ch05

Student:

1. An investment is acceptable if the profitability index (PI) of the investment is:

A. greater than one.
B. less than one.
C. greater than the internal rate of return (IRR).
D. less than the net present value (NPV).
E. greater than a pre-specified rate of return.
2. Graphing the NPVs of mutually exclusive projects over different discount rates helps demonstrate:
A. how the incremental IRR varies with changes in the discount rate.
B. how decisions concerning mutually exclusive projects are derived.
C. how the duration of a project affects the decision as to which project to accept.
D. how the payback period and the initial cash outflow of a project are related.
E. how the profitability index and the net present value are related.
3. Matt is analyzing two mutually exclusive projects of similar size and has prepared the following data.
Both projects have 5 year lives.

Matt has been asked for his best recommendation given this information. His recommendation should be
to accept:
A. project B because it has the shortest payback period.
B. both projects as they both have positive net present values.
C. project A and reject project B based on their net present values.
D. project B and reject project A based on other criteria not mentioned in the problem.
E. project B and reject project A based on both the payback period and the average accounting return.
4. Which of the following methods of project analysis are biased towards short-term projects?
I. Internal rate of return
II. Net present value
III. Payback
IV. Discounted payback
A. I and II only
B. III and IV only
C. II and III only
D. I and IV only
E. II and IV only
5. A project will have more than one IRR if:
A. the IRR is positive.
B. the IRR is negative.
C. the NPV is zero.
D. the cash flow pattern exhibits more than one sign change.
E. the cash flow pattern exhibits exactly one sign change.
6. An investment with an initial cost of $15,000 produces cash flows of $5,000 annually for 5 years. If the
cash flow is evenly spread out over the year and the firm can borrow at 10%, the discounted payback
period is years.
A. 3
B. 3.2
C. 3.75
D. 4
E. 5
7. The difference between the present value of an investment and its cost is the:
A. net present value.
B. internal rate of return.
C. payback period.
D. profitability index.
E. discounted payback period.
8. Which one of the following statements concerning net present value (NPV) is correct?
A. An investment should be accepted if, and only if, the NPV is exactly equal to zero.
B. An investment should be accepted only if the NPV is equal to the initial cash flow.
C. An investment should be accepted if the NPV is positive and rejected if it is negative.
DAn investment with greater cash inflows than cash outflows, regardless of when the cash flows occur,
. will always have a positive NPV and therefore should always be accepted.
E. Any project that has positive cash flows for every time period after the initial investment should be
accepted.
9. The length of time required for an investment to generate cash flows sufficient to recover the initial cost
of the investment is called the:
A. net present value.
B. internal rate of return.
C. payback period.
D. profitability index.
E. discounted cash period.
10. Which one of the following statements is correct concerning the payback period?
A. An investment is acceptable if its calculated payback period is less than some pre-specified period of
time.
B. An investment should be accepted if the payback is positive and rejected if it is negative.
C. An investment should be rejected if the payback is positive and accepted if it is negative.
D. An investment is acceptable if its calculated payback period is greater than some pre-specified period
of time.
E An investment should be accepted any time the payback period is less than the discounted payback
. period, given a positive discount rate.
11. The length of time required for a project's discounted cash flows to equal the initial cost of the project is
called the:
A. net present value.
B. internal rate of return.
C. payback period.
D. discounted profitability index.
E. discounted payback period.
12. The discounted payback rule states that you should accept projects:
A. which have a discounted payback period that is greater than some pre-specified period of time.
B. if the discounted payback is positive and rejected if it is negative.
C. only if the discounted payback period equals some pre-specified period of time.
D. if the discounted payback period is less than some pre-specified period of time.
E. only if the discounted payback period is equal to zero.
13. The discount rate that makes the net present value of an investment exactly equal to zero is called the:
A. external rate of return.
B. internal rate of return.
C. average accounting return.
D. profitability index.
E. equalizer.
14. An investment is acceptable if its IRR:
A. is exactly equal to its net present value (NPV).
B. is exactly equal to zero.
C. is less than the required return.
D. exceeds the required return.
E. is exactly equal to 100%.
15. The possibility that more than one discount rate will make the NPV of an investment equal to zero is
called the problem.
A. net present value profiling
B. operational ambiguity
C. mutually exclusive investment decision
D. issues of scale
E. multiple rates of return
16. A situation in which accepting one investment prevents the acceptance of another investment is called
the:
A. net present value profile.
B. operational ambiguity decision.
C. mutually exclusive investment decision.
D. issues of scale problem.
E. multiple choices of operations decision.
17. The present value of an investment's future cash flows divided by the initial cost of the investment is
called the:
A. net present value.
B. internal rate of return.
C. average accounting return.
D. profitability index.
E. profile period.
18. An investment is acceptable if the profitability index (PI) of the investment is:
A. greater than one.
B. less than one.
C. greater than the internal rate of return (IRR).
D. less than the net present value (NPV).
E. greater than a pre-specified rate of return.
19. All else constant, the net present value of a typical investment project increases when:
A. the discount rate increases.
B. each cash inflow is delayed by one year.
C. the initial cost of a project increases.
D. the rate of return decreases.
E. all cash inflows occur during the last year of a project's life instead of periodically throughout the life
of the project.
20. The primary reason that company projects with positive net present values are considered acceptable is
that:
A. they create value for the owners of the firm.
B. the project's rate of return exceeds the rate of inflation.
C. they return the initial cash outlay within three years or less.
D. the required cash inflows exceed the actual cash inflows.
E. the investment's cost exceeds the present value of the cash inflows.
21. If a project has a net present value equal to zero, then:
I. the present value of the cash inflows exceeds the initial cost of the project.
II. the project produces a rate of return that just equals the rate required to accept the project.
III. the project is expected to produce only the minimally required cash inflows.
IV. any delay in receiving the projected cash inflows will cause the project to have a negative net present
value.
A. II and III only
B. II and IV only
C. I, II, and IV only
D. II, III, and IV only
E. I, II, and III only
22. Net present value:
A. cannot be used when deciding between two mutually exclusive projects.
