CHAPTER 7

Net P11esenr Va.l ue and Other I 11Vestment Rules

Mlll ltiple Choke Question :

t DFFINlTIONS

NET PRESENT V AI.UE

a 1. Tite djffere.nce betv.e.en the presem \'alue of illl 1n,o.esttnerlt ilfld ~m.s cost is. tl1e:
a. net present value.
lb. intcmal rate of lfclu m .
(. pa)back fJeriod.
d. proti [ab~~ ity i ooex.
e. disc-oum.ed payi)ack period.

Dif!i ulry JeJ~el.: &Hy

NET PRESENT VALUJE. RULE

c 2. Which one oflhe f oJIO\\.'mng statements on-cerniln~ ttle[ present ruue (NPV) ~s. (orre.(t?
a. At:l ~nvestment s.houM be a(-cepled if. and only ~f. the PV is. exactly equaJ to z.ero.
lb. Aml ~nvestment s.hould be acc:epled om1ly 1f Ule NPV is ~ua~ [ 0 the 1nit~ al c:as!h flow.
c. Attl ~nve~tment s.hould be acc:epled. if the NPV ~s. pos.illivc and rejecte.d if it is negat~ve.
d, An i pv~;."iimen1 wiih glie~rc-r c :;.:o;h 1n 0n\?.'~ mhun <.:ii!s!h m1Mlnw:o.;, rcg:JJn:iles ' -Llf whe n il-te
cash tl m s occur. win always have a pt.1s.ilil\<'e NPV and tllerefore should ah ays. be
a.c(etJtcd.
e. Any prt1joct that has pos;tive. (asl1tlO\'IS for every ti me. fleriod after the in ~Lial
investment should be accep[oo.

T>ijjiculty level: Easy

PAYBACK
c 3. 'fihe lcnglh n r iil!lie rcttuin:d l{lr ;,m ip\.'c slmcni ln gepcmre c :;J:o;h ~l.ilW<i -o;tJi llic1epl lin
rec.:n\:e.- the in ii1;,IH ..::n, ~ ~)r 11 he 1n\.'c:o.;f mc.n'l i:o.; c~lle1 i 1-tc:
a. net pt'es.e~1t \'alue.
lh. ipkmal nlie n.r re rum.
c pa.ybad:: period.
d. pn.Jlii!.~bi l iiy index.
e. cli $-C~llll nled ctJsh petiiml.

T>i}Jiclllty fr:vel: Easy

PAYBACK RULE
~ 4. \Vhich nne .f..lf mhe fnlluwi ng :o.;iJUemcni s is c.:m,-ed c~mcem1 ng th payfNtCik perind?
Ja. An i pv~;."iimen1 is ~~cc.:epa1~blc if i rt c::tltt!ibled p~yh!.lr.:k period isle '' ilrJ;,m :'i nme pre-
-o;pec.:i mi t."C'lr ['(!rind nf i1m ~'
lh. An ipvt."iimen1 shmdd he nocepmed if ihe ~yhm:k is pnsiiive ;,nd rejected i r 1 ~ i-o;
neg::~Jt ive.
 C'. A n i nvc~l mc:nt S;nnuld he ruj,ecl00 iHhc p~yh;n.: k i :s pus11 i vc ~Uild :j)CCL'l'lkid i r i mj<;
11C~liln1 ve.
d. A n i nvc~l ment is ut:cepm Jhlc if ~' (;:alcu i~ted p:ayh.:~e k peri.,)d j:oo; grc'"der mhmiJ sum(!' .Pire-
-;pecili G'tLpennd nfli m ~.
An i nvc-c:l meQI sl'muld !he ltC<.:eplc:d any i ime the puy1:mc'k period is IC:$<; ln:m l he
di~fiU n l ed. p~lyh:lck pe-rilld, gi\te n Jl pn!'ilive d i$<!fll!l nl mJe.

DISCOUNTED P A\"BACK
c 5. Tihe lc ngJh n f lime required. r<~..n a pmjccfs dio;cftl!lnlod (;il<;h ~ltJW" li n equal m
hc in11iul
cnsl n f lilru: pmj ee l i-; c;)Ued I he;
Ill. nd p1'c~nl v:alue.
b. i nlem:al r:ale M rem
um.
c. payback period.
d. d iscounted profitability index.
c. diiscotmtcd p aybilCk period.

DISCOUNTED PA'\"BACK RULE

d. 6. Tihe discnu ni e~l payh:ack rule smurc~ lh~d )'fH.J "ho uld uccepl pruj ecm
s:
;JJ. whkh have: a clisro~ntcd payba k period that is grcalcrr nhan s.ornc p~c:-spccifjc:d period
or li me.
b. 1f the discmmtcd payoodk is poslti vc: and rejected if it is negati vc:.
c. only if tbc d iscountcrll payback per iod cqual:s some prc-spcdtiicd period of ti111-.c.
d. 1f the discmmtcd payback period! ~s less than sorru: prc~pcciticd period of ti me.
c. only if tbc d iscounted payback per iod is cqua~ to zero.

Difficulty lel-el; Easy

A VERA(~!E At~t:OUNTI N(~ R ll:"FURN

c 7. An j nvcstrncnt' s averragc net income dh~dcd by ~ms average book value dd:i ncs tl:te
average:
a. net present '\o'altae.
b. lnlcrrnal rntc of return.
c. ac<::ounting return.
d. protitabi l~t}' ind.c~.
c. payback period.

D{fficuJry level. f;asy

A VKRA(J!E At~t~OU~TIN(~ R lrfURN fUJL!E

b 8. An i nvc~mcnt is acceptable ~fits. average accounti ng rctum (AAR):
a. is. less than a target AAR.
b. exceeds a target AAR.
c. exceeds the tiirrn's return on equity (ROB).
 d, i. IL."'i:o. ih~m Ihe f1rm ' s n :1urn nq ~~ sc'l (R OA ),
c. is e qt,mul io zc.r n ;lnd n n Iy when i I i (![~uul tn ;ze>m,

I. T!ER AL RATE O F RETUR J

b. 9. The di-;cmm~ m re t h:a1t makes ihe rn: l prc,c;enr \ ':;tl ue nf :m 1n \IC:simenl e:u~ i ly cqi,Ud Ito
~C"IiU i<i c~alled lllc;
a. external rnte of return.
h. i nlarnrd r:aJc ~lf remtllifl .
c. ~vc-mgc ;u:ouunl1n,g rc i urn.
d. p ll'u1ii tlb11il y in ex .
c. e[~ual izer.

Difjiculf}' ltwel. Eas)'

I. T!ER AL RATE OF RETUR Rut.E

d I 0. An 1nvc"'ii lililt.:rll is ~ cep1;1blc if il ' IR R;
a. is e,;nclly equ al to its net present vajue ( PV).
b. is e,;nclly equ al to zcm.
c. is lcs:r; than the required ret11.1r n.
d. cxce&.:d"' ihe n::c1uin.<'tl rei L~JITI.
e. is e,;acdy equ al to ]00 pclicent.

Dif.ficulf}' ltwel: Easy

MUt. TIN.E RA TiES OF R 1' RN

e 1'1. Tihe pos:s]biUly tlilat more than one discount mle will mruce tlilc N!PV of an investment
equal to zero s caUcd the problc m.
a. net present vnlllliC prot1U ng
b. operntio.n..,ll ambiguity
c. llilUlu a!ll y exclusive investment dcdsion
d. issues of &ealc:
e. muhiple rntes of return

Difficulty level: ~fedirmz

A-UJTIJALL\' lf.XC Ll SJ\~E PR()JEt l'S

12. A situation in whiclil accepting one i nve tment prevents mhe LWCcptilllce of another
investment is ciid ld the:
a. net present vnlllliC prot11c.
b. operntio.naJ amb~guity decision.
c. mutuiidJy c."tdusivc illlvestmenl deds.ion.
d. iss.'U es of s.cal problcrn.
c. tlJluhipLc chokes of operations decision.

DifjicuJry level: Easy

PROFIT ABILITY rNDEX
d, 13' The pt"e~ni V<ll ue n r un illl e ' Imen~ . :o.; hli ure C~ISQ n~)WS d1 ....i ded hy nh in1fiJd cuSJI ufi 1-te
i n'\lestment ~s C' aJ led the:
U~. 111ei preseni v:ll ue.
b. irliern:al r:Ue nf return .
'-'. U~'-''eruge accuurtl'i lilg r ei Ltrn.
d.. pmfiiJabilii y index,
c. profile period.

PROFIT ABILfTV INDE . R ULE

a 14. An invcsLmcnt ~s acceptable ~f me profitalbi IJty ~ndex ( P]) of die j mcsi.ITK:nt is:
a. greater tb::m one.
b. k s tiJ_l!Jn one.
c. lf!Tt'!:aier HaLSn the l lilfL!Tiiltd mie u( rc 'l um (IRR ),
d. less tbma lihc net prre cnt vah.LC (N PV ).
c. greater th::m a prrc-spcdt1ed rate of rrctum.

Diffict~lry lewl: Easy

U. CO CEPTS

NET f'R!I:!:SENT VA I!.J JI.

d 15. AU el c consumt, Lhe nc~ present "raliuc of a project increases when:
a. the discount rate increases.
b. <::3ch cash intlow is delayed by one year.
c. the ini rial cost of a pmj cct ~ocreascs.
d. the mtc of return decreases.
c. all rash int1ows occur during the I:.JSmyear of a project's life insm
ca.d of
pcri-odicall)' lhmllllgoout the L~fe of ihe projcC"t.

D~fjicL"'.~lry I ell.el.: J::asy

NET fiR[._ ENT A I!...~J E

a 16. The primLU)" reason tlrml company projects with pos~livc net present valt~es arc
considered! acceptable ms tlrlmt:
a. iliey create "'alue t'oli the mvncrs of the fin111.
b. the plfoje.{'l s. r-al!e of rctum exceeds. the mte of intlalion_
c. they retllll:rrn Lhe ~nWaJ cash outlay witbjn three years odes~.
d. ilie rreqrui red cash intlows exceed the artllllal cash i ntlows.
c. the investment's cost exceeds the pre~c:nl vrurue oftloc cash intlmv:s.
. ET PRESENT VALUE
1 n. lr u pn'l-jt t:i h:as Ill llf!i prescni \'tJ~ Llt! f!'C]LltJ~ tn :tj ;li1, ihen:
I' 11-te J1reseni \t~d li.C [J r ihe cash in tlt:nV'Ii cxcccd!-i ~ h ~ ini ~ id t"(:: , 0 r ihe Jlmjecl.
n. 11-K: p:rfljccl J1T4Xli,JCCS it! r;.de uf rulum lh ;_d j liS I ~~u:;IIl<i i 1-K: rnc required ill ;,c.:'(:cpl [h
proj ect .
m. 11-fe J1Tnj,ec'l l"i e xptclcd Ill iJlH'Idu.cc n nl} llrte n'liliiJim:a.lly rClJUired CU.'h inllm'l:li.
~V, nny de Iay in rccei \li111;!?, i be prnj c.crcd <;:a.<ilh i nflm'I'S will t:~usc lhe pmjeci rn h~n'e 111
negtli i\e llf!l preseni val nc ,
,., 11 ur){l m ~m 1y
b. ll and JV o:nly
c. I, II , :md IV ~)nl y
d. 11, Ill , tlnd IV n nfy
e, J, IJ, :md Ill fm l}

ET PRESE T VALUE
b ~ 8. Nt'l pn.""ienm \'ulu :
a. :.mnO( be used when deciding bet""'cen two mutuaHy cxdushc projects.
b. is more rn ~cful to dct'ismon malk.crn. than d:te intcmru rate of rctmn \\rhcn compadng
ditlerent sized projc1:ts.
c. is easy to explain to non-t1nancial managcr.s ;md tbus is lhe primary method of analysis
used by the lowest le.,.rds of m;magcmcnt.
d. is not an as widely used tool as payback and discoll!lntcd payback
c. lllililf in its mclhodology to lhc average account~ng return.
is ' 'cry siL

Difficulty le,rtd: Easy

PAYBACK
c ~ 9. Payback is mqucnt~y l!lscd to ~llllal)'7..e htdepcndcnt pmjc.('ts because:
il. it considers lhc tim-e val~JC of money.
b. all rdcvant cash t1ows i.lfC induded in th-e tl.IIDiysms.
(;, it is easy and Qll!lick to calculate.
d. it is the mo&t dcsinili1c of aU the a"LlHabk: amu}tk al methods from a t1n;md ru
perspective.
c. it produce'S beucr decisions tb:.m those made using cJ ther NPV oc :IRR.

