is 12%. Initial outlay = $450
Cash flows: Year 1 = $325
Year 2 = $65
Year 3 = $100

Accepted Answer

The payback period is the time it takes for the cumulative cash flows to equal the initial investment. By the end of Year 2, the cumulative cash flow is $390 ($325 + $65). In Year 3, an additional $60 is needed to reach $450, which takes 0.6 years ($60/$100). Thus, the payback period is 2.6 years.

Question 9

The higher the discount rate, the greater the importance of the early cash flows.

Accepted Answer

The higher the discount rate, the more weight is given to present values, making the earlier cash flows more important.

Question 10

What is the NPV of a $45,000 project that is expected to have an after-tax cash flow of $14,000 for the first two years, $10,000 for the next two years, and $8,000 for the fifth year? Use a discount rate of 8%. Would you accept or reject the investment?

Accepted Answer

The answer of What is the NPV of a $45,000...

Question 11

Given the following annual net cash flows, determine the IRR to the nearest whole percent of a project with an initial outlay of $1,800. Year Net Cash Flow
1 $1,000
2 $750
3 $500

Accepted Answer

Using a financial calculator or Excel function, the IRR is approximately 14%. This is the discount rate that makes the net present value (NPV) of the cash flows equal to the initial outlay of $1,800. At an IRR of 14%, the NPV is approximately zero. Therefore, choice A is the best option.

Question 12

Net present value is suitable for comparing projects with unequal lives.

Accepted Answer

Net present value (NPV) does not inherently account for differences in project lifespans, which can lead to misleading comparisons when evaluating projects with unequal lives. Methods like equivalent annual cost (EAC) or repeating the shorter project to match the longer one's lifespan are often used to adjust for this.

Question 13

What is the NPV of a $45,000 project that is expected to have an after-tax cash flow of $14,000 for the first two years, $10,000 for the next two years, and $8,000 for the fifth year? Use a 10% discount rate. Would you accept the project?

Accepted Answer

The answer of What is the NPV of a $45,000...

Question 14

Which of the following is a correct EXCEL formula to solve for the net present value of a project? Assume that CF0 is expressed as a negative number.

Accepted Answer

The answer of Which of the following is a correct...

Question 15

Two projects are under consideration by the same company at the same time. Project Alpha has a NPV of $20 million and an estimated useful life of 10 years. Project Beta has a NPV of $12 million and also an estimated useful life of 10 years. What should the company's decision be?
a) if the projects involve unrelated expansion decisions or
b) if the projects are mutually exclusive because they would have to occupy the same space?

Accepted Answer

The answer of Two projects are under consideration by the...

Question 16

Mutually exclusive projects may be ranked differently when higher or lower discount rates are used.

Accepted Answer

Mutually exclusive projects are those where selecting one project means rejecting the others. The selection of a project primarily depends on the discounted cash flows generated by each project. The level of discount rate used to compute these cash flows can significantly impact a project's profitability. Therefore, when different discount rates are applied, the projects may be ranked differently because of varying cash flows.

Question 17

Webley Corp. is considering two expansion options, but does not have enough capital to undertake both. Project W requires an investment of $100,000 and has an NPV of $10,000. Project D requires an investment of $80,000 and has an NPV of $8,200. If Webley uses the profitability index to decide, it would

Accepted Answer

The profitability index (PI) is calculated as the ratio of the present value of future cash flows (or NPV + initial investment) to the initial investment. For Project W, PI = ($10,000 + $100,000) / $100,000 = 1.1. For Project D, PI = ($8,200 + $80,000) / $80,000 = 1.1025. Project D has a higher PI, making it the preferred choice.

Question 18

Dudster Manufacturing has 2 options for installing legally required safety equipment. Option Ex has an initial cost of $25,000 and annual operating costs over 3 years of $5,000, $5,250, $5,600. Option WYE has an initial cost of $40,000 and annual operating costs of $4,000, $4,200, $4,450, $4,750, $5,100. Whether Dudster chooses Ex or Wye, the equipment is always needed and must be replaced at the end of its useful life. Which choice is least expensive over the long run? Use a discount rate of 9%.

Accepted Answer

The answer of Dudster Manufacturing has 2 options for installing...

Question 19

Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). If the company 's required rate of return is 12%, the project should be

Accepted Answer

To determine whether the project should be accepted or not, we need to calculate the net present value (NPV) of the project using the given cash flows and the company's required rate of return of 12%.

NPV = -Initial Investment + (CF1 / (1+r)^1) + (CF2 / (1+r)^2) + (CF3 / (1+r)^3)

NPV = -115,000 + (140,000 / (1+0.12)^1) + (140,000 / (1+0.12)^2) + (-170,000 / (1+0.12)^3)

NPV = $34,288.71

Since the NPV is positive at 12%, the project should be accepted. Therefore, the correct answer is B.

Question 20

Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000).

Accepted Answer

This project has non-conventional cash flows with both positive and negative cash flows. Therefore, it is possible for this project to have more than one IRR.

Quiz 11: Investment Decision Criteria

If a project has a profitability index greater than 1,

A project has an initial outlay of $4,000. It has a single payoff at the end of Year 4 of $6,996.46. What is the IRR for the project (round to the nearest percent) ?

Dieyard Battery Recyclers is considering a project with the following cash flows Initial outlay = $13,000 Cash flows: Year 1 = $5,000 Year 2 = $3,000 Year 3 = $9,000 If the appropriate discount rate is 15%, compute the NPV of this project.

Equipment should be replaced whenever replacement results in a positive NPV.

Your company is considering a project with the following cash flows: Initial outlay = $1,748.80 Cash flows Years 1-6 = $500 Compute the IRR on the project.