B. is more useful to decision makers than the internal rate of return when comparing different sized
projects.
C.is easy to explain to non-financial managers and thus is the primary method of analysis used by the
lowest levels of management.
D. is not an as widely used tool as payback and discounted payback.
E. is very similar in its methodology to the average accounting return.
23. Payback is frequently used to analyze independent projects because:
A. it considers the time value of money.
B. all relevant cash flows are included in the analysis.
C. it is easy and quick to calculate.
D. it is the most desirable of all the available analytical methods from a financial perspective.
E. it produces better decisions than those made using either NPV or IRR.
24. The advantages of the payback method of project analysis include the:
I. application of a discount rate to each separate cash flow.
II. bias towards liquidity.
III. ease of use.
IV. arbitrary cutoff point.
A. I and II only
B. I and III only
C. II and III only
D. II and IV only
E. II, III, and IV only
25. All else equal, the payback period for a project will decrease whenever the:
A. initial cost increases.
B. required return for a project increases.
C. assigned discount rate decreases.
D. cash inflows are moved earlier in time.
E. duration of a project is lengthened.
26. The discounted payback period of a project will decrease whenever the:
A. discount rate applied to the project is increased.
B. initial cash outlay of the project is increased.
C. time period of the project is increased.
D. amount of each project cash inflow is increased.
E. costs of the fixed assets utilized in the project increase.
27. The discounted payback rule may cause:
A. some positive net present value projects to be rejected.
B. the most liquid projects to be rejected in favor of less liquid projects.
C. projects to be incorrectly accepted due to ignoring the time value of money.
D. some projects with negative net present values to be accepted.
E.Both some positive net present value projects to be rejected; and some projects with negative net
present values to be accepted.
28. The internal rate of return (IRR):
I. rule states that a typical investment project with an IRR that is less than the required rate should be
accepted.
II. is the rate generated solely by the cash flows of an investment.
III. is the rate that causes the net present value of a project to exactly equal zero.
IV. can effectively be used to analyze all investment scenarios.
A. I and IV only
B. II and III only
C. I, II, and III only
D. II, III, and IV only
E. I, II, III, and IV
29. The internal rate of return for a project will increase if:
A. the initial cost of the project can be reduced.
B. the total amount of the cash inflows is reduced.
C. each cash inflow is moved such that it occurs one year later than originally projected.
D. the required rate of return is reduced.
E. the salvage value of the project is omitted from the analysis.
30. The internal rate of return is:
A.more reliable as a decision making tool than net present value whenever you are considering mutually
exclusive projects.
B. equivalent to the discount rate that makes the net present value equal to one.
C. difficult to compute without the use of either a financial calculator or a computer.
D. dependent upon the interest rates offered in the marketplace.
E. a better methodology than net present value when dealing with unconventional cash flows.
31. The internal rate of return tends to be:
A. easier for managers to comprehend than the net present value.
B. extremely accurate even when cash flow estimates are faulty.
C. ignored by most financial analysts.
D. used primarily to differentiate between mutually exclusive projects.
E. utilized in project analysis only when multiple net present values apply.
32. You are trying to determine whether to accept project A or project B. These projects are mutually
exclusive. As part of your analysis, you should compute the incremental IRR by determining:
A. the internal rate of return for the cash flows of each project.
B. the net present value of each project using the internal rate of return as the discount rate.
C. the discount rate that equates the discounted payback periods for each project.
D. the discount rate that makes the net present value of each project equal to 1.
E. the internal rate of return for the differences in the cash flows of the two projects.
33. Graphing the NPVs of mutually exclusive projects over different discount rates helps demonstrate:
A. how the incremental IRR varies with changes in the discount rate.
B. how decisions concerning mutually exclusive projects are derived.
C. how the duration of a project affects the decision as to which project to accept.
D. how the payback period and the initial cash outflow of a project are related.
E. how the profitability index and the net present value are related.
34. The profitability index is closely related to:
A. payback.
B. discounted payback.
C. average accounting return.
D. net present value.
E. internal rate of return.
35. Analysis using the profitability index:
A. frequently conflicts with the accept and reject decisions generated by the application of the net present
value rule.
B. is useful as a decision tool when investment funds are limited.
C. cannot be used to aid capital rationing.
D. utilizes the same basic variables as those used in the average accounting return.
E. produces results which typically are difficult to comprehend or apply.
36. If you want to review a project from a benefit-cost perspective, you should use the method of
analysis.
A. net present value
B. payback
C. internal rate of return
D. average accounting return
E. profitability index
37. When the present value of the cash inflows exceeds the initial cost of a project, then the project should
be:
A. accepted because the internal rate of return is positive.
B. accepted because the profitability index is greater than 1.
C. accepted because the profitability index is negative.
D. rejected because the internal rate of return is negative.
E. rejected because the net present value is negative.
38. Which one of the following is the best example of two mutually exclusive projects?
A. Planning to build a warehouse and a retail outlet side by side.
B. Buying sufficient equipment to manufacture both desks and chairs simultaneously.
C. Using an empty warehouse for storage or renting it entirely out to another firm.
D. Using the company sales force to promote sales of both shoes and socks.
E. Buying both inventory and fixed assets using funds from the same bond issue.
39. The Liberty Co. is considering two projects. Project A consists of building a wholesale book outlet on lot
#169 of the Englewood Retail Center. Project B consists of building a sit-down restaurant on lot #169 of
the Englewood Retail Center. When trying to decide whether to build the book outlet or the restaurant,
management should rely most heavily on the analysis results from the method of analysis.
A. profitability index
B. internal rate of return
C. payback
D. net present value
E. accounting rate of return
40. When two projects both require the total use of the same limited economic resource, the projects are
generally considered to be:
A. independent.
B. marginally profitable.
C. mutually exclusive.
D. acceptable.
E. internally profitable.
41. Matt is analyzing two mutually exclusive projects of similar size and has prepared the following data.
Both projects have 5 year lives.