Difficulty le~re/: Easy

!PAVBAt~K
c 20. l ' hc ad"'illltagcs. of the :payback method of project illJalysis indude the:
t D!pplkation of a discount rate to each separate cas!h tlow.
It bias towards ~iq11 idhy.
~ l J. case of use.
~ V. a.ubiu;y-y cutoff point.
a.. I and II Oil ~y
b. .I and II I on ~y
c. 11 and JD on~y
 d. 'I I und IV n11ly
e, II, Ill, and IV nnl y

Difficulty fe~-ef: Medr~nn

PA BACK
d 2 1. A 11 e1se cc1~Lal, i he p.ui}'hack peril..nJ fnr ~ prtlje~;;i wi11 dtl"Teu ' wihene ver rhe;
<l. i nif i:a.l .t~)sf in re:t..;e:t-;,
b. required return for a pmjcct ncrcas~.
c. ~~ -;igned di ~nU111i Jr<de d.e t'rens.e ' ,
d, C'ISh in rJ n W' Jar~ 1110\1txl f.orw~mJ i 11 ri me ,
e, d.ru.r;,iiun n f u p!rojet:i is l cngf hene~i

DISCOUNTED PAYBACK
d
--
'J'')

tlt
Tbc- d i ' m ti11iCd p:~~yh:lck period nf Ill ]ll'Uj'-~ "''ill tlet:rea:t-;e
di " 1C1Ui11i r:de ::tppl ied m~) i lfte prnje~i i " i ocreasetl,
wt.t~ne\er rhe:

b. i nitia~ C:JJShJ outlay of tbc project ms in-creased.

c, time period of the proje-cmis i ncrca...~d~
d. al!llotml of each project cash t1ow is 'ncreased.
c, C't.)Ms t.)f ihe 1i xecl :as sCI Ull il i zed 1n 'Ihe ]llojec t i ocre~c.

.Difficulty le~rel: Medfum

DISCOUNTED PAYBACK
a 23. The d:Ls.countcd payback ru[c ~IWJY carus.e:
a.. orne posithc net pliC ent \o':liue projects ~o be rejected.
b. d1c mo::.t IU quid projects lo be rcj cctcd in favor of less liqt~ id projects.
c. proje-c~s to llx: incorre-ctly ~cpted dl!tC to grmring the time v~ue of money.
d. proje-cts with negative net pre:scnt value:s to be accepted.
-c. some p~jects to be a~epted whkh would omhcnvis.<: be rejected under the payback
rule.

INTER AL RATE OF RIE R.

h 24. 'f hc 'nternal rare of return UK.R):
[, rule states tnat a projec-t \.?'ith an IRR that m
s less than the roequhed rate should be
accepted.
[[. is the rate generated solely by the cash tlmvs of an investment.
[[[. is. the rate that cm.11scs l:hc net plrC ent value of a pr~jcct to exactly cquat zcm.
IV. can etlcctively be used to analyze all i nvcsLrncnt sec nruios.
a. I and IV o:nJy
b. II and Ill on ~y
c, 1. II, and IU on~y
d. n, m and IV on~y
I
INTER AL RATE OF Rl:: R.
:a,25. Tile i rtlt.'T'rt:l1 nHe t)f rerum rnr pmj ec.:i wi 11 int.,.ea-;c i r:
:i-. I1-te i rtil i ~~1 ens I nf rthe pll'oj(!l(;l ~an he n."tlu~cd,
b. 11-te lumul anltmnl nf mhc c:;~-;t. i udlnw~ i-; rudu c.:ed,
c. each cash intlow is moved st!c'll tmm h occurs one year later than origilllliiUy projected.
d. Il-K: required mile [1 r relum i ' reduoe~i
e, 11-te s:a.lv;,~gc V~ihLe nf rihc pr.f..ljcc mi ' nmiUt.."tLfmm ~ hot! ~m:a.l ~i s.

INTER AL RA TB OF Rl:: R
r 26. l'he inter nail rate of return is:
;,t, molic reli ~lh1e :a..o; ~ decisiu111 m~ai.Ji ng ~~~lll mlhun lilcl presc nI val uc- whcrae\t-r you ;il.re
mn ick-riqg n'mfUull y e t: In i \ 1c pmjeel-;,
b. equivalent to the discount rntc th..1l mnkcs the net present 'ln~oe equal to one.
c. diffic!Jllt to compute without the usc of either a nnanc~al calculator m a computer.
d. dependent upon the interest rates oftered ~n the mnrkcti place.
e. u bctiL'T' mc'l'hod()lngy lhun net pn:,.elll \ 1ulnc when dc..ding wilh uncn:n venmitmal c:a..;lh
t1mvs.

Difficulty fe~~/: Medium

INTER AL RA TB OF Rl:: R
a 27. l'he inter nail ITtle of return tends to be;
a. easier for managers to comprehend thnill the net present va.h.1c.
b. extremely accurate C'\'Cn whcn cash tlow estimates arc faulty.
c. ignored by mostti nrn1ciaJ rnml_yst:s .
d. U"iod primari ~)' to diffcrcntbtc bct,.~ccn mutually e.xch.1:shrc P~.i ccts.
c. utilized in projc"Cm;:mn1)"5ls only when mu~tiple net pres.enl vaBrues. apply.

Difficulty fe~re/: Easy

I <CRE:ME TAL INTER AL RATE OF RETURN

c 28. You arc try~ng to dctciJTIIline 'i.l ,rhelher lo accept project A or pmjc.ct B. These :pmjccts
DJFC munml1y exdusivc. As p'<!JIIt ofyom analysis. you :should compute the ~ncK:mcnted
IR R by detmlnh11g:
iL tlrlc i nEcrna.l rate of return for the cash Hm~ of ellC'h pmjccl.
b. tl!tc net present ralue of each projec-musing the ~ntcrnal mtc of return as the di cmuu
rate.
c_ the di scount rate tllat equates. l!he dm countca payback periods for eac-h project
d. toc di scount rate that ma!kes. the net. present value 1.1f each project cqua.l to 1.
c. the inlcrnal rate of return for the dr~ftcrenrcs an the rash tlows ot'llhc two p-HJ:ic- ts.
 Difficllltj (e~-el: M edr11m

I CREMENTAL lNTERNAL RATE OF RETURN

b 29. Grap hing Htc iliJcremcnm:al TRR helps cxplai11:
tl . Wh)1 ~me ptt'loject is :al W;tys S\l.pcriur m n mmher prf~oj cd .
b. lhnv.1 de c1iun::;. .tnnccmi11g mUll mtl ly e:-;c1u~ ive prnjecm~ :are dcri \ICd .
c. fh)V~! H1c tlum~iup n f :a projcc Jaffec r he decision ;1' ~n which pmjec l 10 ~C'---ep.
d. lhnV~l i he. nem IJlllt;SA;n v;tilue :md I he i mi i al cu.~h n nMlnw ~)f :l. pmj~LI me rel :decl
c. lbow the protlmbility ~ndc:-.~ and tbc net prc~ent value arc lidated.

PROFITA81LIT\' D:EX
d 30. The profitabmty index ~s d osdy rdatcd to:
:1. payback.
b. d i counted paybar k.
<:. ihc ~'i,:crugc :;tC'cmmli ng rci urn ,
d. 111e rreserd '!,.-;til ue.
c. muu.mlly cxdusive wrojccts.

Difficulty {ew!l: Easy

PROF1TA81LITY D:E
b 3 t. Anallysis using the profitability ndex:
:1. frcquendy oonili cts with the: accept and Kjc:ct dedsions generated by the application of
the net present value rnk.
b. is usd111l as a decision tool '1.\tlen investment f11.mds ru-e ~intitcd.
c. is us.cful }vhen trying to detemJj nc which one ot' two mu ttmUy ex.dushe pJrOjC(:l:S
shoold be accepted.
d. uti~ izes the :same basic vari abk:o. as those used in the a,,.crn,gc accmml ing rctiJm.
c. fPI OOU(:CS reslll!~ts \.'1-'hkh l:yfPtc<illy arc difficult to comprehend or app~y.

Difficulty {e~rel: Metffum

PROFITA81LITY D:EX
e 32. :If you wanl to rc"'ic"\' a projC(:t from a bcnciil~ost peupcctive. )'01.11 shouldlus.c lhc
_ _ method of ana~ys~s.
a. net present value
b. paybac:k
C. i ntcrmd rate of return
d. avcrngc acc:omllh ng return
c. profitability ndex

Di!Jk.:ulty lvt1: Easy

PlltOt TF A81LlT\' INDILX

b 33 . When the present vaue of the cash ~nt1ows exceeds. the ~nhial cost of a project. then
the prrojcct should be:
a. m.cceptcd because the httemal rate. ot' Ietum is posmd ve.
h. m.ccepted because the prontabrli m y i ndcx j s. greater than I .
c. m.cceptcd because the pronrabrlit)' index is negative.
d. Jeject cd because the internal rate of rerurn is ne,gad vc_
c. Jejeoted because the net present value. is. ncgarive.

MUTUALI.Y F.XCl.UST\fiE. PROJECTS

c 34. Whi ch one of the fo.llowing ~s d11c best example of two mutually exc.lusive pmjccts?
a. planning to build a . .,raJiehousc and a rt:taH outLet side by side
b. buying s.uftlcient equ~pmcnt to ma.m.11facm ure both desks. and cha.itrS simulta.ncous.y
c _ us.i111~ an emJ'm
y watehouse for s.tora,ge or 1'ent:i l'llg it entre1y out to aoother fintl
d. the company s.ales. force fo protnote s.aJes. of both shoos. and socks
us.itl~
e. buyi1~g bolll nveJitory and fixed ass.et.s ILI.Si ng t'unds. fmn'll the smY.h~ bond issue

Diffi~'ulry lev.el.: Medium

MUTUA Ll~ Y F.XCLUST\ff.. PROJ IE.CTS

d 35. 'll:Je Liberty Co. is cons.idcr~ng two projects. .!Project A consists of builldi ng a wholesale
book oollel on lut #169 of !.he E~~glem')od Relad Center. iProject B consist:s of building
il sit-down restaurant Otllm #169 ofthe En~lewood Relail Center. When try~ng to
d~.cide whether or blili ld the book ourJet OJ~ the tes.taue.ant, man~enl~JU s.l!'tould rely
most hea ~lyon ll11~ .ana.l:yi~s. results. fmllr'li the _ _ l!r"teUlod of <Hlalys.is..
a. pmtitab~ht:y index
b. if:itema.~ r.uc of relllrl'll
c. payback
d. net presem vaue.
e. accooflting rale of return

.M UTUA L Y EXeLUSIVE PROJECTS

c 36. When two p.t'Oje.cls. both requ:i re the total use of the same Jitn~Le..d eoono~~r'tric resource,
l1le pmjects. are gene.rnlly considered to be:
a. independent
b. mar~im11U y prnfiriJab le.
c_ mutual ~)' exclusive.
d. :ltX:epi:ahle.
e. intenm~ly protitalbJe.

