QUESTIONS ON CHAPTER-11 (INVESTMENT APPRAISAL)

1. The LMN Corporation is considering an investment that will cost $80,000 and
have a useful life of 4 years. During the first 2 years, the net incremental after-
tax cash flows are $25,000 per year and for the last two years they are $20,000
per year. What is the payback period for this investment?

a. 3.2 years.
b. 3.5 years.
c. 4.0 years.
d. Cannot be determined from this information.

2. Assume that a firm has accurately calculated the net cash flows relating to two
mutually exclusive investment proposals. If the net present value of both
proposals exceed zero and the firm is not under the constraint of capital rationing,
then the firm should

a. calculate the IRRs of these investments to be certain that the IRRs are greater
than the cost of capital
b. compare the profitability index of these investments to those of other possible
investments
c. calculate the payback periods to make certain that the initial cash outlays can be
recovered within a appropriate period of time
d. accept the proposal that has the largest NPV since the goal of the firm is to
maximize shareholder wealth and, since the projects are mutually exclusive, we
can only take one

3. Which of the following statements regarding cash flow patterns (for time
periods 0, 1, 2, 3, and 4) is correct?

a. The sequence of -$100, $50, $40, $60, and $50 is a non-conventional cash flow pattern.
b. The sequence of -$100, $600, -$1,100, $600, and $20 potentially has a maximum of
two internal rates of return.
c. The sequence of +$100, -$1,100, and $1,600 is a conventional cash flow pattern.
d. The sequence of -$50, $50, $70, $60, and -$150 potentially has at most two internal
rates of return.

4. Which of the following statements is correct regarding the internal rate of

return (IRR) method?

a. Each project has a unique internal rate of return.

b. As long as you are not dealing with mutually exclusive projects, capital rationing, or
unusual projects having multiple sign changes in the cash-flow stream, the internal rate of
return method can be used with reasonable confidence.
c. The internal rate of return does not consider the time value of money.
d. The internal rate of return is rarely used by firms today because of the ease at which
net present value is calculated.

5. A project has the following cash inflows $34,444; $39,877; $25,000; and
$52,800 for years 1 through 4, respectively. The initial cash outflow is $104,000.
Which of the following four statements is correct concerning the project internal
rate of return (IRR)?

a. The IRR is less than 10%.

b. The IRR is greater than or equal to 10%, but less than 14%.
c. The IRR is greater than or equal to 14%, but less than 18%.
d. The IRR is greater than or equal to 18%
6. The NPV of the following set of cash flows is:

Year 0 1 2 3

-£1,000 £500 £500 £500

Discount rate: 12%

a. +£1,201
b. -£1,201
c. +£201
d. +£889

7. In discounted cash flow analysis, which of the following is a bad decision rule?

a. If NPV is greater than or equal to 0 then accept

b. If IRR is greater than or equal to opportunity cost of capital then reject

c. If NPV is greater than 0 then reject

d. If IRR is less than opportunity cost of capital then reject

8. If the NPV of a project is £550 when discounted at 10 per cent and -£430
when discounted at 12 per cent, which of the following is the IRR?

a. 10.28%

b. 10.56%

c. 11.22%

d. 11.12%

9. Which of the following is not a disadvantage of using the IRR method rather
than the NPV method of project appraisal?

a. IRR does not take into account the time value of money

b. IRR ranks in terms of percentage returns whereas NPV ranks in terms of absolute
amounts of money

c. If the cash flows are non-conventional there may be more than one IRR

d. IRR has an implicit reinvestment assumption which is not reasonable

10. Which is the correct NPV of the following project when the discount rate is
9% per year?
 Points in time Cash flow
(yearly intervals) £m
0 -5
1 2
2 2
3 2
4 1.8

a. –£0.3378m
b. £1.3378m
c. £2.8m
d. £11.3378m

11.

Identify the correct internal rate of return of the following project cash flows:
Points in time Cash flow
(yearly intervals) £m
0 -3
1 1.1
2 1.1
3 1.1
4 1.1

a. 17.2%
b. 2.727%
c. 11%
d. 10%

Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The firm
expects the project to generate annual cash flows of $7 million over the next five years. Its cost of
capital is 18 percent.

12. What is the payback period for this project?

a. 2.8 years
b. 3.0 years
c. 3.2 years
d. 3.4 years
13. What is the discounted payback period for this project?

a. 3.9 years
b. 4.3 years
c. 4.7 years
 d. 5.1 years
14. What is the net present value of this project?

a. $890,197
b. $1,213,909
c. $905,888
d. $777,713
15. What is the internal rate of return on this project? (Round to the nearest percent.)

a. 17%
b. 18%
c. 19%
d. 20%

16. Toni adds $3,000 to her savings on the first day of each year. Tim adds $3,000 to his
savings on the last day of each year. They both earn a 9% rate of return. What is the
difference in their savings account balances at the end of thirty years?
a. $35,822.73
b.$36,803.03
c. $38,911.21
d. $39,803.04
e. $40,115.31

17. The Great Giant Corp. has a management contract with its newly hired president. The
contract requires a lump sum payment of $25 million be paid to the president upon the
completion of her first ten years of service. The company wants to set aside an equal amount
of funds each year to cover this anticipated cash outflow. The company can earn 6.5% on
these funds. How much must the company set aside each year for this purpose?
a. $1,775,042.93
b.$1,798,346.17
c. $1,801,033.67
d. $1,852,617.25
e. $1,938,018.22

18. The great, great grandparents of one of your classmates sold their factory to the
government 104 years ago for $150,000. If these proceeds had been invested at 6%, how
much would this legacy be worth today? Assume annual compounding.
a. $ 936,000.00
b. $ 1,086,000.00
c. $60,467,131.54
d. $60,617,131.54
e. $64,254,159.44