Matt has been asked for his best recommendation given this information. His recommendation should be
to accept:
A. project B because it has the shortest payback period.
B. both projects as they both have positive net present values.
C. project A and reject project B based on their net present values.
D. project B and reject project A based on other criteria not mentioned in the problem.
E. project B and reject project A based on both the payback period and the average accounting return.
42. Given that the net present value (NPV) is generally considered to be the best method of analysis, why
should you still use the other methods?
A. The other methods help validate whether or not the results from the net present value analysis are
reliable.
B You need to use the other methods since conventional practice dictates that you only accept projects
. after you have generated three accept indicators.
C.You need to use other methods because the net present value method is unreliable when a project has
unconventional cash flows.
D. The internal rate of return must always indicate acceptance since this is the best method from a
financial perspective.
E The discounted payback method must always be computed to determine if a project returns a positive
. cash flow since NPV does not measure this aspect of a project.
43. In actual practice, managers may use the:
I. IRR because the results are easy to communicate and understand.
II. payback because of its simplicity.
III. net present value because it is considered by many to be the best method of analysis.
A. I and II only
B. II and III only
C. I and III only
D. I, II, and III
E. None of these
44. No matter how many forms of investment analysis you do:
A. the actual results from a project may vary significantly from the expected results.
B. the internal rate of return will always produce the most reliable results.
C. a project will never be accepted unless the payback period is met.
D. the initial costs will generally vary considerably from the estimated costs.
E. only the first three years of a project ever affect its final outcome.
45. Which of the following methods of project analysis are biased towards short-term projects?
I. Internal rate of return
II. Net present value
III. Payback
IV. Discounted payback
A. I and II only
B. III and IV only
C. II and III only
D. I and IV only
E. II and IV only
46. If a project is assigned a required rate of return equal to zero, then:
A. the timing of the project's cash flows has no bearing on the value of the project.
B. the project will always be accepted.
C. the project will always be rejected.
D. whether the project is accepted or rejected will depend on the timing of the cash flows.
E. the project can never add value for the shareholders.
47. You are considering a project with the following data:
Internal rate of return 8.7%
Profitability ratio .98
Net present value -$393
Payback period 2.44 years
Required return 9.5%
Which one of the following is correct given this information?
A. The discount rate used in computing the net present value must have been less than 8.7%.
B. The discounted payback period will have to be less than 2.44 years.
C. The discount rate used to compute the profitability ratio was equal to the internal rate of return.
D. This project should be accepted based on the profitability ratio.
E. This project should be rejected based on the internal rate of return.
48. Accepting positive NPV projects benefits the stockholders because:
A. it is the most easily understood valuation process.
B. the present value of the expected cash flows are equal to the cost.
C. the present value of the expected cash flows are greater than the cost.
D. it is the most easily calculated.
E. None of these.
49. Which of the following does not characterize NPV?
A. NPV does not explicitly incorporate risk into the analysis.
B. NPV incorporates all relevant cash flow information.
C. NPV uses all of the project's cash flows.
D. NPV discounts all future cash flows.
E. Using NPV will lead to decisions that maximize shareholder wealth.
50. The payback period rule:
A. discounts cash flows.
B. ignores initial cost.
C. always uses all possible cash flows in its calculation.
D. Both discounts cash flows; and always uses all possible cash flows in its calculation.
E. None of these.
51. The payback period rule accepts all investment projects in which the payback period for the cash flows
is:
A. greater than one.
B. greater than the cutoff point.
C. less than the cutoff point.
D. positive.
E. None of these.
52. The payback period rule is a convenient and useful tool because:
A. it provides a quick estimate of how rapidly the initial investment will be recouped.
B. results of a short payback rule decision will be quickly seen.
C. it does not have to take into account time value of money.
D. All of these.
E. None of these.
53. The discounted payback period rule:
A. considers the time value of money.
B. discounts the cutoff point.