~IUTUALL Y EXCLUSIVE PROJECTS

c 37. Matt is analyzin~ two nmtually e~dusi ve projects. o f s.im~lar s.ize aftd has. prepared the
 toiJmv~ng rlala. Both p:rojccms have 5 year Jh:cs.

l~roject A Pro ject B

Net pcs.cnt valuc $15J~O $14.6Y3
I~ayback period 2.76 years 2.51 years
Averagc a{'COuttti ng relll1111 Y.3 percent ii)_6 percent
ttequ ~red rcl.UJ:n 8.3 perce ttt 8.0 percent
ttcqu~rca AAR Y.0 perce 111 ii)_O percent

Matt has been a~d for h ~s, bes.l recommendlll.iol1 gi vcn this. iuformatio:t:L Hi s.
~rcrorrullCndation should be to accept

a. :project B because ~t has the s.hmtcst payback period.

b. both p~rojc..cts as they both have po-sitive oct prcse nt vah.Lcs.
c. project A and rejecm.proj eel B based on their net pmscnt vaJ ues.
d prnje t B and reject project A 'based 011 ~their iil.\'erage accourrlt~n~ returns.
e. project B iil.fld reject project A based OJl ibom the payback period ru1dl the avemge
accoontim1g rebllrl'll.

lNVE li'M ENT ANA t VSIS

a 38 . Given tlmt the net present vaLue (NPV) is geocraUy cons.iderccl to be the lbesmn1ciliod
of analysis , why shoo ld yt:.u sli U use tlle otl 1er n'tetl1ods~
a. TI 1e otltel' nt eLhods help \'ali date whether OJ' f lot tlle results. front the m1el pres.cnl value
ilJJlalys.is arc m'C.~i.able.
b. You ne.ed lOuse me orl1er metbo!llii s.i11ce oon cntiona~ praaice d ictates. []);at you on~y
accept projects. after you have genermed mrec accept i ooicillOrs.
c. You need lO use oilier tnelht'lds because the net prcseJ1t .?a:! uc. mctbod is U!fireliahle
'i.'.rlren a pmjoct has unconventional cash flow~.
d TI.1e average accoulflling rerum n1ust ah a)'S. indicrue acceptance s.ince tl11is. is. t!11e best
method ftmn a financial penpectjve.
e. TI1e cliscou nledl payback methoo ~tmst always be ompuled lo deterrtlli ne i r a project.
I'CllH"'ElS. a positive casl1flow s.ince N PV does. oot med!lum'e tll is. aspect of a. m)rojecl.

Dijj'i.c;ulty le."t>.el: Medium

J ~ViES'J tE T A LYSJS
e 39 . In acmal [practice., mana._~s. rrequemily us.e tlre:
I. AAR: ht:cm1~c ihe infmrm~a~i nn is ~u ~reu,dil y :1\':a.ilu,hl ~.
II. IRR lk.X"aus.e r.he re.su~ts. are. easy to corrmur1icate. and under~tand.
Ill, p::tybu, k Oet:~IIIS(: nf i m~ ' impl ~ciy.
IV. net pr.ese nl vaLue ibecaus.e it is cons.jdeted by ltillnY lo be lhc bes.t method of anays.~~-
a. 1 ilJJ~d 1~1 only
h. n ilml monly
c:. I. H], a nd TV [mly
d. II . m. und ]V only
e. 1 U. Jll. and IV
INYEST~IiENT ANA LYSIS
a 40. Ncl m;_U icr hnw many rnr ms n f inv.e:..rmenl tlnuly:!iois ynu tin;
~ 11-te u hud re, ulr'i fmm :a. prnjecm m :l}' vury si~n i l'lc:milll y f rom m he expecred re"'iUlt .
h. It.e i 11Et.'TiiJ:Jl rnle nf miurn willl ul WJays pmdut"C Ihe nll.) rdi:alhfc re~ulh.
<.:. ~~ pmje~;.:r "ri ll ne\'eli be. a cepled urde ':o; Hte p~ayb:Jck periud ~..;mer .
d. 11-te i rtil i1.1l cosrs will ~elilf!mll y \'aliy c:nn ' idcr~b[y fmm Ihe c"'il ima~C1 cosl'i.
e. only the ti~t three y~ru-s. of a proj e'Ct ever atlect its. tinal outcome.

Drffic~~v fe~-el; E(ZS)'

INYESTMIEJ T J\ ALYSIS
b 4] . \Vbicb of the followilllg methods. of p~jcct ~al~ts.i are bias.ed to'Willfds short-teml
projocts?
[. i ntcmall rate of return
~~. n ' t"'Ulllilfi ng r:;JII (! n f reatJJrn
~ ~ J. p.aybtJck
[V , d~SCOUIJlted IJXIyb.aC k
a. J ~md J1 only
b. 1II and IV only
<.:. II nrtd llll1m Iy
d. 1and ]V only
e. ]] :md IV only

Difficulty few!/: Medium

INVESTMIE. T ANALYSIS
a 42. lf a pr0:ject is assigJJJcd a rcqui red mtc of rctm n equal to zero. then:
il. tlrlc: timing of the project's cash flows bas liiO bcari ng Olil lhc value of me pmjccl.
b. tlrlc: projec-t will a~ways be accepted.
c. thlc project will ili1ways be rejected.
d. whctlllcr the project is accepted or rejected wiU depend on the tim~ng of dll: cash now .
e. tbc project can never add valll!.c for the shareholders.

Difficulty few!/: Medium

b iCIS U) Rl "LES
e 43. Yoo arc consider~ng a pmjcct whh the followilllg data:

[nternal mtc of return 8. 7 percclilt

ProtitaWHty ratio .98
Net Jnesc!tt va.J.uc ..$393
I ~ayback period 2.44 years.
Kcquircd return 9.5 percent

\Vhicn one of the fol]o.,v:i ng ~s comet gmvcn this illlformation~

 t~. Tt1t: tli ' ouni wie used in C:llcllifmiing ihe pel pn::sc:nl \ 1uluc mu$mh~\'c hoen le. ~ h:;m 8.7
pen:: '!ilt .
b. Tbc:: di sccm111ied puyn:.J.ck pt:ri<~..uJ wi~ l h::t e io he ks<.i 1han 2.44 y'<=:;J.N,
<:. Tile di ' cm111i nlie u~d iu ~;;nrrrpnie mlhe pmfii ahi lirty r:art in w:as '-xtu:a.l mn ilrte i llltt::rml.ll'a~e
nf 1'C:i urn .
d. Tllis rmjed . lilmdd lhe :act:ep~t:tl h~J~t:d nn I he profiiJIIniliiy r~liin.
e. Tl'tis rmjecl llould lhe rcj cc I ctl hus.ed !l n I he i niem:al .!Tale Cl f re~um .

Difficlllf! fe~rel: Medi10n

NE'f PRF.SE T VALUE

c: 44. Ac:c: p~ing pl.lsiiivc Nf'V prnje~;;i ' henl.'-lli~ ihe ~ll'lckhnldcr htGmsc:
t.c: mnsr eusily undcr-o;inotl valu:ai ifr prnCc"'is.
i i i ' m
h. I he prcsenll \'ill LIC n r 'lli'Je e,; j!)L~med <:ar<;h rn n w ' Jlrf.' ei}IUJil fn he en~ .
c. the present vru.ue of t1tK: exp~tcd cash tlows. arc greater than the cost.
d. ~l ~s the mo t easily calculated.
c. None of the above.

NE'f PRF.SE T VALUE

:a, 45. \Vhich n r i llc rnll1lWi ng dnc~ nni chmnderi 2't.: NPV?
a. NPV does not incorporate r~sk i111to tllc :.malysis.
b. N PV in-corporates all rdev:mt intbrmation.
c. NPV u es aU of the project's cash t1ow .
d. NPV dhco!r!inls aU future cash flows.
c. Us~ng NPV will ~cad to decisions that maximkrc slil::u-cboldcr '\vc..'llth.

PAVBACK
e 46. The payba-ck period rule:
a. dri comus cash tlows.
b. ~gnores initial cost.
c. aiwa~--s rnscs aJ lpossib~c cash tlows ~Iii its. calcublion.
d. B()th A and C.
c. None of the above.

Diffic:ulty few/: Easy

PA\'BA: K
c 47. The paybock period mle accepts alll ~nve:stment project s i111 .,-.,bich lhe payback pcr]od foli
the cash tlmvs 1~:
a.. equal to the cutoff poi111t.
b. greater rtha.n the cuto1ilf poilllt.
c. less than dle cutoff point.
d. pos~ti vc.
 e. Nnrte n r the uhu,.c.

PAVBACK
d 48. T he p :t)'l:li!i k peried rule i n r~ln \<'emeni mild usdu l M~ll IJcc(':mse:
ii pro\'ide quick c..""ii i [TI~de of lmw mpidly ihe irui ial in\'e 'rtmeni \.Yilllhe realuped.
10, resulf<; nf ~~ shuri fl~l}'b:;Jck_ nl le dcci"'iitt. m W'i ll IJe Ctuick)Y see n,
c. ~l dbcs not take into ac<:ount time ,raJue of money.
tl, All nnhe ~b1\lC ,
e. Nnrte [) r lhc uht.We.

DISCOUNTED PAYBACK
a 49. The discmmted payback period ndc :
~. ccmsit&!:P.) Ihe lime \1ulue uf mnney.
10, tli srnun'l Ihe (;uinflf pninl,
c. ~gnores liliACeitain -cash tlows..
dl. ~s p referred to the NPV mle.
c. None of the above.

Difficulty fe~re/: Easy

PAVBACK
c 50. The payback period 111le:
a. ~lcnnincs a cutoff point so that all projects accepted lby tthc N PV ruk wiU be accepted
lby the paybadk fP'=riod r!Jlle.
lb. determines a 'CUtoff point oo that dcpreciiltion is jltls.t equal to posid ...c 'Cash flow's in the
payba'Ck year.
c. requires an ml'litrary choice of a cutotf point.
d. varks the cutoff point wilh llhe ~nlerc:sl rate.
c. B()ili A and D.

AVERAGE ACCOUNTI G RETUR

c 51 . The average acrounli no retl.!lm is detcrrni ned by:
a. dh~ding the yearly 'Cash tlo\VS by the investment.
lb. divjdJing lDc average c-a0 tlows by the mn'\o'eSIIIUClll.
c. dh~ding the a verngc net mcome by the a' rerngc investment
dl. dh~ding the a vcrngc net income by lhc in~li all investment.
e. cli\Fjcling tbc net inco:mc by tloc cah t1ow.

Diffit:ulty fervt;.~/: Ea~

AVERAGE ACCOUNTI G RETURN
In 52. The in\'c">lmcnmdtlt~<.;~nn rul mh~r n.::l:ailcs :a,\cr:a,gc nci im:nmc ~ n :ave rng<= 1 n ve~h,ienl is
rl hc;
n. t~i ~c: nun ied ca~ll llo'i. mcHeud.
b. average acoounti ng return method.
c. JIVt'r:lge PJ)'ID::.ck melhnd.
tl, uvcr~1gc prnfilbi fil y imle .
e. Nnne nr lhe uhtw~ .

