Complete Test Bank + Net Present Value And Other + Ch5

Principles of Corporate Finance, 13e (Brealey)

Chapter 5 Net Present Value and Other Investment Criteria

1) Which of the following investment rules does not use the time value of money concept?

A) Net present value

B) Internal rate of return

C) The payback period

D) Profitability index

2) Suppose a firm has $100 million in excess cash. It could

A) invest the funds in projects with positive NPVs.

B) pay high dividends to the shareholders.

C) buy another firm.

D) do all of the options.

3) The following are measures used by firms when making capital budgeting decisions except

A) payback period.

B) internal rate of return.

C) P/E ratio.

D) net present value.

4) The survey of CFOs indicates that the NPV method is always, or almost always, used for evaluating investment projects by approximately

A) 12 percent of firms.

B) 20 percent of firms.

C) 57 percent of firms.

D) 75 percent of firms.

5) The survey of CFOs indicates that the IRR method is used for evaluating investment projects by approximately

A) 12 percent of firms.

B) 20 percent of firms.

C) 76 percent of firms.

D) 57 percent of firms.

6) Which of the following investment rules has the value additivity property?

A) The payback period method

B) The net present value method

C) The book rate of return method

D) The internal rate of return method

7) If the net present value (NPV) of project A is +$100 and that of project B is +$60, then the net present value of the combined projects is

A) +$100.

B) +$60.

C) +$160.

D) +$6,000.

8) If the NPV of project A is + $30 and that of project B is -$60, then the NPV of the combined projects is

A) +$30.

B) -$60.

C) -$30.

D) -$1,800.

9) You are given a job to make a decision on project X, which is composed of three independent projects A, B, and C that have NPVs of + $70, -$40 and + $100, respectively. How would you go about making the decision about whether to accept or reject the project?

A) Accept project X as it has a positive NPV.

B) Reject project X.

C) Break up the project into its components: Accept A and C, but reject B.

D) Break up the project into its components: Accept C.

10) If the NPV of project A is + $120, that of project B is -$40, and that of project C is + $40, what is the NPV of the combined project?

A) +$100

B) -$40

C) +$70

D) +$120

11) The net present value of a project depends upon the

A) company's choice of accounting method.

B) manager's tastes and preferences.

C) project's cash flows and opportunity cost of capital.

D) company's profitability index.

12) Which of the following investment rules may not use all possible cash flows in its calculations?

A) NPV

B) Payback period

C) IRR

D) Profitability index

13) The payback period rule

A) varies the cut-off point with the interest rate.

B) determines a cut-off point so that all projects accepted by the NPV rule will be accepted by the payback period rule.

C) requires an arbitrary choice of a cut-off point.

D) varies the cut-off point with the interest rate and requires an arbitrary choice of a cut-off point.

14) The payback period rule accepts all projects for which the payback period is

A) greater than the cut-off value.

B) less than the cut-off value.

C) positive.

D) an integer.

15) The main advantage of the payback rule is that it

A) adjusts for uncertainty of early cash flows.

B) is simple to use.

C) does not discount cash flows.

D) better accounts for salvage costs at the end of a project.

16) The following are disadvantages of using the payback rule except the rule

A) ignores all cash flow after the cut-off date.

B) does not use the time value of money.

C) is easy to calculate and use.

D) does not have the value additivity property.

17) Which of the following statements regarding the discounted payback period measure is true?

A) The discounted payback measure uses the time value of money concept.

B) The discounted payback measure is better than the NPV rule.

C) The discounted payback measure considers all cash flows.

D) The discounted payback measure exhibits the value additivity property.

18) If the cash flows for project A are C0 = −1,000; C1 = +600; C2 = +400; and C3 = +1,500, calculate the payback period.

A) One year

B) Two years

C) Three years

D) Cannot be determined

19) The cost of a new machine is $250,000. The machine has a five-year life and no salvage value. If the cash flow each year is equal to 25 percent of the cost of the machine, calculate the payback period for the project.

A) 2.0 years

B) 2.5 years

C) 3.0 years

D) 4.0 years

20) If the cash flows for project Z are C0 = -1,000; C1 = 600; C2 = 720; and C3 = 2,000, calculate the discounted payback period for the project at a discount rate of 20 percent.