C. ignores uncertain cash flows.
D. is preferred to the NPV rule.
E. None of these.
54. The payback period rule:
A. determines a cutoff point so that all projects accepted by the NPV rule will be accepted by the payback
period rule.
B. determines a cutoff point so that depreciation is just equal to positive cash flows in the payback year.
C. requires an arbitrary choice of a cutoff point.
D. varies the cutoff point with the interest rate.
EBoth determines a cutoff point so that all projects accepted by the NPV rule will be accepted by the
. payback period rule; and varies the cutoff point with the interest rate.
55. Modified internal rate of return:
A. handles the multiple IRR problem by combining cash flows until only one change in sign change
remains.
B. requires the use of a discount rate.
C. does not require the use of a discount rate.
D Both handles the multiple IRR problem by combining cash flows until only one change in sign change
. remains; and requires the use of a discount rate.
E Both handles the multiple IRR problem by combining cash flows until only one change in sign change
. remains; and does not require the use of a discount rate.
56. A mutually exclusive project is a project whose:
A. acceptance or rejection has no effect on other projects.
B. NPV is always negative.
C. IRR is always negative.
D. acceptance or rejection affects other projects.
E. cash flow pattern exhibits more than one sign change.
57. The two fatal flaws of the internal rate of return rule are:
A. arbitrary determination of a discount rate and failure to consider initial expenditures.
B. arbitrary determination of a discount rate and failure to correctly analyze mutually exclusive
investment projects.
C. arbitrary determination of a discount rate and the multiple rate of return problem.
D. failure to consider initial expenditures and failure to correctly analyze mutually exclusive investment
projects.
E. failure to correctly analyze mutually exclusive investment projects and the multiple rate of return
problem.
58. A project will have more than one IRR if:
A. the IRR is positive.
B. the IRR is negative.
C. the NPV is zero.
D. the cash flow pattern exhibits more than one sign change.
E. the cash flow pattern exhibits exactly one sign change.
59. Using internal rate of return, a conventional project should be accepted if the internal rate of return is:
A. equal to the discount rate.
B. greater than the discount rate.
C. less than the discount rate.
D. negative.
E. positive.
60. The internal rate of return may be defined as:
A. the discount rate that makes the NPV equal to zero.
B. the difference between the market rate of interest and the NPV.
C. the market rate of interest less the risk-free rate.
D. the project acceptance rate set by management.
E. None of these.
61. The problem of multiple IRRs can occur when:
A. there is only one sign change in the cash flows.
B. the first cash flow is always positive.
C. the cash flows decline over the life of the project.
D. there is more than one sign change in the cash flows.
E. None of these.
62. The elements that cause problems with the use of the IRR in projects that are mutually exclusive are:
A. the discount rate and scale problems.
B. timing and scale problems.
C. the discount rate and timing problems.
D. scale and reversing flow problems.
E. timing and reversing flow problems.
63. If there is a conflict between mutually exclusive projects due to the IRR, one should:
A. drop the two projects immediately.
B. spend more money on gathering information.
C. depend on the NPV as it will always provide the most value.
D. depend on the payback because it does not suffer from these same problems.
E. None of these.
64. The profitability index is the ratio of:
A. average net income to average investment.
B. internal rate of return to current market interest rate.
C. net present value of cash flows to internal rate of return.
D. net present value of cash flows to return on equity.
E. present value of cash flows to initial investment cost.
65. Which of the following statement is true?
A One must know the discount rate to compute the NPV of a project but one can compute the IRR
. without referring to the discount rate.
B One must know the discount rate to compute the IRR of a project but one can compute the NPV
. without referring to the discount rate.
C. Payback accounts for time value of money.
D. There will always be one IRR regardless of cash flows.
E. Return on equity is the ratio of total assets to total net income.
66. Graham and Harvey (2001) found that and were the two most popular capital budgeting
methods.
A. Internal Rate of Return; Payback Period
B. Internal Rate of Return; Net Present Value
C. Net Present Value; Payback Period
D. Modified Internal Rate of Return; Internal Rate of Return
E. Modified Internal Rate of Return; Net Present Value
67. What is the net present value of a project with the following cash flows and a required return of 12%?