.Difficulty fe~el: Easy

MO DIFIED 1 TERNAL RA TIE OF RET RN

d 5''. 1\tndified 1n1cm.al mrc uf rd nm :
h~ndle . mhe muhiple IR R pr.f..lblem hy com hirn~ng cU~ 'h llmvs unm1 1 only nrrtt ch:tngc ill
s ~gn change remains.
b. requJres tlhe usc of ::11 discount rate.
c. dOc not reqt~he the usc of a dj s.oount r.ate.
tL. Rurh A uml R.
c. llotJh A and C .

.Difficulty fe~el: Medium

A \' ERA(iE ACCO UNT [N(i Rli.T IJRN

d 54. The :slbmtcoming(s) of the a':emge a-ccounti ng rctlll!m (AAR method Is (are):
a. the me of net income instead of caslb tlows.,
b . the pattern of income tlows. bas no impact on the AAR.
c. there is no elcar~cnt decision mle.
d. All of the above.
c. None of the above .

.Difficulty fe~el: Medium

INTER AL RATE OF RIE

c. 55. The avo fatal flaws of tbc i ntem:aB ra.tc of return rule arc:
a. arbitrary detcrmi nation of a ruscoUJnl rate and fuilure to considtcr inilial expe.ndr~L11.ucs.
b . arbitrnry dctcnmnation of a d1sroUJnl rate and faih.m:: to .corrccl~y ttnal:yze m!JJLual.ly
exclusive investment pn~i c~ts.
c. arbitrnry determination of a d1sC1JIJJnl rate and tlrtc mll!IILip!e rnte of return pmb~em.
d . t"aHI!lrc to consider initia.l cxpcnditl!llfcs and faill!lrc to cmTc.cdy analyze muruaHy
exclusive itncstment pn~j ce>ts.
e. faHI!lrc to concctly ana.Jy.zc. mutu al ly exd usive in es.uuem projec ts and the LlrmJtiplc rate.
of liCtlll!rn problem.

MIJT UALL V E'.~H;LUSl I PROJE ,l .S

d 56. A m!l!ltuaUy cxdusmve project is a proj cx;t 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 !low panern exhibits more than one sign change.

Dijjicu./1)>level: Easy

INTERNAL RATE OF RETURN

d 57. A project wi ll have more than one IRR if:
a. the IRR is positive.
b. the IRR is negative.
c. the NPV is zero.
d. the cash !low panern exhibits more than one sign change.
e. the cash tlow pattern exhibits exactly one sign change.

Dijjicully level: Easy

INTERNAL RATE OF RETURN RULES

b 58. 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.

Dijjicully level: Easy

INTERNAL RATE OF RETURN

a 59. The internal rate of return may be detlned as:
a. the discount rate that makes the NPV cash tlows equal to zero.
b. the difference between the market rate of interest and the NPV.
c. the market rate of imerest less the risk-free rate.
d. the project acceptance rate set by management.
e. None of the above.

Dijjicully level: Medium

MULTIPLE INTERNAL RATE OF RETURNS

d 60. The problem of multiple IRRs can occur when:
a. there is only one sign change in the cash tlows.
b. the tlrst cash tlow is always positive.
c. the cash tlows decline over the lite of the project.
d. there is more than one sign change in the cash tlows.
e. None of the above.
 Difficulty level: Easy

TTh'ONG AND SCALE ISSUES WITH INTERNAL RATE OF RETURN

b 6 1. T he elemems thar cause problems with rhe use of rhe IRR in proj ects rhar are mutually
exclusive are:
a. the discount rate and scale problems.
b. tirni ng and scale problems.
c. the discoum rme <md timing problems.
d. scale and reversing flow problems.
e. Liming and reversing tlow problems.

Difficulty level: Meditun

NET PRESENT VALUE DECISION

c 62. If there is a contlicr between mutually exclusive proj ects due ro the IRR, one should:
a. drop the rwo 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 AAR because ir does not suffer from these same problems.
e. None of the above.

Difficulty level: Meditun

PROFITABILITY INDEX
e 63. T he profitability index is rhe rati o of:
a. average net income to average investmem.
b. internal rare of rerum to current market interest rare.
c. net presem value of cash flows ro i mernaI rate of return.
d. net present value of cash flows to average accounti ng remrn.
e. present value of cash tlows to initial investment cosr.

D({]iculty level: Emy

INVESTMENT DECISION RULES

a 64. Which of rhe fo llowing statement is rrue?
a. One musr know rhe discoum rare to compute the NPV of a project but one can compute
the IRR without referring ro the discoum rate.
b. One musr know rhe discoum rate ro compur.e the IRR of a pn:~jecr bur one can compute
rhe NPV without referring ro the discoum rate.
c. Payback accounts for rime value of money.
d. T here will always be one TRR regardle-ss of cash tlows.
e. Average accounting renun is the ratio of total assets to total net income.

Di{]iculty level: Medium

CA PITAL BUDGETING PRACTICE

b 65. Gr!.lh:a.m :a.ntl Harvey (100 I) r~ld ntl ih:a1
1_nod_ were ~he l \Vo nlll ' l pof!Ular capiilal
hudgci in;g mci llud~.
a. lni etn ul R!.lie of Reium; PtYh!.l.tk Periud
h. lni etn <tl R<lie nf Reium; NemPr~enE Value
c:. NemPrc-.;enFV aluc; Payb:ack Period
d. Mndifie d lrderpul R::tie nr" R ei urn ; lniem:a.l R::de ~lf Rei urn
e. Mf>t~ified l11ierpul R::tie or" Re iiJrn ; Nei Pre~pi Vulue

I n . PROBILEMS

. ET PRF.SE T \ 1ALUIE
b 66. W h!.li is ihe llet pll'esen'l value nf a prnjec mwiih i i'Je fullnw ing CJISh n~m!$ ::tllld Jl rt:t{Ui red
return of l2 percent?

Y carr _c~sb ElmY

0 -$28.900
~ $~ 2.450
2 $l9.630
3 $ 2.750
a. -$287 .22
b. -$177.62
c. $177.62
d. $204.36
c. $28.7.22

Difficulty {e\ref: Easy

NEt rRESE Nl ' \ 'ALUIE

n 67. \Vhat is Lhc net present ,,.nluc of a pr~jcc-~ that !has an initial cash oud1ow of l 2.6i'O
and Lhc to~ lowing casb intlows? The rcq lll!ircd return is ] t .5 pe1rrcnt.

Year C~sb Tnt1mv1i

l $4.375
2 $ 0
3 $8.750
4 $4JOO
a. $218.68
b_ $37tU 6
c. $768.20
d_ $1..249_65
c. $1.37L02

Difficult)' lew!: Easy

NEt PRE'iE 1' \"AlUIL

b 68. A project wi]l prod'ncc cash intlo.,..,s of $l.750 a )'Car for four years. Tbc project
 iniliall) (.'\l) s .$ 10,600 II ~J gci raricEi l,n yc:ar fi\1c, 1he pmjoc \~i U he c.:luscd and ;,1s a
ru ' ulf <ihn uld pn'lllhJce ~~ cu.<ih i n~lnw nf 8.500. \Vh<1 i" m hc nei pre~cnl \o'al uc ,,f Htis
prnjccmi f ~lht: rer~U i ll'ed rutc nf n:~urn 1s I 3.75 pcrt:en1
iJ. -$5,4 74.76
b. -$1 .m 1.4o
<:. -$9 35 .56
d. $1 ,0 1 L40
e. $5 ,474.76

.Difficulty {e~rel: Easy

NET PRF.SE T VALUE

::1. 69. Ynu arc cnnsidet'ing ihe l'nllm\/ing li Wn m uiiL~::~Hy c xcl ~~"ii \le pnlj.ed~ mlhumwili 1110i be
um i"i 11.25 pcrceni fwr pmjed A :1ml 10.75 pen.;eni fulf
repe:ded. The rt:tfuin:d r:de of rem
project B. \Vhich proj eel hould yo1111 accept and why?

Y.'1.( f__mb;_t A E!ro jctB

0 -$48,000 -$ 126,900
~ I 8.400 $ 69,700
2 3l ,300 $ 8.0,900
3 U ,700 $ 0
a. project A~ bccaus.e its NPV is about $33:5 mnore than the NPV of project B
n. prnjccmA; hocuus.e ii h::~"i ih e higher rot.Juirud r:de n r ruuam
c. project :B~ bccau e it has. the ] ~es.t aota.J cash inflow
d. project :B ~ bee au e it returns aU ~ts cash flows "'"'~ th in two year
c. project :B ~ bee au e it is the large'St s.iJzcd project

.Difficult)' fewd: Medium

NET PRESENT VALUE

a 70. Yoo rue ronsider~ng n.vo mlll!l11.1ally cxclushrc projects. with the foUo"-""'ing cash t1ow.;;.
\ViH your choice between lhe l '\J,'O projects differ if doc required mtc of return is 8
pc:rcenl rather than l] percent'] 1f so, what should you. do?

Ysnr Jf!roi!;.QLA (!m jctB

0 -$240.000 -$ 19 &.000
] 0 $110.800
2 0 $ &2.500
3 32:5,000 $ 45,000
a.. yes; S:cJect A at & percent and B a t 11 pel' cent
b. yc:s; Select B at 8 percent and A at 11 pcrccnt.
c. yes; &eJect A at & percent and s.ck ot ndd:Jcr illl I I perc-ent.
d. no; Regardless ohhc r-cqujred rate, project A ruways ha5 the hJgller NPV.
c. no; RcgardJc:ss ohhe requhrcd rate, project B always has. tbc higbcr NPV.

Diffku lty fe~rel: Medfum

INTERNAL RA l 'E ot REll R~

b 71. What is the internal rate of return on an investment with the following cash t1ows'?

Year Cash Flow

0 -$123,400
I $ 36,200
2 $ 54,800
3 $ 48,100
a. 5.93 percent
b. 5.96 percent
c. 6.04 percenr
d. 6.09 percent
e. 6.13 percent

Dijjicu./1) level: Easy

INTERNAL RATE OF RETURN

a 72. An investment has the following cash !lows. Sho uld the project be accepted if ir has
been assigned a required remrn of9.5 percent? Why or wh)' not?

Year Cash Flow

0 -$24,000
I $ 8,000
2 $12.000
3 $ 9,000
a. yes; bemuse the IRR exceeds the required return by about 0.39 percent
b. yes; bemuse the IRR is less t han the required renurn by about 3.9 percent
c. yes; bemuse the IRR is positjve
d. no; because the IRR exceeds the required return by about 3.9 percen t
e. no; because the IRR is 9.89 percent

Dijjicully level: Medium

INTERNAL RATE OF RETURN AND NET PRESENT VALUE

e 73. You are considering two independent projects wlith the following cas h tlows. The
required :remrn for both projects is 10 percenr. Given this information, which one of
the following statements is conect?

Year Project A Project B

0 -$950,000 -$.)25,000
I $330,000 $ 55,000
2 $400,000 $ 50,000
3 $450,000 $ 50,000
a. You should accept project B since it has the higher IRR and reject pr-oject A because
you can not accept bo th projects .
b. You should accept project A because it has the lower NPV and rejecn project B.
c. You should accept project A because it has the higher NPV and you can nor 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.

Difficulty level: Meditun

INTERNAL RATE OF RETURN

e 74 . You are considering an invesunent with the following cash tlows. If uhe required rate
of rew m for this investment is 13.5 percent, shouJd you accept it based solei) on the
internal rate of return rule? Why or why not?

