Profitability Measures Review

____ 15. Which of the following capital budgeting techniques does NOT take into account the cost of capital?
a. Payback Period
b. Net Present Value
c. Internal Rate of Return
d. Profitability Index
e. All of the above take into account the cost of capital

____ 16. If a proposed investment's payback period is 3 years, its initial cost is $50,000, and its useful life is 10 years,
which of the following must be true?
a. cash inflows over the investment's useful life total $150,000.
b. cash inflows over the first three years total $50,000.
c. the accounting profits generated by the investment over the first three years total $50,000.
d. none of the above

____ 17. If a net present value analysis for a normal project gives an NPV greater than zero, an internal rate of
return calculation on the same project would yield an internal rate of return __________ the firm's
cost of capital.
a. greater than
b. less than
c. equal to
d. cannot be determined from the information given

____ 23. A project has the following cash flows:

0 1 2 3
($500) $100 $200 $250

What is the project's NPV if the interest rate is 6%?

a. ($17.76)
b. $482.24
c. ($537.78)
d. $22.44
A; CF CF0 500 +/- ENTER; C01 100 ENTER; C02 200 ENTER; C03 250 ENTER NPV
I = 6 ENTER; NPV CPT <17.76>

____ 24. A project has the following cash flows:

Year 0 1 2 3 4
Cash flow ($240,000) $60,000 $100,000 $60,000 $80,000

The project's interpolated payback period is:

a. four years
b. three and one-half years
c. three and one-quarter years
d. none of the above
 60 + 100 + 60 + 20 = 240

____ 26. The future cash flows of a stand-alone capital project follow:

Year 0 1 2 3
Cash flow ($5,000) $2,500 $2,500 $2,500

If the company's cost of capital is 14%, what is the approximate NPV of the project?
a. $5,804
b. $1,217
c. $6,217
d. $804
CF0 = -5000, C01 = 2500, F01 = 3; NPV: I=14; NPV = $804

____ 28. An investment project requires an initial outlay of $100,000, and is expected to generate annual cash inflows
of $28,000 for the next 5 years. The cost of capital is 12 percent. Determine the internal rate of return for the
project (to the nearest tenth of one percent).
a. 12.0%
b. 12.6%
c. 3.6%
d. 12.4%
from problem 27: IRR = 12.38%, or about 12.4%.

____ 30. Sigma is thinking about purchasing a new clam digger for $14,000. The expected net cash flows resulting
from the digger are $9,000 in year 1, $7,000 in year 2, $5,000 in year 3, and $3,000 in year 4. Should Sigma
purchase this digger if its cost of capital is 12 percent?
a. Yes, NPV = $3,176
b. Yes, NPV = $5,082
c. Yes, NPV = $16,605
d. Yes, NPV= $19,084
= - CF0 = -14000, C01 = 9000, F01 = 1 C02 = 7000, F02 C03 = 5000, F01 = 1 C04 = 3000, F04 = 1
NPV: I=12;
NPV = -$14,000 = $5,082

____ 31. J&J Manufacturing is considering a project with the following cash flows. Calculate the interpolated payback
period of the project.

Year CF
0 (100,000)
1   40,000 
2    50,000 
3    50,000 

a. 1.2 years
b. 2.2 years
c. 3.2 years
____ 32. Calculate the profitability index for a project with the following cash flows. Assume a cost of capital of 10%

Year Cash Flow

0 (15,000) 
1  5,000
2  8,000
3 10,000 

a. .78
b. 1.13
c. 1.24
d. 1.57
InPV of Inflows:
0 CF0
5,000 C01
8,000 C02
10,000 C03
10 I/Y
PV = 18,670; Cost = 15,000; PI = 18,670/15,000 = 1.24

____ 34. What is the IRR of a project requiring a $1000 investment which yields cash inflows of $700, $700, and
$2000, in years 1, 2 and 3 respectively. The cost of capital is 12%. (Round to nearest %)
a. 32%
b. 46%
c. 54%
d. 75%

-1,000 CF0
700 C01
700 C02
2,000 C03
IRR = 75%

____ 36. A stand-alone capital project has the following projected cash flows:

Year 0 1 2 3
Cash flow ($4,000) $1,500 $1,200 $2,395

If the firm's cost of capital is 14%, which of the following statements is true?
a. the IRR is greater than the cost of capital and the project should be undertaken
b. the project should be rejected because the IRR is 12%, which is less than the project's cost
of capital
c. the IRR is less than 12% and the project should be undertaken
d. the NPV of the project is positive and the project should be undertaken
= - CF0 = -4,000, C01 = 1,500, C02 = 1,200, C03 = 2,395; NPV; I = 14; NPV = -$144 IRR =
 12%

____ 40. You are considering the following 2 mutually exclusive projects. Using the equivalent annual annuity method
and a cost of capital of 10%, which project should be selected? (Round to nearest $)

Project A Project B
Year Cash Flow Cash Flow
0 (20,000) (20,000)
1 15,000   5,000
2 20,000 10,000
3 15,000
4 50,000

a. Project B because of an EAA of $12,060

b. Project A because of an EAA of $5,857
c. Project B because of an EAA of $38,320
d. Project A because of an EAA of $10,165
A; Calcula
Project A Project B
-20,000 CF0 -20,000 CF0
 15,000 C01   5,000 C01
 20,000 C02 10,000 C02
       10 I/Y 15,000 C03
NPV = 10,165 50,000 C04
       10 I/Y
NPV = 38,230

EAA:
-10,165 PV -38,230 PV
          2    n           4    n
        10 I/Y         10 I/Y
PMT = $5,857 = EAA PMT = 12,060 = EAA

_____ 41. Cash flows for an investment are expected to be: year 0, -25,000; years 1 and 2, $8,000; years 3
through 6, $12,000. Estimate the investment’s NPV. Required return is 11.5%. NPV = $18,239

_____ 42. Cash flows for an investment are expected to be: year 0, -25,000; years 1 and 2, $8,000; years 3 through 6,
$12,000. Estimate the investment’s IRR. IRR = 32.15%

_____ 43. Cash flows for an investment are expected to be: year 0, -25,000; years 1 and 2, $8,000; years 3 through 6,
$12,000. Estimate the investment’s PI. Required return is 11.5% PI = 1.73

_____44. Cash flows for an investment are expected to be: year 0, -25,000; years 1 and 2, $8,000; years 3 through 6,
$12,000. Estimate the investment’s EAA. Required return is 11.5% EAA = $4,373
_____48. An investment opportunity is estimated to require an immediate cash outlay of $22,000, followed by cash
inflows of $6,000 for years 1 and 2, a negative cash flow of $3,000 in year 3, and cash flows of $13,000 in years
4 and 5. The required return is 12.25%. Estimate the investment’s PI. PI = 1.07

_____49. An investment opportunity is estimated to require an immediate cash outlay of $22,000, followed by cash
inflows of $6,000 for years 1 and 2, a negative cash flow of $3,000 in year 3, and cash flows of $13,000 in years
4 and 5. The required return is 12.25%. Estimate the investment’s EAA. EAA = $410

_____50. Fill in the table. Each box for each method should be marked Y or N.

PBP NPV IRR PI

Incorporates time value of money? Y Y Y
Incorporate risk? Y Y
Included all projected cash flows Y Y Y
Indicate whether value created? Y Y
Indicate how much value created? Y