A. -$287.22
B. -$177.62
C. $177.62
D. $204.36
E. $287.22
68. What is the net present value of a project that has an initial cash outflow of $12,670 and the following
cash inflows? The required return is 11.5%.

A. $218.68
B. $370.16
C. $768.20
D. $1,249.65
E. $1,371.02
69. A project will produce cash inflows of $1,750 a year for four years. The project initially costs $10,600 to
get started. In year five, the project will be closed and as a result should produce a cash inflow of $8,500.
What is the net present value of this project if the required rate of return is 13.75%?
A. -$5,474.76
B. -$1,011.40
C. -$935.56
D. $1,011.40
E. $5,474.76
70. You are considering the following two mutually exclusive projects that will not be repeated. The required
rate of return is 11.25% for project A and 10.75% for project B. Which project should you accept and
why?

A. project A; because its NPV is about $335 more than the NPV of project B.
B. project A; because it has the higher required rate of return.
C. project B; because it has the largest total cash inflow.
D. project B; because it returns all its cash flows within two years.
E. project B; because it is the largest sized project.
71. You are considering two mutually exclusive projects with the following cash flows. Will your choice
between the two projects differ if the required rate of return is 8% rather than 11%? If so, what should
you do?

A. yes; Select A at 8% and B at 11%.

B. yes; Select B at 8% and A at 11%.
C. yes; Select A at 8% and select neither at 11%.
D. no; Regardless of the required rate, project A always has the higher NPV.
E. no; Regardless of the required rate, project B always has the higher NPV.
72. What is the internal rate of return on an investment with the following cash flows?

A. 5.93%
B. 5.96%
C. 6.04%
D. 6.09%
E. 6.13%
73. An investment has the following cash flows. Should the project be accepted if it has been assigned a
required return of 9.5%? Why or why not?

A. yes; because the IRR exceeds the required return by about 0.39%.
B. yes; because the IRR is less than the required return by about 3.9%.
C. yes; because the IRR is positive.
D. no; because the IRR exceeds the required return by about 3.9%.
E. no; because the IRR is 9.89%.
74. You are considering two independent projects with the following cash flows. The required return for both
projects is 10%. Given this information, which one of the following statements is correct?

A. You should accept project B since it has the higher IRR and reject project A because you can not
accept both projects.
B. You should accept project A because it has the lower NPV and reject project B.
C. You should accept project A because it has the higher NPV and you can not accept both projects.
D. You should accept project B because it has the higher IRR and reject project A.
E. You should accept both projects if the funds are available to do so since both NPV's are > 0.
75. You are considering an investment with the following cash flows. If the required rate of return for this
investment is 13.5%, should you accept it based solely on the internal rate of return rule? Why or why
not?

A. Yes; because the IRR exceeds the required return.

B. Yes; because the IRR is a positive rate of return.
C. No; because the IRR is less than the required return.
D. No; because the IRR is a negative rate of return.
E. You can not apply the IRR rule in this case because there are multiple IRRs.
76. What is the profitability index for an investment with the following cash flows given a 9% required
return?

A. .96
B. .98
C. 1.00
D. 1.02
E. 1.04
77. Based on the profitability index (PI) rule, should a project with the following cash flows be accepted if
the discount rate is 8%? Why or why not?

A. Yes; because the PI is 1.008.

B. Yes; because the PI is .992.
C. Yes; because the PI is .999.
D. No; because the PI is 1.008.
E. No; because the PI is .992.
78. You are considering two independent projects both of which have been assigned a discount rate of 8%.
Based on the profitability index, what is your recommendation concerning these projects?

A. You should accept both projects since both of their PIs are positive.
B. You should accept project A since it has the higher PI.
C. You should accept both projects since both of their PIs are greater than 1.
D. You should only accept project B since it has the largest PI and the PI exceeds 1.
E. Neither project is acceptable.
79. You would like to invest in the following project.