Year Cash Flow

0 -$ 12,000
I $ 5,500
2 $ 8,000
3 -$ 1,500
a. yes ; becau se 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 nue of return
e. You can not apply the IRR rule in this case because there lU"e multiple IRRs.

Difficulty level: Medium

PROFITABILITY INDEX
d 75. What is the protltabili ty index for an investment with the following c.ash !lows given a
9 percent required return?

Yeru Cash Flow

0 -$21 ,500
I s 7,400
2 s 9,800
3 s 8,900
a. .96
b. .98
c. 1.00
d. 1.02
e. 1.04

Difficulty level: &1sy

PROFITABILITY INDEX
e 76. Based on the profitability ind.e x (PI) rule, should a project with the following cash
tlows be accepted if the discount rate is 8 percent? Why or why not?

Year Cash Flow

0 -$18,600
I $ 10,000
2 $ 7,300
 3 $ 3.700
;,s, yc.~ ~ IJcctuJJ"ic 1he PI i ' I .008
h. )'L':'i~ IJcctuJJ"ic 1hc PI i ' .992
c. )'e:<i~ bcc;JU"ie li he PI i ' .999
d. nn; becau"ie ~he PI i ' I .008
t:, nn; bec:afU"ie ~file PI i ' .992

Difficui('l' fe~re/; MedilDn

PROFIT ABU ILITY INDEX

c . ng h~n independe nt prnjt:cl$ huih of v.1hi<.: tt h.Jtve hee n JIS ' igned
77. YnJ a rc cfmsicte:."T"i
n dis~;;num nde nr 8 pc,n.c ni, R:ascd un mhc pmfiio.ilii li1y i111dt:;'lrl, u.lrt.U is your
rc<.:nflllmcmkd iem c.uliJCt."T'Iililllg i hese prnjed-.?

Project A Project B
Ye.Dr C~sh,Flm\' Ycar C:JJsh Elqw
0 -$38,500 0 -$412.000
1 $20.0{1() I $10,000
2 $24JJOO 2 $40,000

a. You should accept bO(h projects since both of thtcir Pis me positive.
b. You should accept pr~icct A s~ncc it has the higher Pl
<.:. Yl'tl]l shllUid :attepl bnH1 prc~f!!(;i"i .. ~ nee hn'l h nr H.eir Ph Uli"C ~:dell" ihn I.
d. Y04.1 hould only accept p11ojcc1 B since it has llbe la11gest PJ and the PI exceeds 1.
e. d th:eT project is acceptable.

Difficulty few!/: Medium

PROFIT ABILITY I DEX

d 78. You would 11kc to in\es.t in tbe t'oUowing project.

Ye.Dr c~-.h Flow

0 -$55,000
] $30.000
2 $37.000

Victorla. ym1r boss, ins.sts that only projects tbat can retwm at least $L to in today's
doUrus tb11 every $] invested can be at:ccptcd. Six also insists on applfy~ng a ] 0 percent
d ~scount rate to all >Cash tlmvs. Bascd on these critcri a. YOl' shrn1ld~
a. accept tlrle proje.cm because it retm:ns il .hnost $ 1.22 for every $ J i nvcsm
cd.
b. at:ccpl the projc'Cmbcca!!lsc it has a pos ~tj vc Pl
c. accept tlrle proje.cm because lihc N1v is 2.,8.5].
d. reject dR: project because the PI is !.05.
e. reje'C lilhe proj e ~t because the IRR exceeds l0 percent.

Diffil:ulty level: CllaHeuge

rA 'VBAt~K PI!:RJ( )D
c: 79. If \'!till cn"i 2,600 h"Ltc:'-.Lui re u smuU ice cn:um em. Cart tlc:o; nlie c~pccm.c.d ro he
$1 .400 :a ycu.- I"M m hn...-e ye~11 ' . AfreTii he Uilrec year'. m
hc carl is e ~:rx:de~Ut.l be \\1Hni hie ' :<i
U ' rlh:;Jil is he .e:~.pec:led remaining life nr HJC c:noling ~l.tn'l. Wtu~m ~ ~rte ~}TI::tck period
nf ri he ice cream c::u,i ?
~l . .&6 ye:ar;
b. 1.46 year"i
c. 1.86 year"i
d. 2.46 year"
e. 2.86 year"i

Difficlllty fe~rel: E(lsy

PA BACK PERIOD
e 8:0. Ynu me cnl!lsidcri ng u plrujL-c wirlh a11 inirl ial ct:l"i1 nf $41,300. \\'tutl i-; Hte )R~yh:Jd:
period foli thh projccmif the cash jnt1ows arc $5:50, 970. $2.600, and $500 a year o.,cr
dl!: rnexmfour years, rcspect~vcly.
a. 2.04 _years
b. 2.'"'6 year"i
c. 2.89 ye:ar""i
d. 3.04 _years
c. 3.36 _years

Di.fficulry (e~el: (lsy

PA \'BA<:K Pli:R l()b

d 81 . A project has an irnjtiaJ cosr of $1,900. The cash int1ows rulic $0, $500, $900. and $700
ova the nc.xrt four )'"Cru-s, respccdvdy. What Ls the payback [PCriod?
a. 2.71 years
b. 2.98 years
c. 3.11 years
d. 3.71 ycru:s
C. IJ]C\fCf

Difficulty {e~rel: Easy

PAYBACK PERIOD
c 82. Jack ~s considcr~ng ad.dirng toys to his general store. He esthnatcs tlmt the cost of
inventory wiU be $4.200. The remodeling CXfPCns.cs and sheh.. ~ng costs arc estimated at
$1 jUU. Toy s.alles mrc expected to produc.c net cash int1m\rs of$ ~ ,200, $1 jUU, $] ,600.
and $1 ,7 50 over the next four ycru-s, rcspccthcly. Should J ilc!k add loys to his -slorc if
!he assigns a three-ycru payback: period to this project?
a. yes ; bc~ause the payback [PCrioo is 2.94 yerus
b. yes ; because the payback period is 2.02 yerus
c. yes ; lbccat1se the paylback period ~s 3.80 ycalis.
d. rno~ because the payback period is 2 .02 years
c. no; !because tbc payback period is 3.80 years

.Difficulty lew!/: Medium

DISCOUNTED PAY HACK PERIOD
c id OOM ~lr $8,500 ;~nd produc:e t::;tSh in fl nw of $2,600, 54.900.
83. A iJmljee'l h1.1, ' un ini m
and $1.500 over the next ihrcc .:Y-ears, respecthcly. \Vhat is llle discounred payback
perind if rhe requi red mre u f m lum 1<i 7 pen:enr~
:1, 2,1"' y:;J.T"i
b. 2.33 yerJ.T"i
(;, 2.67 y:a.T"i
d. 2. 91 years
e. ne.,."Cr

Diffic~lty fe~ref: Metli~Dn

DISCOUNTED PA YHACK PERIOD

c 84. Yanc} ms considedng a project \Vhich wiD prodm;e cas!h intlows of $900 a yc;:~.r for 4
years. The project has a ~ pc!J"CICnt n::qui rf.':d rate of retnm nndl an i rul:i :II cost of 2.800.
\Vhni is rhe d1scn un~oo payhJ.c!k pcrind?
a. 3.11 .years
b. 3.1& years
c. 3.8.2ycars
d. 4.18. years
C. IJC"'Cf

Difficulty le\~1: Medium

DISCOUNTED P AYHACK PERIOD

e 85. Gilmy Tmcblood ~s considcri lllg an i n,.cslnlc:nt which wi Ucost her $] 20.000. The
invc Lmcnt produce.., no C'ash nov.. tor tlllc first ycrn:. In the second ycru lhc cash
intlow is 35JlUO. Th~s. int1ow wW ~ncreasc to $55.~ ill.lld then $75,000 for loc
following two years before ccasmng pcnnancndy. Ginny requ ires a l 0 percent rate of
return and has a requ ired! drlscountcd 1XJiy'back period of thrf.':e years. Ginny shou~d
_ _ d"Jj s pmjcct bcca~ars.c the discm.11ntcd payback period is _ _
:.~. accept~ 2.03 )~.
b. accept~ 2.97 years..
c. accept; 3.97 years.
d. reje~t; 3.03 years.
c. reject; 3.97 ye-ars.

lJiffil:ulty level: Medium

A \t' ERAfiE ACl."C:liJNTl G R ET UR

c 86. t.urrys l...antcms is c-onsi dcri ng Cl project which wm produce sales of $240.000 Cl year
for the ncxl nvc years. n 11c protil n1ar_gjn is estimated at 6 percent. '11tc project "'~,r~IJ
rost $290J1lX!l a.nd be depreciated slrnight-linc lO a book value of zem over tllc life of
toc project..Lany's ihas a H:qu~n:::d account~n,g rctl!lrn of8 percent l'his project shouM
be becal!lis.e the AAIR is
a. rejected~ 4.14 pcn.--ent.
 h. rejecletl; 6 pen:erd.
<.:. rejecletl; 8.28 pen.--cfl._
d. u<:t-eph=d; S. 28 percenl.
c. u~ccpred; 9.93 pen.enl,

Diffic11.fty fe~-el: Medr11m

AVERAGE ACCOUNT~NG RETURN

d 87. A proJect has <m initial oosmof$ 3&.000 and! a four-year life. Tihe comptmy uses
:d rnigh i -lint: dep..eci::~li ic~on li cJ ::t. hllllk value Elf zern nver rhe 1i fe nf illilf: pr<l~ecm, The
projected l!ll!l i RC<l)m ~ fr.om lhe rmjecl i"i $1,000. $ 11.200, I.SOO, :mtl $ L700 u year fnr
rt.t 111e:-:~ fnur yt;;tJT"i, re~~C'i ~\ ~ly. \.Vh;~~ is rhe avem~"rt :K"<.lnUni ing ren11rn1
:1. 3 .55 pen.-eni
b. 4. I 3 pen.--cni
c. 4 .2S percent
d. i .ll percent
c. t4.2 l percent

AVERAGE ACCOUNTI G RETUR

d 88. A pmjte'l prnduces i~n nu;)l !lei ipc:nme nf $9.500, 12.500. ;)nd 15.500 El\'e r ihe m hrce
years of its li fc. rc-spoct~vcly. The i11hi al cost of the: proj cct is 260.400. 'fhis cost ~s.
dcp11eciated stra.ight-Hne to a zcro book "'aluc over tl:Jrcc yeaJJs. \Vha.l is the average
at:ooll!lntj ng rntc of rctum ~t' the 11e-qu ired disc:oont mtc is i ]XIfcent?
a. 4. SO percent
b. i. 32 pen..--cnt
c. 8.97 percent
d. 9 .60 percent
c. 10.21 percCTit

Difficufty {e~re/: Med;um

AVERA(.i:E ACl.""-OIJNTI (i RET U R

d 89. A project has avcrngc nc~ irn.:omc of $2.1 00 a year ovc11 its 4-yot:ar l~tc. The ~n~lht.l rosl
of the project ]s. $65.000 ""hich wi~~ be depreciated "sing slrniight-l]nc dep:rc:dat~on to a
book value: of zero over the ~j tc of tbc project. Tlrtc fi lim wants to CLUll a .ru Llimal
avcmgc ocoom11n.i ng lfC:tli.ll.m of 8.5 pclirenL The lilrm should tlrtc project based o:n
the AAit of
a. a~cepl~ 6.46 p;:rcenm.
b. accept; i) .69 percent
c. a~cepl~ I 2.92 perocent.
d. reje-ct~ 6.46 percent.
C.. reject ~ rl.92 peTCCIIlL

Difficulty {eve/: M eJfum

AVERAGE l\CCOUNT G RETUR
a 90. Ji.f url1n i$ ~mul j:.ri ng a pll"uje:d ~md t lil! ' g.amlh elied ilrtc f4)11nwing d:U~. "BtLc~ietl nn ihis d:iJ~,
\:\o'h:art ;... ilrle n.,_-emge uo;;ou.nling r~lie nf rc'l um? The fillTI <lepn..--c1il!mt.-.; im tL~set s n ing
slr~aigh I- Ii nc dc p n::ci:all ~nn 1u a ZcT4) b t.)l.lk ~,o :dt.Le m rer ihe li fc nf 1he ~l!i<id .