A) 1 year

B) 2 years

C) 3 years

D) >3 years

21) Internal rate of return (IRR) method is also called the

A) discounted payback period method.

B) discounted cash flow (DCF) rate of return method.

C) modified internal rate of return (MIRR) method.

D) book rate of return method.

22) The quickest way to calculate the internal rate of return (IRR) of a project is by

A) trial and error method.

B) using the graphical method.

C) using a financial calculator.

D) doubling the opportunity cost of capital.

23) If an investment project (normal project) has an IRR equal to the cost of capital, the NPV for that project is

A) positive.

B) negative.

C) zero.

D) unable to be determined.

24) If the cash flows for Project M are C0 = -1,000; C1 = +200; C2 = +700; and C3 = +698, calculate the IRR for the project.

A) 23 percent

B) 21 percent

C) 19 percent

D) 17 percent

25) The IRR is defined as

A) the discount rate that makes a project's NPV equal to zero.

B) the difference between the cost of capital and the present value of the cash flows.

C) the discount rate used in the NPV method.

D) the discount rate used in the discounted payback period method.

26) Which of the following methods of evaluating capital investment projects incorporates the time value of money concept?

A) Payback period, discounted payback period, and net present value (NPV) only

B) Discounted payback period, net present value (NPV), and internal rate of return only

C) Net present value (NPV) and internal rate of return only

D) Payback period, discounted payback period, net present value (NPV), and internal rate of return

27) Driscoll Company is considering investing in a new project. The project will need an initial investment of $2,400,000 and will generate $1,200,000 (after-tax) cash flows for three years. Calculate the IRR for the project.

A) 14.5 percent

B) 18.6 percent

C) 20.2 percent

D) 23.4 percent

28) The following are some of the shortcomings of the IRR method except

A) IRR is conceptually easy to communicate.

B) projects can have multiple IRRs.

C) IRR cannot distinguish between a borrowing project and a lending project.

D) it is very cumbersome to evaluate mutually exclusive projects using the IRR method.

29) Project X has the following cash flows: C0 = +2,000, C1 = -1,300, and C2 = -1,500. If the IRR of the project is 25 percent and if the cost of capital is 18 percent, you would

A) accept the project.

B) reject the project.

30) Project X has the following cash flows: C0 = +2,000, C1 = -1,150, and C2 = -1,150. If the IRR of the project is 9.85 percent and if the cost of capital is 12.00 percent, you would

A) accept the project.

B) reject the project.

31) If the sign of the cash flows for a project changes two times, then the project likely has

A) one IRR.

B) two IRRs.

C) three IRRs.

D) four IRRs.

32) Project Y has following cash flows: C0 = -800, C1 = +5,000, and C2 = -5,000. Calculate the IRRs for the project.

A) 25 percent and 400 percent.

B) 125 percent and 500 percent.

C) -44 percent and 11.6 percent.

D) No IRRs exist for this project.

33) Music Company is considering investing in a new project. The project will need an initial investment of $2,400,000 and will generate $1,200,000 (after-tax) cash flows for three years. Calculate the NPV for the project if the cost of capital is 15 percent.

A) $169, 935

B) $1,200,000

C) $339,870

D) $125,846

34) Muscle Company is investing in a giant crane. It is expected to cost $6.5 million in initial investment, and it is expected to generate an end-of-year cash flow of $3.0 million each year for three years. Calculate the IRR.

A) 14.6 percent

B) 16.4 percent

C) 18.2 percent

D) 22.1 percent

35) A project will have only one internal rate of return if

A) the net present value is positive.

B) the net present value is negative.

C) the cash flows decline over the life of the project.

D) there is a one-sign change in the cash flows.

36) Story Company is investing in a giant crane. It is expected to cost $6 million in initial investment, and it is expected to generate an end-of-year after-tax cash flow of $3 million each year for three years. Calculate the NPV at 12 percent.

A) $2.40 million

B) $1.20 million

C) $0.80 million

D) $0.20 million

37) Dry-Sand Company is considering investing in a new project. The project will need an initial investment of $1,200,000 and will generate $600,000 (after-tax) cash flows for three years. However, at the end of the fourth year, the project will generate -$500,000 of after-tax cash flow due to dismantling costs. Calculate the MIRR (modified internal rate of return) for the project if the cost of capital is 15 percent. The reinvestment rate is 12 percent.