Camille, your boss, insists that only projects that can return at least $1.10 in today's dollars for every $1
invested can be accepted. She also insists on applying a 10% discount rate to all cash flows. Based on
these criteria, you should:
A. accept the project because it returns almost $1.22 for every $1 invested.
B. accept the project because it has a positive PI.
C. accept the project because the NPV is $2,851.
D. reject the project because the PI is 1.05.
E. reject the project because the IRR exceeds 10%.
80. It will cost $3,000 to acquire a small ice cream cart. Cart sales are expected to be $1,400 a year for three
years. After the three years, the cart is expected to be worthless as that is the expected remaining life of
the cooling system. What is the payback period of the ice cream cart?
A. .83 years
B. 1.14 years
C. 1.83 years
D. 2.14 years
E. 2.83 years
81. You are considering a project with an initial cost of $4,300. What is the payback period for this project if
the cash inflows are $550, $970, $2,600, and $500 a year over the next four years?
A. 2.04 years
B. 2.36 years
C. 2.89 years
D. 3.04 years
E. 3.36 years
82. A project has an initial cost of $2,100. The cash inflows are $0, $500, $900, and $700 over the next four
years, respectively. What is the payback period?
A. 1 years
B. 2 years
C. 3 years
D. 4 years
E. never
83. Jack is considering adding toys to his general store. He estimates that the cost of inventory will be $4,200.
The remodeling and shelving costs are estimated at $1,500. Toy sales are expected to produce net cash
inflows of $1,200, $1,500, $1,600, and $1,750 over the next four years, respectively. Should Jack add
toys to his store if he assigns a three-year payback period to this project?
A. Yes; because the payback period is 2.94 years.
B. Yes; because the payback period is 2.02 years.
C. Yes; because the payback period is 3.80 years.
D. No; because the payback period is 2.02 years.
E. No; because the payback period is 3.80 years.
84. A project has an initial cost of $8,600 and produces cash inflows of $3,200, $4,900, and $1,500 over the
next three years, respectively. What is the discounted payback period if the required rate of return is 8%?

A. 2.05 years
B. 2.13 years
C. 2.33 years
D. 3.00 years
E. never
85. Homer is considering a project which will produce cash inflows of $950 a year for 4 years. The project
has a 9% required rate of return and an initial cost of $2,900. What is the discounted payback period?
A. 3.05 years
B. 3.74 years
C. 3.81 years
D. 3.92 years
E. never
86. Ginny Trueblood is considering an investment which will cost her $120,000. The investment produces no
cash flows for the first year. In the second year the cash inflow is $35,000. This inflow will increase to
$55,000 and then $75,000 for the following two years before ceasing permanently. Ginny requires a 10%
rate of return and has a required discounted payback period of three years. Ginny should this
project because the discounted payback period is .
A. accept; 2.03 years
B. accept; 2.97 years
C. accept; 3.97 years
D. reject; 3.03 years
E. reject; 3.97 years
87. You are analyzing two mutually exclusive projects and have developed the following information. What
is the incremental IRR?

A. 11.11%
B. 13.01%
C. 14.91%
D. 16.75%
E. 17.90%
88. The Camel Company is considering two mutually exclusive projects with the following cash flows. The
incremental IRR is and if the required rate is higher than the crossover rate then project
should be accepted.

A. 13.94%; A
B. 13.94%; B
C. 15.44%; A
D. 15.44%; B
E. 15.86%; A
89. You are analyzing a project and have prepared the following data:

Required payback period 2.5 years

Required return 8.50%
Based on the profitability index of for this project, you should the project.
A. .97; accept
B. 1.05; accept
C. 1.18; accept
D. .97; reject
E. 1.05; reject
90. You are analyzing a project and have prepared the following data:

Required payback period 2.5 years

Required return 8.50%
Based on the internal rate of return of for this project, you should the project.
A. 8.95%; accept
B. 10.75%; accept
C. 8.44%; reject
D. 9.67%; reject
E. 10.33%; reject
91. You are analyzing a project and have prepared the following data:

Required payback period 2.5 years

Required return 8.50%
Based on the net present value of for this project, you should the project.
A. -$2,021.28; reject
B. -$406.19; reject
C. $7,978.72; accept
D. $9,836.74; accept
E. $12,684.23; accept
92. You are analyzing a project and have prepared the following data:

Required payback period 2.5 years

Required return 8.50%
Based on the payback period of for this project, you should the project.
A. 1.87 years; accept
B. 2.87 years; accept
C. 2.87 years; reject
D. 3.13 years; reject
E. 3.87 years; reject
93. You are considering the following two mutually exclusive projects. Both projects will be depreciated
using straight-line depreciation to a zero book value over the life of the project. Neither project has any
salvage value.

Required rate of return 10% 13%

Required payback period 2.0 years 2.0 years
Based on the net present value method of analysis and given the information in the problem, you
should:
A. accept both project A and project B.
B. accept project A and reject project B.
C. accept project B and reject project A.
D. reject both project A and project B.
E. accept whichever one you want as they represent equal opportunities.
94. You are considering the following two mutually exclusive projects. Both projects will be depreciated
using straight-line depreciation to a zero book value over the life of the project. Neither project has any
salvage value.