Yc:a.l' C :)!oin Fln.w N c'l l lilt n mc

0 -$642,000 nliJJ
I $ ~ 70,000 9500
2 $240,000 579.500
..,
..) $205.000 4.500
4 $ ~ 95,000 34.500
;,1. 13.08 pcrccnl
b. 15,77 pcrccni
c, 2 I ,8-3 pcrccni
d. 26. I 7 pcrc cnl
c. 31 .54 percent

Difficulty level: Medium

l NC REJ\l EN'FAL JNTERNAL RA"I E ()If RI!:'I." URN

c 9]. Yoo arc analyzing tlbc tblllowi ng two nmtrnally cxdusivc Jinojccls and have dcvdopcd
tlrtc foUowing irtformatio:n. \Vnat i ~he ~nC'IfCnlentall IRR?

Project A Project B
Year c~~h [Jo).'l Cash Flo_w
0 84,500 -$16,900
] $29,000 $25,000
2 $40,000 $35 ,000
3 $27.000 $26,000
a. II , l l percent
b. 13.UJ. percent
c. 14.9 l percent
d. 16.7'5 percent
c. 17.90 percent

Diffil:ulty lew/: Medium

l NC REJ\l EN"FAL JNTE.R AL RA"FE ( n' REl"URN

b 92. Toe \Vin ton Co. 1s considering two nmtuaUy cxdushc projects \'\rith lhc fotlowing
c-ash flow'S. The ill{'rcme ntal IRR is a!lld it' llhe rcqu ired rate is h~ghcr fh an the
c1rossovcrr rate tbcn proje<::t _ _ slrtould be accepted.

Projc-t A P~jcct B
Year Cash flow Cash Flow
0 - 7S..OOO -$60.000
] $30.000 $25 .000
2 $3S.,OOO $30.000
3 $3S.,OOO $25 .000
 ~l. 13.94 pc~cnf~ A
b. 13.94 pt~~cnt B
c, 15.44pc~cni~ A
d. 15.44 pc~cni~ B
e, 15.8.6 pc:re:cni~ A

Yc:;~.r C:ash tlnw

0 -$ 169,00)
] $ 46,200
2 $ 87,300
3 $ 41 ,000
4 $ 39,(MX)
R eq 11 ired PJyb:ad:: periE'Id 2.5 }'t.'-'JIT$
Required AAR 1'.25 percent
Required rerum S. 50 percent

PROFITA81LITY DEX
b 93. Based on the proti tabi1ity inde.~ of _ _ for thJs proJect, you -should _ _ the
projc'Cm .
a. .91'; accept
b. 1.05; acrepl
c. 1.1S; a-crept
d. .9'7'; reject
e. 1.05; reject

Difficulty le~rel: Easy

INTER AL RATE OF R!E R.

tl 94. 'Based on the ~llt crn;rl Ji'LllC of return ot' _ _for th~s project, j'O!III SOOU~d the
projc'Cm .
:1. 8.95 pcrocnt; acccpm
b. 10.'7'5 percent; accept
c. 8.44 pcrocnt; rcj ect
d. '::J .67 perc-ent~ rej ect
-c. 10.33 percent; reject

Difficulty lew!!: Easy

~1!:1. !rRE..~.E NT \" ALUll:

c 95. Based on the. net [present value of tbr this pLoj cct, you should !.!he
proje'Cm
.
a. -$2.02] .28~ n:jccl
 h. -$406. 1 9~ rej~
c. $7.978.72 ~ ~u:ot:pf
d. $9.1B6.74 ~ m:ccpt
t: $12.684.23~ i.U.:l't:pi

Difficui~v few/: Ecsy

PAYBACK PER.OD
c 96. Based on the 'JX!Iyback period of _ _ tbr lh LS pmjcct. ) fOU shou[d _ _ the
prnjccr.
i.l. I .87 ~(::a.T-.; ; :a.cccpl
h. 2.87 yem-.; ; :a.ttcpi
<.:. 2.8.7 yeat"i; rcjt:c: i
d. 3.13 yer1r<;; n:jt:c:'l
c. 3.&7 years ; rcjcot

Use u~e fo:lh~Wiln&! rirlf:OI'IIIJatimill to iUJlswer questions 91 tl~nu~b l Ol..

Yol.ll ilfC consideri ng the tbUov.ing 1:\\'0 m1r.ttually exclusive pmjccts. Both p~iccts r;.vHl be
dtprec:i :dod u~illl~ -;i mi gh m
-li 1i1C deprcciulion I n a zcm ht.)llk valUe nver ihe I i fc c)f i llc )ll'njcc m.
Ndthcr project has. any salvage vaJ.nc.

Project A ~jcot B
Year Cash E!ow .Year CU5h Row
0 -$75.000 0 -$70,(0}
[ [9,000 1 $10,04J)
2 8,000 2 $16.000
12,000 3 $72.(0)
Rcqruircrl rate of return 10% 13%
Rcqruircrl payback per iod 2.0 years 2.0 years
Reqru.rcrl acoounli ng return 8% 11 %

Nl1. PRE.~ENl' \ ' ALU[

c 97. B~L:;cd on the nc~ present value mctt.Jod of analysis and ghen tt.Je information in the
problem, }IOU should~
a. accept both project A and project B.
b. accept project A and reject project B.
c. accept project H and rej cc t proj-ect A.
d. rcjc(;tlboth project A and project B.
c. accept wihkhcvcr one )IOU wam as they rcplicscnt equal oppon unitBes..

Difficulty fe~~/: Medium

INTIRNAL RA l'E Oli RETl RN

e 98. Based UfPOll the ~ntcmal liatc of return (JRR) and the ntbnnali on pro,idcd in dle
probkm, you should:
 [l, 1,\(:Cepl N lth prnjeL"I A ;,mtl prujL"CI n.
b. rujed ho11l iJ1mj,cd A ::mtl p ll'njcx:t B,
<:.. U<;t."Cpl f"t~r.:ct A and l!'ejec: I pmjec:l B.
d. 1,\<;cepl f"t~cd R und rej e.cmpmjccm A.
e. 1g111.m.: I tle IR R !iU~ a111d U<lc ~lQG\1 1-te:r rnr.:Htud n{ n n ~lil ysi<~.

PAYBACK PERIOD
b 99. Ra.~ed t!Jpo n tile. p tl.yb:ack JlL"ri od uprl Ihe in l~lrm:a.i ifm I"n\o'ide.tl in lile iJ1m'hle.m, you
:o.llc"MJld :
~l, u<;cepl llxlth prnjred A ;,mtl prujLocl R.
b. rujed hn11l iJ1mjeC'i A rJllltl p mjt.'>Ct R.
<:. utoepl f"t~t.o:cl A and l!'ejed pmjed B.
d. m:cepl projc'Cl B and rej eel project A.
c. require that management extend lllc paybaC'k. period tor project A since it has a h~gher
i niLia~ cost

PROFITABILITY I D:E
e ~ 00. Ra..~d upn n mile pmnfil~hi l ily index (Pn ::~ml ~ lrtt l lll~~nmal itlll pnw1tkd 1n lhe pmblem,
you shoU~Id:
a. ;u:cept both project A :md project B.
b. a-ccepl project A and licjcct project B.
c. m:cept proje'Cl B and reject project A.
d. reject both project A and project B.
c. disregard the Pl method in tthis case.

Difficulty le~re!: Medfum

AVERA(TIE ACCOIJNT[N(T RETU R

c Wt Based upon tbc a"'cragc a-cooLmtj ng retmm (AAR' and the infommion provJ<kd in the
prob lem, you:
a. hotdd accept both ]project A and project B.
b. shoold accept project A because ttle AAR e.'tcecds the requhcd rnte.
c. shoold accept pr~jcct A because thc AAR is less than the required rntc.
d. shoold accept wh.idle' 'eli pmje~t .YOU prct<:r as they rur-c eq uhruent from an AAR
perspective.
c. c:.m not corn pule the AAR of either p:roje'Ct

Difficulty {e~rel: Medium

~El' !PRES.E Nl' \1 ALUIJ:

d 102. A :25 hwestmenl prodl!lccs. $27.50 at the end otftthc. year \\'Jdl no rts.k. Which oi the
tblilo'Lvi n,g is trw:?
a. NPV i-s [POSitive if t.hc intercs.t rate ~s kss mhan l 0%.
 lb. PV is ne~.alive iflthc inlelfcsll'me is les.s than 10%.
c. NPV is zero if the i nlcresl rate is. equali to I0%.
d. Both A :rnd C.
C~ one of' mfle albove.

D(fjkulry level: ChalltP1~i.'

PA\"HACK
h 103. Corts.idet an iuvest rtl.enl with an ~nitia~ oost o f $20,000 ilf!ld i s expe.cred ~o la.s.Ltbl' 5
yc:urs. '11te cxpeotcd cash t1ow in yean 1 :md 2. arc 5 .ouu, i 111 years 3 and 4 arc $5 ,500
and in year 5 is. $ ~ ,000. l'hc tot ali c-ash inr1m.v is. expected to be $22.WJ olf an a'\:cragc
of $4.400 per year. C41~~nputc the pa)'back period ~ n years.
a. 3.1 8 years
lb. 3.82 years
C. 4.00 yeaJ'S
ct 4.55 yeru-s
e. None or me ~ove.

D ISCO Nli'ED PAYBACK

c 104. An invcsmncnt '1.\ridJ an initial cos.t of$15.000 produces cas.h tlows. of $:5J..Jt.JV annuaily
for .5 yeat'S. If the cash tlm ~s. evenly s.pread out ove1 the year and lhe firtn can borrow
at 1O!fi; , tile d~s.coulf.licd paybock period is years.
a. 3
t).3.2
C. 3.75
d. 4
e. :S

DlSCO li'ED PAYBACK

h l O:S. An i nveslrL-.eut pmjoct has. ll1e cas.h flow strerun of S--2j{). $7 5, 125. $ HJO, and $:50.
TI1e cost of cap1tal ~s. 12'i.o . Whlli ~s. tihe dis.count payba k: period?
a. 3.15 yeru
t). 3. 3R yeru
e. 3.45 yeru
[l 3.60 Yttll"i
e. 4. 0.5 yeru-s

NET PRI:SE T VALUE A D INTERNAL RATE OF RE RN

Ja I06. An i 11~e:~~hneni c~lSi 10.000 wiih t!:t[llC<:ied cush li~l\,'S nf $3,000 ft)r 5 }'t."Jlf!'. The
discount rme is 1:S.2JS2%. l lhe NPV i ~ _ allld the IR:R is._ fot the projeeL
a. $0; 1:5.2382%..
 b_ $3.33; 27.2242%_
c. $5,U(JO: 0%_
't Can nol ans.weJ ,,..~lhollit. one or the other value as ~nput.
c. None of the above_

IV. F.S AYS

INTF.RXAI. RATF. OF RF..TURN

ao7. list and brictly discuss the adva.Jlltag:cs and disad\ra.Jlltagcs of the jnt.crnru rate of return
{IKR ) r l!llc.

The JdVcmfae." ofrh.e mJe are ir.~ Jose reJarilm.'ilrip wirh NPV wld rh.e ea.\'t! wirlt rwhii..-h
ir i." tmder.fluod ami l.nmmuni ared. The hWJ di.wtf~wda e.-r Jre rlw; 1l1ere rrw,v be
1W~liiJlle .wlurio-ru wulrlut rule may lemi lo a rauki.Jrg rmflii..i iu e~aluaring rrwitwlly
t:.,.x lrtsiPe inves'fme111s. The srudem .dwuM add a brief expJa.narhm demcm.urorinR their
u.nderstanding t.i f ea.h

PV VS. PI
1OS. Exp1ai I'll the d ifferences. aJJ:ld si t:ni1arities. betv.een ~1et present \'alue (N PV) and l.lle
prontab~ljty index (f 1.,_

The NPV wrJ PI are bct.'li aHy rhe same (;a/(;ularimr. a1uf b.orlr l'ule ... lead fo1f1e .tJme
a ,eprlrejec;i rle,i,~imr. Tire main dif!eren,e berweert tlu: l'wo iii thJi rhe Pi mlJy be useftd
itt Jetermi~ting whi Jr r'roje,r... /(1 a{.- ept if. 'r.mtf.\' are linril'et f: lm'We~rer. rhe Pima,; lead
/ (J i.rl m're,t de<.isimL'i i.n c;mrsidering murually exc:lusi.w: imre.~tmeJrt.~.

NPV ANn PROJF. T VAJ.UF..

109. Gi\'eJ) the. gooD-s oflfltm value aJ'Id s!h:lli'ebolder wealth ttiaxi~nization. \rve have stre~oo
me irrnpt.xt:mce of net preseflt value (NPV)_ And yet. f!riany li oonc ia.l dec-i~ion-ftlak.efi ill
some of l.he mosl p1~omj ncnl finns. j n llJe 'i. odd conti nue to us.e les.s. des.ir-.:11ble tne.amrcs.
su cib as. the payback period and ll1e il\'el!'age accoulflling remm (AAR)_ W hy do you
Lhi nk lllri s. i~ [Jle case?

Thi." i.-r an (Jpt!H-eJrrled que.~t~-mr wlu"dt atlm ....~ the {..reJiive .m~dem 111 ~JN! uJate tm the
vafl~e (Jfmm-di.\,ow~led c:a:rh flow evafuali.t)Pl mea:rure.~- We tt:iie ir cH a .'iiln'iJrJ;fmarrl to
st~.u thai e~t!ll ra.limwl {i.nJm:ial nrmragen ii.tmretiml!.\' find it e.:rpeJiem 111 u...'e a grrmp
of mea.~ure.fi. For exanrple, firnr.ii may re('l rm the JRR beclJu.~e it is ewier 10 explain ro
l10t:1Td members llr.o.n NPV. Al:io.fm 141-rge projects. AAR pro~ides sha relr.o{de"ts with
some invigh.t.v lJ." io rlu! pmjec;t '.\' impJc:1 rm net ini..nme and t!lJming., per $iwre.

] TER "AL RATE OF RETUR

~ ]0_The Z igg)' Tri tn and Cut Cornpa.ny C;:lJJl purchase equipment on sale. fOJ~ $4.300. The.
:a.~scJI h:a.., ::t li hree-ycmr I ifc, \'-'il l [JlTHttuce .. [.:~ISh n nw Cl r $1,200 in i be r1 11"S!I i.lJlld ~ecnn~l
yt.~r, :a.nd $3,000 i rt ih mhird yeu!f. The ioicrc,o;i raft: 1~ 12%. C:;~.ku hlie mhe prnjt.~f'
payhac.:k. AI~~. c.:Jdcul:a'IC pmjt.~l 's ]RR. Shn ul d ihe pmj cLI be li :alkeli1? Chec.:k ycmr
answer by comput~ng iJhe pmje t's. NPV _
 Payback - 2.63 years.
IRR = 10.41%. Do not wkeprojectas IRR < 12%
Reject 1he projecl NPV = ($136.60)

1\'f ULTIPLE METHODS OF VA LUA TJON

I ll. The Ziggy Tri m and Cut Comp<'ln)' can purchase e<tuipment on sale for $4,300. The
asset has a three-year li fe, wil l produce a cash flow of$1,200 in the lirst and second
yem, and $3,000 in the third year. T he interest rate is 12%. Calculme the projec~s
Discounted Payback and Proliwbi li t)' Index assuming end of )'ear cash !lows. S hould
the project be taken? lf the Average Accouming Retum was positive, how would this
affect your decision'!

Time 0 - Cashjlows = $-4,300, Presefl/ Value ofCashjlows = $-4,300

Time I and 2 - Cashjlows = $1,200 each period, Presefll Value ofCashjlows =
$2,028.06for bolh periods, Stun oj'Prese11t Value ofCashj1ows = $ -2,271.94 a/ the end
of lime 2
Time 3 - Cash .flows = $3,000, Presenl Value f?{Cash.flows = $2,135.34, Sum of
Presem ValueofCashj7ows = $ -136.60
Discoumed Payback ca11not be calculated as NPV < 0; NPV = $ -136.60
PI= CFA7/ !In ilia/ Jnves/lnen/ = $4,163.40/$4,300 = .968 = .97
8 01h measures i11dica1e rejeclion. A posilive accouming rale of rewm should 1101
change !he decision. DPP and P I ilulica/e liwllhe coslf?{capilal is 1101 being covered.

MULTIPLE METHODS OF VALUATION

112. 111e Walker Landscaping Company can purchase a piece of equipmem for $3,600. T he
asset has a two-year life, will produce a cash tlow of $600 in the first year and $41,200 in
the second yeru. T he imerest rate is 15%. Calculate the project's payback assuming
steady cash !lows. Also calculat.e the project's IRR. S hould the project be taken'!
Check your answer by computing the project's NPY.

Payback = /.714 years

Calculaled IRR = 16.67%. Accep11he projec/. NPV = $97.54.

INTERNAL RATE OF RETURN AND NET PRESENT VALUE

113. 111e IRR rule is said to be a special e<ISe of the NPY nile. Explain why this is so ;md
why it has some limitations NPV does not?

AI some K, NPV = $0; by de.finilion, whm NPV=O, K=IRR.

Problems occur due to conjlicls with muwally exclusive projec/s, liming and size
problems, mulliple sign clumges presenl problem for IRR
NPV always !he best choice
 SOLUTIONS TO TEST BANK PROBLEJ\IS

Chapter 7
12 450 19 630 2 750
66 NPV = - $28900 + $ 1 + $ 2 + $ 3 NPV = -$177.62(ne mive)
. ' (1+ .12) (1+.12) (1+.12) ' g

CFo -$28,900
co, $12,450
FOt I
co, $19,630
F0 2 I
col $2,750
F03 I
I = 12%
NPV CPT
-$177.62

67. NPV = - $ 12670 + $4,375 + $0 + $8,750 + $4,100

1 2 4
' (1+.115) (1+.115) (1+.115) 3 (1+.115)
NPV = $218.68

CF0 -$12,670
co, $4,375
FO, I
co, $0
FO, I
co) $8,750
F03 I
co, $4,100
FO, I
I = 11.5%
NPVCPT
$218.68
68.
NPV = - $1 0,600 + .t l ,750 I '+' $1,750 , -r $1 ,750 3 + $1 ,750 + $8,500
.
0+. 1375) (I +.1 375 ~ ( ~ +. ~ 375) (1 +. 1375) (1+ . 1375)~
NPV ""' -$ 1.0 11 .40

CFo -$1 0,fi00

C{) l $1 750
All 4
CHz $fl ._)(){)

Ah 1
I= 13.7:5%
NPVCPT
-$ ~ .m 1AQ (negative)
oo~, ~ s,4()() 3 ~ ,3(1(1 $ u,100 . P.
69. Npv
A
-
Q
- .p
-o
4Q

v+
(1 + .1125) 1
+
(l+ .J J25i
+
(l+ .Jl25i
N V
1
A
=.,. 2.32u.46
;:_

CFo -$48.000
col $1SAOO
t-"0, 1
co! $3 1.300
.,
~
co3 $1 (.700
Ah 'I
1::: n .2:5%
NPV CPT
2.326.46

NPV = - $ ~ 26 900+ .$uCJ,?Oll + SO,CJOO NI~V11 ;;:: 56

R ~ (I + .1075)1 0 + . ~075) 2 ~ I,W L

CFo -$126.900
co1 $69.700
A) I I
co! $80.900
m I
I = 10.75%
NPVCPT
1.991 .56

Difference in NPV = $2.326.46 - $1,99 1.56 !:::! $334.90

llihc :m:s\Ver sIllt."'i thut rl hc NPV nf Pmjed A e t.:ecd:s ihe NPV n f pr>~-lj~ R hy
~b~lUi $335.

$325.000
70. NPVA ~'1{ = - $2401000 + . ~ PV II..K~ !!!! l7.995.48
. (1 + .08)'
 II' - $325.000
N PV"' 1 L~ = - "'240,000 + _ ~ ~ N PV t L ,, 'l- = 2.362.80 (ncgathc:-)
(l +.t lr

CFu -$240.000
co, $0
FO, 2
COz $325 ,000
Ah 1
1=8% 1=1 ] %
NPV CPT NPVCPT
17,995.4S -$2,362.8() (ncgui i\'c)

_ . . . $liO,ROO $82.500 $45,000 . . _

NP\11H 1 -$198,000+ a + ., + ~, NPVa.R<.T- $1 L0 45.:50
. " (1 + .0~) (1 + .Ot;t 0 + .Ut;)"
$ 11 o _~oo $~2.soo 45,000 ,
NPV,3 11 .._ ~ - $J 98~ooo + + + ~ Nl~v~~. ~~~ = $L682.28
7
. (l +.ll) I + .1 1)- (I + . 1~ )

Cf'o -$19S.OOO
co, $11 0.,800
FO, I
COz $~2. 5UD
Ah 1
COio $45,000
FTh I
1=8% T= II %
NPV CPT NPVCP'li"
[ 1.045.50 $1 ,6S2.28

A11 8 pt.."J"Cc.nl. PJt~oci A h~as 1hc h igher NPV.

A11 [ I p<-'1'c enl, PrujfX!i ll h;,~~ ihe h1g}1er IPV,

71. Cf'o -$123.400

co, $ 36.200
F01 I
CD:! $ 54,800
Ah I
CO;. $ 48, 'I 00
f'0:3 I
IRR CPT
5.96%
72. CF0 -$.24,000
cv1 $ s.ooo
FOI I
cv! $ 12.000
m. ~
co $ 9.000
'F (h II
IRR CPT
9.89 perce nt

Tih prnjec~ <ihould be ~cccpted bcc:al.il"ic 1 he l R R uf 9.89 pen:cnr cxccccls the

rc qu1red m l urn 4)f 9.5 pen.-enl.

73. PmjccmA: Pr~lje<.:t R:

Cfo -$95{),000 CFn -$] 25,0CIQ
CO I $330.{)00 col 55,000
F01 l F01 l
col $4oo.ooo co 50,000
'f'O., 1 F01 1
OJ, $450.000
'Ah t
IRRCPT IRR CPT
1l .06 percent ~] .79 percent

l= w ] ~ w
NPV CIPT NPVCPT
l8.670.17 $3,88&.05

Si nee these arc ~ndepcndcnt projects and both tloc JRR and IPV ndcs say accept. }'Otl
sho uld accept both pro:jccts f lh crc ru-e suffidenl t\mds to do so.

74. Since CO, is a 11cgativc va~111e. tbcre arc nmJtiplc IRRs. l'hus. lhc lRK mJc does.
ool apply.
 V $7,400 $9.800 $&.900 PV
15. p b!\-c< = (t .09) + {1.09)! + (L ;09) ~ ~
1 uol'lon. = 1.m.s9

CFo u
cu, $7.400
FOt l
Ctlz $9.800
~ l
CUJ. $~,900
F0_1 ]
I =9
NPV CPT
2 L909.8':l

Pl- 2 L,909.89 ; l.02

21,500

1u.ooo $7.300 ....,700

76. PV mn = $(1.08) + 1
,+
(LOS) - (LOS) 3
; PV;,m...,., =$]8,45S.Ol

CF,, ()
co, $ 10 .00U
FO, l
co~ $7.,300
Ah l
CO! $3.700
fO.J l
I= 8
NPVCPT
18.455.01

$18,455.0 I
Pl - - 99"
.$ LK,6UU - . -
 .
77. PVA. inf to....~ =$20,000
.
(LO&)
+
$24,000
1 . ~ PV
(LOSt
? ;nn,,.,.,. = $39.094.65
t ..

P.mjt::c'l A: Prnjeci B;
CFJ) $ o CF11 $ 0
co. $20,{0) co, $10.000
FO, l FO 1
rn~. $24,{0) CO;z $40.000
~ I FO~
I= 8 I= 8
NPV CPT NPVCPT
39,094.65 $43,552.8.1

PI _ 39,094.65 ~ t0 2 Pl = $43,552.81 ~ t.04

{l,- $38.500 El 42,000

Because lhe projects. .are independent and the~r P]s. exceed 1.0. boll1 p:rojoclS
shoo ld be accepted.

30,000 $37,000 . -
78. PVinflw.. - + ., ~ NPV1n~:::::::: $57,8:.11.24
o. 1u) 1
u.tur
CFB $ 0
CU, $3-0 ,UOO
FD, l
c~ $37,000
ro~ l
l 10=
rpy CPT
$57.851.24

PI = $57~85 l.24 ;;::: L05

$55J)(10

YoU :d muld n:je~:.; i rhe pmjed ' i nee mihc PI uf 1.05 i.o; 1css mhun Vi ci.uriSIJ. ' rL'1-JJUircmc nI of
I. W. Tmi ' W~\ni h meniiuni ng rih:ai ihe NPV n.f ilrli:o.; pmjec'i 1s
$2$5 1.24 nrtd mhc IRR i"i 13.71 pen.-eni, lbum h Elf \.\1hich wnuld llt)!imully irrulic:a!le
pmjeci uccepiunce, Hnwe\ler, neiiher illt NPV llt)f rhe mR meei mhe re~1ui remeill~
~lf rei urning $ I , I 0 fur c\'try $ I spenl.

79. P;t \oblc k periud

-
=J + '$2'600- I,400 : : : I .86 .ve:a;r.;
~t4100

\.~. k ' d 3 + $4,300 - $.550 - . 970 - $2,600 = 3_36. ye,ars

&0. P::l")'IU&.LC' pcno !:

$500
81.

~,. k "od 3 ( 4 200 + $ ~.5-00) - $1.200 -

P a,....>ac .. pe:n . =- + $1 ,750

S3. The prtlj c..-cr n e\<'er i(lJl ) '' hack un " di M:oU n1cd. ha!i.i. .
OCF $2,600 .$4,900 1500 $ _ _
= (I+ _07)' + (I+ .07)1 + 0 + .07) ~ ncF!: 7,934.20, wlnch IS les HJ:m llle
i nitial cost of $8.500

Year Discounted cash t1ow

I $825.69
2 $757.5 I
$6~4.97
4 $637.58

- .._..II l k 3 $2~800 - $825.69 - $757.51 - $694.97

D1soounLUI pav )ac = . + ; : :; 3.82 years
~ .$637.58 ~

ss. Ye:u- C. h n~. .w Di:scnunl ed c::Jsh lltlW

1 $ 0$ 0.00
2 $35,000$:!8,925 .62
3 $55,000$411,322.3 ~
4 $75,000$51 ,126.0 I

- d b k
0 1SCoume pay oc =3 +
.$120,000- o-.$28,925.62-$4
$ ~.
1,322.31
5
~
226 01 = 3.97 years
Ginny sho uM rejec t the project since the payba.ck pcrh:xl of 3.97 years exceeds the
required 3 years..
 .06 X $240~000 _
A AR
, ~ : AAR =9.93 percem; T1le proJect shoo1d be. a.cc-eptect
.5 X ( 290,000 + 0)
($ 1,000+$1,200 + 1 ,500+ .~ 1,700) -:-4
87. AAR = == 7. 11 poetrccnt
.5x ($3 8,000 + 0)
($9,500 + ~ 2,500 -+ $ ~ 5,500) -;. 3
88. AAR ~ . = 9.60 ifk-"'t'Cem
.5 X (.~260,400+0)

2,~ 00
8.9. AAR = = 6.46 pc~ccnl
.5 X ($65,000 + 0)
The finn sh t ruld reje.l tbe proj oct hase.d on lhe J\A R.

9 0. AAR - ($9,500 + $79,500 + $44,500 + $34,.500) + 4 =13.08 pel'Cf!lll

.5 X ($642,000 +0)

9L Ycar Proj cct A Cash Row Ptrojc:ct B Cash Flow D ~ffcrcncc

0 -$8.4.500 ~$76.~ -$7,600
l $19.000 $2.5,(0) $4,000
2 $40,000 $35.~ $5,000
3 $:27,000 $26JJOO $],000

CFo -$7.600
co, $4 ,000
FO, ]
co~ $5,000
'FO, l
co, $] ,000
Hl3 ~

LRRCPT
I 7 .t~99 percent ;;; ] 7 _9%
92. Year Project A Cash Jrlow l~rojcct H Cash flow Difference
0 -$75.000 -$60,lKl.l -$ 15,utl!l
J $30.00U $2:5J.K.IO $ :5,000
2 $35.01JU $30.m.IO $ :5.000
3 $3.S.OOU $2:5J100 $10,000

Cash tlows. for (AB : Cash t1mvs for A: Cash tlows for B:
CF0 -$1 5.000 CF 11 ..$75.~ CF0 -$60,000
co, $ 5.01JU co, 30,000 co, $25 .000
toll, 1 FO, 1 FO 1
C{):! $ s.ooo cn1 ""35,000 C{)2 $30 000
FO~ :l fU! I Jolh ]
co~ $10 .000 co:} ~35.000 C<h $25 000
FOJ ] ru~ I JoUJ ]
IRRCPT ] =d5 I ::::; IS.
13 .~4 percent PV CI)T NPVCFr
$565.05 $86 1.35

'lrhc cros.rovcr rate ~s. l3.94 pe~cc nt. At a. Tate higher thant!r.c cro~soverr m.te, such
as. IS. percent, Pmject B 'i.v.iU have t!hc higher Nt>V and should be acrcptcd

93. PV _ $46~200 + $&7 300 + 4 l,OOO + 39.000 ; PVirdt.>v.~ =

irl '-"" (1 + .0~5) 1 (1 + .085) 2 (1 + .0~5) 3 (1 + .085)<1
l76.978.72

CFn 0
col $46..200
FO, ]
CO:t; $87.300
FOz ]
co, $41.000
~ ]
m $39.000
F04 ]
l= 8.5
NPVCPT
l 76,978.72

PI =$176,Y78.72
169,0()0
; ; .
1.05; You s.hould accept beca.l!.ltse the PI 1s greater than L
.
 94. cr:;ll -$ 169,(0)
co1 - 5,200
FOI I
C(h S7,300
FO! l
c~ ooo
J.
FO~
co4 39,000
ro4 I
IRRCPT
J 10.75 pen:~om
y t.lU should [lt.:Ccpt h ct.' !.lUSC llrtc IR R nr I 0.75 pTt.:C"!Ilt c ;(Cc<ls mh~ rcq~1red rei um elf s.so
pL"l'(;C n'l .

95. C n -$169,000
col 6.200
f0 1
co,
f0 1
co1 ~.000
FO . .
c~ 39.000
f-04 l
PVCPI
$7,97&.72
You should acc ept because the PV is posiLi\1e.

96.
I . k .
1.'aybac penod =2 + J6CJ.OOO - $46.200 - 87,300 ::: 2.o07 yc:ars
4 ~ ,000
Bared on payback, rl1e project should he :rejocled because [])e B)a.ybad:: pe.l'lo.dl of
2.87 years exceeds. rlle :requ1 i'e.d period of 2.5 yeai's.
97. rPV =- 75,000 + 19,000 + $48,000 + .~ 12.000
3
. . PV A = -$9,042.07
l\ (J + .l0) 1 0 +- .) 0)-z (1.10)

. J0,000 16,000 $72ll00 . ' .

PVB = -$70,000 + I + l + l . NPV h ... S-1.279.52
(1+ .13) (1+ .13) (I . I3)

Cash flows for A; Casb t1o'>vs for B;

CF{} -$75,001) CFfl 70.000
co, 19,000 co, $10,000
F01 l FO I
co1. S4s.ooo col $t6.ooo
fU1 I ro~ 1
C11 12,000 0)3 $72.000
Flh 1 FO, 1
l= 10 [ = n
PVCPT NPVCPT
-$9 ,042.07 $] ,279.52

Project IB should be accepted and project A s.loou[d be rcj cctcd.

9&. Beca!JJr~c lhe~carc mutually e.xdusi vc projects. IJbe [RR n~lc should! not be applicdl.
ID -L- k , , $75,000 - J 9,000 - 48,000
99. .oa)'uuC pen 00 tor A = 2 + ~ 2.67 years
12,000
- $70 000 - $1 0~000 - $16~000
Payback penod forB - 2 + :::: 2.61 year '
$7~000 -
either project pays back within 2 years. tnu s.. the.y shouLd both be rejected.

HMJ Becau se these are mutuaJ iy e:-:dusivc proJects.. the PI mle s.hou ld not be. applied_

., 01 . Tbc AAR c-an not be computed because the oct ~nco1.nc. '!.vas. not pm,~ded

102. NPV =($27.50/1.1) 25JJO =$U

103. l~ayback Period;;; ($5.t.M.l.l + .S.S.OOO + $:5.500;::; ~ 5500 for 3 years~ remai!llder $20.utM.I
$ l :5.:500 == 4..500. $4.500/$5.500 = . 818 ! 8 ;;; .82) ;;; Payback Period ;;; 3.81 years

'104. Dis.<'04mted I>:J.~back: A. 1.n;::: $"15.00JJ$5,utM.I = 3. PM.Ir;;; l PV=-3 FV;:::Q Jl/YJR:;:::;IO

N=~3.75

HJ5 . $7:5/1. ~ 2 = $66.96, I :25/L t 22 == W .65. $1 OWL 123 = $71..18, $:5011.124 = $3 L 78

3 yr. CF~ $2:50- $66.%- $99.65 - 7 l . I 8 = $U.21 +Fraction= $12.211$31.78 = .38
Dis.<"oontcill Pa~back: 3 + . 38 == 3.38 years.

I06. $-2001 U 0 ;;; $-181.82: $-181 .82 + l 500 ;;; $ 1.318 . 18~ Cash tlow 0 =$-1 .000: Cash li1ow
~ ;;; $1.318. I 8