A) 11.5 percent

B) 12.6 percent

C) 28.2 percent

D) 20.4 percent

38) Mass Company is investing in a giant crane. It is expected to cost $6 million in initial investment, and it is expected to generate an end-of-year cash flow of $3 million each year for three years. At the end of the fourth year, there will be a $1 million disposal cost. Calculate the MIRR for the project if the cost of capital is 12 percent.

A) 17.8 percent

B) 15.3 percent

C) 23.8 percent

D) 22.1 percent

39) If the cash flows for project A are C0 = -3,000, C1 = +500; C2 = +1,500; and C3 = +5,000, calculate the NPV of the project using a 15 percent discount rate.

A) $5,000

B) $2,352

C) $3,201

D) $1,857

40) One can use the profitability index most usefully for which situation?

A) When capital rationing exists

B) Evaluation of exceptionally long-term projects

C) Evaluation of nonnormal projects

D) When a project has unusually high cash flow uncertainty

41) The profitability index is the ratio of the

A) future value of cash flows to investment.

B) net present value of cash flows to investment.

C) net present value of cash flows to IRR.

D) present value of cash flows to IRR.

42) The following table gives the available projects (in $millions) for a firm.

If the firm has a limit of $210 million to invest, what is the maximum NPV the company can obtain?

A) 200

B) 283

C) 307

D) 347

43) The following table gives the available projects (in $millions) for a firm.

The firm has only $20 million to invest. What is the maximum NPV that the company can obtain?

A) 3.5

B) 4.0

C) 4.5

D) 5.0

44) The benefit-cost ratio is defined as the ratio of

A) net present value cash flows to initial investment.

B) present value of cash flows to initial investment.

C) net present value of cash flows to IRR.

D) present value of cash flows to IRR.

45) What is the profitability index of an investment with cash flows in years 0 thru 4 of -340, 120, 130, 153, and 166, respectively, and a discount rate of 16 percent?

A) .15

B) .22

C) .35

D) .42

46) Which investment analysis technique is used the least by CFOs?

A) Net present value

B) Internal rate of return

C) Payback

D) Book rate of return

47) How does modified internal rate of return (MIRR) differ from IRR?

A) MIRR does not consider cash flows occurring after the cut-off date.

B) MIRR uses NPV, IRR does not.

C) MIRR calculates the PV of cash inflows and then divides by the PV of the investment.

D) MIRR reduces the number of sign changes in a cash flow sequence.

48) The profitability index is always less than 1.

49) The profitability index of a positive NPV project is always positive.

50) Present values have the value additivity property.

51) The payback rule ignores all cash flows after the cut-off date.

52) The discounted payback method calculates the payback period and then discounts the payback period at the opportunity cost of capital.

53) The internal rate of return is the discount rate that makes the PV of a project's cash inflows equal to zero.

54) The IRR rule states that firms should accept any investment (normal) project offering an internal rate of return in excess of the cost of capital.

55) In the case of a loan project (borrowing), one should accept the project if the IRR is more than the cost of capital.

56) There can never be more than one value of the IRR for any sequence of cash flows.

57) Decommissioning and clean-up costs for any project are always insignificant and should typically be ignored.

58) The benefit-cost ratio is equal to the profitability index plus one.

59) Soft rationing may be used to control managerial behavior.

60) The internal rate of return is the discount rate that makes the NPV of a project's cash flows equal to zero.

61) A project's internal rate of return depends on its level of risk.

62) A project's "book value" represents, essentially, the market valuation of the project.

63) Accounting earnings from a firm's income statement, prepared according to generally accepted accounting principles (GAAP), are typically the best data source for calculating a project's NPV.

64) The discounted payback method discounts cash flows at the opportunity cost of capital and then calculates the payback period.

65) The discounted payback method will never accept a negative-NPV project.

66) The denominator of the profitability index is the present value of the investment.

67) Briefly explain the value additivity property.

68) Discuss some of the advantages of using the payback method.

69) Discuss some of the disadvantages of the payback rule.

70) What are some of the disadvantages of using the IRR method?

71) What are some of the advantages of using the IRR method?

72) Briefly discuss capital rationing.

73) Briefly explain the term soft rationing.

74) Briefly explain the term hard rationing.