Required rate of return 10% 13%

Required payback period 2.0 years 2.0 years
Based upon the internal rate of return (IRR) and the information provided in the problem, you should:
A. accept both project A and project B.
B. reject both project A and project B.
C. accept project A and reject project B.
D. accept project B and reject project A.
E. ignore the IRR rule and use another method of analysis.
95. You are considering the following two mutually exclusive projects. Both projects will be depreciated
using straight-line depreciation to a zero book value over the life of the project. Neither project has any
salvage value.

Required rate of return 10% 13%

Required payback period 2.0 years 2.0 years
Based upon the payback period and the information provided in the problem, you should:
A. accept both project A and project B.
B. reject both project A and project B.
C. accept project A and reject project B.
D. accept project B and reject project A.
E. require that management extend the payback period for project A since it has a higher initial cost.
96. You are considering the following two mutually exclusive projects. Both projects will be depreciated
using straight-line depreciation to a zero book value over the life of the project. Neither project has any
salvage value.

Required rate of return 10% 13%

Required payback period 2.0 years 2.0 years
Based upon the profitability index (PI) and the information provided in the problem, you should:
A. accept both project A and project B.
B. accept project A and reject project B.
C. accept project B and reject project A.
D. reject both project A and project B.
E. disregard the PI method in this case.
97. A $25 investment produces $27.50 at the end of the year with no risk. Which of the following is true?
A. NPV is positive if the required return is less than 10%.
B. NPV is negative if the required return is less than 10%.
C. NPV is zero if the required return is equal to 10%.
D. Both NPV is positive if the required return is less than 10%; and NPV is zero if the required return is
equal to 10%.
E. None of these.
98. Consider an investment with an initial cost of $20,000 and is that expected to last for 5 years. The
expected cash flows in years 1 and 2 are $5,000, in years 3 and 4 are $5,500 and in year 5 is $1,000. The
total cash inflow is expected to be $22,000 or an average of $4,400 per year. Compute the payback period
in years.
A. 3.18 years
B. 3.82 years
C. 4.00 years
D. 4.55 years
E. None of these
99. An investment with an initial cost of $15,000 produces cash flows of $5,000 annually for 5 years. If the
cash flow is evenly spread out over the year and the firm can borrow at 10%, the discounted payback
period is years.
A. 3
B. 3.2
C. 3.75
D. 4
E. 5
100.An investment project has the cash flow stream of $-250, $75, $125, $100, and $50. The cost of capital is
12%. What is the discounted payback period?
A. 3.15 years
B. 3.38 years
C. 3.45 years
D. 3.60 years
E. 4.05 years
101.An investment cost $10,000 with expected cash flows of $3,000 for 5 years. The discount rate is
15.2382%. The NPV is and the IRR is for the project.
A. $0; 15.2382%
B. $3.33; 27.2242%
C. $5,000; 0%
D. Can not answer without one or the other value as input.
E. None of these.
102.An investment with an initial cost of $14,000 produces cash flows of $4,000 annually for 5 years. If the
cash flow is evenly spread out over the year and the firm can borrow at 10%, the discounted payback
period is years.
A. 2.5
B. 2.68
C. 4.53
D. 4.87
E. Never
103.An investment project has the cash flow stream of $-3250, $80, $200, $75, and $90. The cost of capital is
12%. What is the discounted payback period?
A. 1.24 years
B. 1.85 years
C. 2.24 years
D. 2.85 years
E. 3.05 years
104.An investment cost $12,000 with expected cash flows of $4,000 for 4 years. The discount rate is
15.2382%. The NPV is and the IRR is for the project.
A. -$634.89; 12.60%
B. $0; 15.2382%
C. $4,000; 0%
D. Can not answer without one or the other value as input.
E. None of these.
105.List and briefly discuss the advantages and disadvantages of the internal rate of return (IRR) rule.
106.Explain the differences and similarities between net present value (NPV) and the profitability index
(PI).

107.Given the goal of maximization of firm value and shareholder wealth, we have stressed the importance
of net present value (NPV). And yet, many financial decision-makers at some of the most prominent
firms in the world continue to use less desirable measures such as the payback period and the average
accounting return (AAR). Why do you think this is the case?

108.The Ziggy Trim and Cut Company can purchase equipment on sale for $4,300. The asset has a three-
year life, will produce a cash flow of $1,200 in the first and second year, and $3,000 in the third year. The
interest rate is 12%. Calculate the project's payback. Also, calculate the project's IRR. Should the project
be taken? Check your answer by computing the project's NPV.

109.The Ziggy Trim and Cut Company can purchase equipment on sale for $4,300. The asset has a three-
year life, will produce a cash flow of $1,200 in the first and second year, and $3,000 in the third year. The
interest rate is 12%. Calculate the project's Discounted Payback and Profitability Index assuming end of
year cash flows. Should the project be taken? If the Average Accounting Return was positive, how would
this affect your decision?

110.The Walker Landscaping Company can purchase a piece of equipment for $3,600. The asset has a two-
year life, and will produce a cash flow of $600 in the first year and $4,200 in the second year. The interest
rate is 15%. Calculate the project's payback assuming steady cash flows. Also calculate the project's IRR.
Should the project be taken? Check your answer by computing the project's NPV.
111.The IRR rule is said to be a special case of the NPV rule. Explain why this is so and why it has some
limitations NPV does not?

112.Discuss how frequently publicly traded firms use different capital budgeting tools.
 ch05 Key
1. A

2. B

3. C

4. B

5. D

6. C

7. A

8. C

9. C

10. A

11. E

12. D

13. B

14. D

15. E

16. C

17. D

18. A

19. D

20. A

21. D

22. B

23. C

24. C

25. D

26. D

27. E

28. B

29. A

30. C

31. A

32. E

33. B

34. D

35. B

36. E
37. B

38. C

39. D

40. C

41. C

42. A

43. D

44. A

45. B

46. A

47. E

48. C

49. A

50. E

51. C

52. D

53. A

54. C

55. D

56. D

57. E

58. D

59. B

60. A

61. D

62. B

63. C

64. E

65. A

66. B

67. B

68. A

69. B

70. A

71. A

72. B

73. A

74. E
75. E

76. D

77. E

78. C

79. D

80. D

81. E

82. D

83. E

84. E

85. B

86. E

87. E

88. B

89. B

90. B

91. C

92. C

93. C

94. E

95. B

96. E

97. D

98. B

99. C

100. B

101. A

102. C

103. C

104. A

105. The advantages of the rule are its close relationship with NPV and the ease with which it is understood and communicated. The two
disadvantages are that there may be multiple solutions and the rule may lead to a ranking conflict in evaluating mutually exclusive investments.
The student should add a brief explanation demonstrating their understanding of each.

106. The NPV and PI are basically the same calculation, and both rules lead to the same accept/reject decision. The main difference between the
two is that the PI may be useful in determining which projects to accept if funds are limited; however, the PI may lead to incorrect decisions in
considering mutually exclusive investments.

107. This is an open-ended question which allows the creative student to speculate on the value of non-discounted cash flow evaluation measures.
We use it as a springboard to stress that even rational financial managers sometimes find it expedient to use a group of measures. For example,
firms may rely on the IRR because it is easier to explain to board members than NPV. Also, for large projects, AAR provides shareholders with
some insights as to the project's impact on net income and earnings per share.
Reject the project NPV = ($136.60)
IRR = 10.41%. Do not take project as IRR < 12%
108. Payback - 2.63 years.

Both measures indicate rejection. A positive accounting rate of return should not change the decision. DPP and PI indicate that the cost of capital
is not being covered.
PI = ΣCFATt/Initial Investment = $4,163.40/$4,300 = .968 = .97
Discounted Payback cannot be calculated as NPV < 0; NPV = $-136.60
Time 3 - Cash flows = $3,000, Present Value of Cash flows = $2,135.34, Sum of Present Value of Cash flows = $-136.60
Time 1 and 2 - Cash flows = $1,200 each period, Present Value of Cash flows = $2,028.06 for both periods, Sum of Present Value of Cash flows =
$-2,271.94 at the end of time 2
109. Time 0 - Cash flows = $-4,300, Present Value of Cash flows = $-4,300

Calculated IRR = 16.67%. Accept the project. NPV = $97.54.

110. Payback = 1.714 years

Problems occur with IRR due to conflicts with mutually exclusive projects, timing and size problems, multiple sign changes. NPV always the best
choice
111. At some K, NPV = $0; by definition, when NPV = 0, K = IRR.

112. Graham and Dodd (2001) surveyed CFO's of publicly traded firms and found that IRR and NPV were the most frequently used capital
budgeting tools followed by payback, discounted payback, accounting rate of return, and finally profitability index. More important than the exact
ordering is the recognition that NPV and IRR are the most preferred capital budgeting tools.
 ch05 Summary
Category # of Questions
AACSB: Analytic 105
AACSB: Reflective Thinking 7
Blooms: Analyze 5
Blooms: Apply 39
Blooms: Evaluate 2
Blooms: Remember 13
Blooms: Understand 53
Difficulty level: 1 Easy 48
Difficulty level: 2 Medium 54
Difficulty level: 3 Hard 10
Ross - Chapter 05 112
Topic: Problems with the IRR Approach 16
Topic: The Discounted Payback Period Method 11
Topic: The Discounted Payback Period Method; The Profitability Index 1
Topic: The Internal Rate of Return 27
Topic: The Payback Period Method 18
Topic: The Profitability Index 14
Topic: Why Use Net Present Value? 25