Chapter 08 - Net Present Value and Other Investment Criteria
Multiple Choice Questions
105. Baker's Supply imposes a payback pa yback cutoff of 3.5 years for its international investment projects. If the company has the following two projects available, should it accept either of them?
A. Accept both Projects A and B A. Accept B. Accept B. Accept Project A but not Project B C. Accept C. Accept Project B but not Project A D. Both D. Both Project A and B are acceptable but you can only select one project E. Reject both Projects A and B Payback A = 3 + [($57,000 - $9,000 - $14,800 - $18,900)/$19,600] = 3.73 years Payback B = 3 + [($61,000 - $16,500 - $26,300 - $15,600)/$4,900 = 3.53 years The firm should reject both projects.
AACSB: Analytic Bloom's: Analysis Difficulty: Basic Learning Objective: 08-01 Summarize Summarize the payback rule and some some of its shortcomings. Section: 8.2 Topic: Payback period
106. You're trying to determine whether or not to expand your business by building a new manufacturing plant. The plant has an installation cost of $26 million, which will be depreciated straight-line to zero over its three-year life. If the plant has p rojected net income of $2,348,000, $2,680,000, and $1,920,000 over these three years, what is the project's average accounting return (AAR)? A. 11.69 percent B. 14.14 percent C. 15.08 percent D. 17.82 percent E. 19.21 percent AAR = [($2,348,000 + $2,680,000 + $1,920,000)/3] + [($26,000,000 + $0)/2] = 17.82 percent
AACSB: Analytic Bloom's: Analysis Difficulty: Basic Learning Objective: 08-02 Discuss accounting rates of return and some of the problems with them. Section: 8.3 Topic: Average accounting return
107. What is the IRR of the following set of cash flows?
A. 12.93 percent B. 14.90 percent C. 15.81 percent D. 16.33 percent E. 17.78 percent The IRR is the rate that makes the NPV equal zero.
AACSB: Analytic Bloom's: Analysis Difficulty: Basic Learning Objective: 08-03 Explain the internal rate of return criterion and its associated strengths and weaknesses. Section: 8.4 Topic: Internal rate of return
108. What is the NPV of the following set of cash flows at a discount rate of zero percent? What if the discount rate is 15 percent?
A. -$41,700; -$8,665.07 B. -$41,700; $1,208.19 C. $0; $1,208.19 D. $2,500; $1,208.19 E. $2,500; -$8,665.07 NPV0 percent = -$41,700 + $13,200 + $11,900 + $19,100 = $2,500
AACSB: Analytic Bloom's: Analysis Difficulty: Basic Learning Objective: 08-04 Evaluate proposed investments by using the net present value criterion. Section: 8.1 Topic: Net present value
109. Chestnut Tree Farms has identified the following two mutually exclusive projects:
Over what range of discount rates would you choose Project A? A. 8.28 percent or less B. 8.28 percent or more C. 9.33 percent or more D. 9.55 percent or less E. 9.55 percent or more
Project A should is preferred if the discount rate is 9.55 percent, or less.
AACSB: Analytic Bloom's: Analysis Difficulty: Basic Learning Objective: 08-03 Explain the internal rate of return criterion and its associated strengths and weaknesses. Section: 8.4 Topic: NPV Profile
110. Jefferson International is trying to choose between the following two mutually exclusive design projects:
The required return is 12 percent. If the company applies the profitability index (PI) decision rule, which project should the firm accept? If the company applies the NPV decision rule, which project should it take? Given your first two answers, which project should the firm actually accept? A. Project A; Project B; Project A B. Project A; Project B; Project B C. Project B; Project A; Project A D. Project B; Project A; Project B E. Project B; Project B, Project B
The firm should select project A because the PI rule should not be applied to mutually exclusive projects.
AACSB: Analytic Bloom's: Analysis Difficulty: Basic Learning Objective: 08-04 Evaluate proposed investments by using the net present value criterion. and 08-06 Calculate the profitability index and understand its relation to net present value. Section: 8.1 and 8.5 Topic: Net present value and profitability index
111. Consider the following two mutually exclusive projects:
Whichever project you choose, if any, you require a 14 percent return on your investment. If you apply the payback criterion, you will choose investment _____, if you apply the NPV criterion, you will choose investment _____; if you apply the IRR criterion, you will choose investment ____; if you choose the profitability index criterion, you will choose investment ____. Based on your first four answers, which project will you finally choose? A. A; B; A; A; B B. A; A; B; B; A C. A; A; B; B; B D. B; A; B; A; A E. B; A; B; B; A Payback A = ($54,000 - $12,700 - $23,200)/$27,600 = 2.66 years Payback B = ($23,000 - $11,600 - $11,200)/$12,500 = 2.02 years
The company should select Project A based on net present value. Payback ignores some cash flows and the time value of money. Neither the internal rate of return nor the profitability ratio are reliable methods when projects are mutually exclusive.
AACSB: Analytic Bloom's: Analysis Difficulty: Basic Learning Objective: 08-01 Summarize the payback rule and some of its shortcomings.; 08-03 Explain the internal rate of return criterion and its associated strengths and weaknesses.; 08-04 Evaluate proposed investments by using the net present value crit erion. and 08-06 Calculate the profitability index and understand its relation to net present value. Section: 8.1, 8.2, 8.4, and 8.5 Topic: Comparing investment criteria
112. Textiles Unlimited has gathered projected cash flows for two projects. At what interest rate would the company be indifferent between the two projects? Which project is better if the required return is above this interest rate?
A. 11.76 percent; A B. 12.49 percent; A C. 12.49 percent; B D. 13.15 percent; A E. 13.15 percent: B
AACSB: Analytic Bloom's: Analysis Difficulty: Basic Learning Objective: 08-03 Explain the internal rate of return criterion and its associated strengths and weaknesses. Section: 8.4 Topic: Net present value profile
113. Quattro, Inc. has the following mutually exclusive projects available. The company has historically used a 4-year cutoff for projects. The required return is 1 1 percent.
The payback for Project A is ____ while the payback for Project B is _____. The NPV for Project A is _____ while the NPV for Project B is _____. Which project, if any, should the company accept? A. 3.92 years; 3.64 years; $780.85; $1,211.48; accept both Project A and B B. 3.92 years; 3.79 years; -$211.60; $1,211.48; accept Project B only C. 3.92 years; 3.79 years; $780.85; -$7,945.93; accept Project A only D. 4.06 years; 3.64 years; $780.85; $1,211.48; accept both Project A and B E. 4.06 years; 3.79 years; -$211.60; -$7,945.93; reject both projects Payback A = 3 + ($82,000 - $15,700 - $18,300 - $23,900)/$26,200 = 3.92 years Payback B = 3 + ($125,000 - $38,600 - $33,400 - $31,200)/$27,500 = 3.79 years
AACSB: Analytic Bloom's: Analysis Difficulty: Basic Learning Objective: 08-01 Summarize the payback rule and some of its shortcomings. and 08-04 Evaluate proposed investments by using the net present value criterion. Section: 8.1 and 8.2 Topic: Payback and net present value
114. Miller and Sons is evaluating a project with the following cash flows:
The company uses a 10 percent interest rate on all of its projects. What is the MIRR of the project using the reinvestment approach? The discounting approach? The combination approach? A. 8.46 percent; 7.29 percent; 8.59 percent B. 8.46 percent; 7.38 percent; 8.61 percent C. 8.54 percent; 7.29 percent; 8.61 percent D. 8.54 percent; 7.38 percent; 8.59 percent E. 8.54 percent; 8.23 percent; 8.61 percent
Reinvestment approach:
Discounting approach:
Combination approach:
