Financial Management MCQ's

Multiple Choice
Identify the choice that best completes the statement or answers the question.

____ 1. A ____ is a capital budgeting model that considers the time value of money when evaluating proposed
projects.
a. cash flow model
b. nondiscounting model
c. discounting model
d. rate of return model
____ 2. The time required for a project to return its investment is the
a. accounting rate of return.
b. interest.
c. net present value.
d. payback period.
____ 3. If the annual cash flows are not an annuity (equal each period), payback is calculated by
a. dividing the investment required by the average annual cash inflow.
b. dividing the average annual cash inflow by the investment required.
c. accumulating the net cash flows until they equal the initial investment.
d. Payback cannot be calculated for a project with unequal cash flows.
____ 4. What is a weakness of the payback method?
a. It emphasizes projects with possible liquidity problems.
b. It ignores the profitability of investments beyond the payback period.
c. It can be used in conjunction with discounted cash flow methods.
d. both a and b above
____ 5. Why would a company use the accounting rate of return?
a. to ensure that a new investment will not adversely affect accounting income
b. because it does not consider the time value of money
c. because it is a measure of liquidity
d. all of the above
____ 6. When the discount rate is decreased,
a. the present value of future cash flows increases.
b. the present value of future cash flows decreases.
c. there is no change in the present value.
d. net present value would equal zero.
____ 7. If a project has a net present value of £0 when a discount rate of 10 percent is used, what can be concluded
about the rate of return of the project?
a. The rate of return is greater than 10 percent.
b. The rate of return is less than 10 percent.
c. The rate of return equals 10 percent.
d. The rate of return is 0.
____ 8. A follow-up analysis of an investment decision is called a(n)
a. performance review.
b. feedback session.
c. audit.
d. postaudit.
____ 9. Why do the NPV method and the IRR method sometimes produce different rankings of mutually exclusive
investment projects?
a. The NPV method does not assume reinvestment of cash flows, while the IRR method
assumes the cash flows will be reinvested at the internal rate of return.
b. The NPV method assumes a reinvestment rate equal to the discount rate, while the IRR
method assumes a reinvestment rate equal to the internal rate of return.
c. The IRR method does not assume reinvestment of the cash flows, while the NPV method
assumes the reinvestment rate is equal to the discount rate.
d. The NPV method assumes a reinvestment rate equal to the bank loan interest rate, while
the IRR method assumes a reinvestment rate equal to the discount rate.
____ 10. The Bradshaw Company is considering purchasing equipment for £78,000. This equipment will save the
company £22,000 in operating costs annually. The payback period for this equipment is
a. 3.5 years.
b. 4 years.
c. 2.2 years.
d. 0.3 years.
____ 11. Lewis Manufacturing Company is planning to invest in equipment costing £240,000. The estimated cash
flows from this equipment are expected to be as follows:

Year Cash Inflows

1 £100,000
2 75,000
3 55,000
4 40,000
5 __50,000
Total £320,000

Assume that the cash inflows occur evenly over the year. The payback period for this investment is
a. 3.75 years.
b. 3.25 years.
c. 2.4 years.
d. 1.3 years.
____ 12. Kaylin Company purchased a piece of equipment for £100,000 that had a useful life of 5 years. The
equipment had no salvage value. It saves the company £40,000 a year and costs the company £5,000 a year to
operate. What is the accounting rate of return on the equipment?
a. 30%
b. 15%
c. 40%
d. 35%
____ 13. The present value of £2,000 to be received three years from now and earning a 12 percent return is
a. £1,424.
b. £1,760.
c. £2,440.
d. £2,720.
____ 14. A firm is considering a project requiring an investment of £14,150. The project would generate annual cash
inflows of £3,300 per year for the next seven years. The approximate internal rate of return for the project is
a. 6%.
b. 8%.
c. 12%.
d. 14%.
____ 15. Brooks Company invested in a project that is expected to have an annual cash flow of £10,000. The project's
life is five years and has an IRR of 14 percent. How much was the initial investment in the project?
a. £34,330
b. £50,000
c. £36,050
d. £29,140
____ 16. Lake Kariba Company is considering buying a new boat that would cost £120,000. The accountant
determined that the boat promises an internal rate of return of 10 percent and has a life of four years. The
accountant resigned and the president wanted to check her calculations. What were the approximate annual
net cash inflows from the project?
a. £20,490
b. £30,000
c. £37,855
d. Net cash inflows cannot be determined from the information given.

Figure 13-1

A project requires an investment of £90,000 in equipment. Annual cash inflows of £15,000 are expected to
occur for the next ten years. No salvage value is expected.

____ 17. Refer to Figure 13-1. If the cash inflows occur at the end of each year, the net present value of the project
using a 12 percent discount rate would be
a. (£12,210).
b. £5,250.
c. (£5,250).
d. £12,210.

Figure 13-2

Investment £80,000
Annual revenues £50,000
Annual variable costs £15,000
Annual fixed out-of-pocket costs £10,000
Salvage value £5,000
Discount rate 12%
Expected life of project 8 years

____ 18. Refer to Figure 13-2. The net present value of the project is
a. £24,500.
b. £36,411.
c. £44,200.
d. £46,220.

Figure 13-3

Glady, Inc., is considering the purchase of production equipment that costs £800,000. The equipment is
expected to generate annual cash inflows of £250,000. The equipment is expected to have a useful life of five
years with no salvage value. The firm's cost of capital is 14 percent.
____ 19. Refer to Figure 13-3. If depreciation is £190,000 per year, Glady's accounting rate of return based on the
average investment would be
a. 15.0%.
b. 7.5%.
c. 6.25%.
d. 5.5%.
____ 20. Refer to Figure 13-3. Excluding the effect of income taxes, Glady's net present value of the project is
a. £165,200.
b. £450,000.
c. £58,250.
d. £233,550.
____ 21. Refer to Figure 13-3. The approximate internal rate of return of Glady's project is
a. 16%.
b. 20%.
c. 24%.
d. 25%.

Figure 13-5

Investment £120,000
Annual revenues £70,000
Annual variable costs £15,000
Annual fixed out-of-pocket costs £11,000
Salvage value £27,000
Discount rate 14%
Expected life of project 3 years

____ 22. Refer to Figure 13-5. The present value of the annual net cash inflows from operations is
a. £101,416.
b. £101,897.
c. £102,168.
d. £104,618.
____ 23. Refer to Figure 13-5. The net present value of the project is
a. (£3,215).
b. £393.
c. £6,102.
d. £6,412.
____ 24. A firm is considering a project with an annual cash flow of £200,000. The project would have a 7-year life,
and the company uses a discount rate of 10 percent. Ignoring income taxes, what is the maximum amount the
company could invest in the project and have the project still be acceptable?
a. £718,200
b. £1,400,000
c. £973,600
d. £200,000
____ 25. A firm is considering a project with an annual cash flow of £240,000. The project would have an 8-year life,
and the company uses a discount rate of 12 percent. Ignoring income taxes, what is the maximum amount the
company could invest in the project and have the project still be acceptable (rounded)?
a. £977,480
b. £1,125,228
c. £1,160,582
 d. £1,192,320
____ 26. Which of the following capital investment models would be preferred when choosing among mutually
exclusive alternatives?
a. payback period
b. accounting rate of return
c. IRR
d. NPV
____ 27. In computing the net present value of a project, a manager uses a cost of capital number that is too low. This
error causes the manager to compute a net present value that:
a. is lower that what it in fact should be.
b. is higher that what it in fact should be.
c. has no effect on the net present value computation.
d. is undefined in mathematical terms.
____ 28. The internal rate of return model assumes that all net cash inflows are reinvested at the:
a. project's internal rate of return.
b. discount rate.
c. prime rate.
d. none of the above.
____ 29. The problem with the accounting rate of return is that it fails to consider the:
a. profitability of the project.
b. life of the project.
c. timing of cash flows.
d. effect on net income.
____ 30. Which of the following is a capital investment criterion, but NOT captured in any of the basic capital
budgeting models examined in the text?
a. the period of time required to recoup an initial investment
b. various non-quantitative factors
c. the time value of money
d. the company's discount rate

Problem

31. A capital investment project requires an investment of £1,000,000. It has an expected life of five years with
annual cash flows of £240,000 received at the end of each year.

Required:

a. Compute payback for the project.

b. Compute the internal rate of return for the project.
c. Compute the net present value of the project using a 12 percent discount rate. Ignore income taxes.
d. Would you recommend this project be accepted? Why or why not?
32. A capital investment project requires an investment of £75,000 and has an expected life of four years. Annual
cash flows at the end of each year are expected to be as follows:

Year Amount
1 £40,000
2 £30,000
3 £10,000
 4 £35,000

Required:

a. Compute payback assuming that the cash flows occur evenly throughout the year.
b. Compute the net present value of the project using a 12 percent discount rate.
33. A capital investment project requires an investment of £350,000. It has an expected life of ten years with
annual cash flows of £50,000 received at the end of each year.

Required:

a. Compute payback for the project.

b. Determine the accounting rate of return for the project, based on the initial capital investment.
c. Compute the internal rate of return for the project.
d. Compute the net present value of the project using a 14 percent discount rate.
e. Would you recommend this project be accepted? Why or why not?
34. Explain what a capital investment decision is. In your answer, distinguish between independent and mutually
exclusive capital investment decisions.
35. A capital investment project requires an investment of £450,000. It has an expected life of six years with an
annual cash flow of £90,000 received at the end of each year. The company uses the straight-line method of
depreciation. Ignore income taxes.

Required:

a. Compute payback for the project.

b. Compute the net present value of the project using a 12 percent discount rate.
c. Would you recommend this project be accepted? Why or why not?
36. Van Dyke Company is evaluating a capital expenditure proposal that has the following predicted cash flows:

Original investment £45,000

Cash flow:
Year 1 £17,500
Year 2 25,000
Year 3 15,000

Salvage value -0-

Discount rate 14%

Required:

Determine the following values:

a. Net present value of the investment

b. Proposal's internal rate of return
c. Payback period
Financial Management MCQ's
Answer Section

MULTIPLE CHOICE

1. ANS: C PTS: 1
2. ANS: D PTS: 1
3. ANS: C PTS: 1
4. ANS: B PTS: 1
5. ANS: A PTS: 1
6. ANS: A PTS: 1
7. ANS: C PTS: 1
8. ANS: D PTS: 1
9. ANS: B PTS: 1
10. ANS: A
SUPPORTING CALCULATIONS:
£78,000/£22,000 = 3.5 years

PTS: 1
11. ANS: B
SUPPORTING CALCULATIONS:
3 + (£10,000/£40,000) = 3.25 years

PTS: 1
12. ANS: A
SUPPORTING CALCULATIONS:
Depreciation = £100,000/5 = £20,000 each year

ARR = (£40,000 - £5,000 - £20,000)/(£100,000/2) = 30%

PTS: 1
13. ANS: A
SUPPORTING CALCULATIONS:
£2,000  .712 (PVIF, n = 3, 12%) = £1,424

PTS: 1
14. ANS: D
SUPPORTING CALCULATIONS:
£14,150/£3,300 = 4.287879

PVAF of 4.288, n = 7, corresponds to 14%

PTS: 1
15. ANS: A
SUPPORTING CALCULATIONS:
£10,000  3.433 = £34,330

PTS: 1
16. ANS: C
SUPPORTING CALCULATIONS:
£120,000/3.170 = £37,855

PTS: 1
17. ANS: C
SUPPORTING CALCULATIONS:

Investment £(90,000)
Present value of cash inflows
(£15,000  5.650) __84,750
Net present value £ (5,250)

PTS: 1
18. ANS: D
SUPPORTING CALCULATIONS:

Investment £(80,000)
Present value of cash inflows
[(£50,000 - £15,000 - £10,000)  4.968] 124,200
Present value of salvage value
(£5,000  0.404) ___2,020
Net present value £ 46,220

PTS: 1
19. ANS: A
SUPPORTING CALCULATIONS:
(£250,000 - £190,000)/(£800,000/2) = 15%

PTS: 1
20. ANS: C
SUPPORTING CALCULATIONS:

Investment £(800,000)
Present value of cash inflows
(£250,000  3.433) __858,250
Net present value £ 58,250

PTS: 1
21. ANS: A
SUPPORTING CALCULATIONS:
£800,000/£250,000 = 3.2

PVAF of 3.274, n = 5, corresponds to 16%

PTS: 1
22. ANS: C
SUPPORTING CALCULATIONS:
£70,000 - £15,000 - £11,000 = £44,000
 £44,000  2.322 (PVAF, n = 3, 14%) = £102,168

PTS: 1
23. ANS: B
SUPPORTING CALCULATIONS:

Investment £(120,000)
Present value of cash inflows
[(£70,000 - £15,000 - £11,000)  2.322] 102,168
Present value of salvage value
(£27,000  0.675) ___18,225
Net present value £ 393

PTS: 1
24. ANS: C
SUPPORTING CALCULATIONS:
£200,000  4.868 (PVAF, n = 7, 10%) = £973,600

PTS: 1
25. ANS: D
SUPPORTING CALCULATIONS:
£240,000  4.968 (PVAF, n = 8, 12%) = £1,192,320

PTS: 1
26. ANS: D PTS: 1
27. ANS: B PTS: 1
28. ANS: A PTS: 1
29. ANS: C PTS: 1
30. ANS: B PTS: 1

PROBLEM

31. ANS:
a. 4.17 years £1,000,000/£240,000

b. Between 6% and 7% £1,000,000/£240,000 = 4.167

Annuity discount factor, 5 years, 6% = 4.212

Annuity discount factor, 5 years, 7% = 4.100

c. NPV using a 12 percent discount rate:

Investment £(1,000,000)
Present value of cash inflows (£240,000  3.605) ____865,200
Net present value £ (134,800)

d. No, the project should not be accepted. Although the payback period is less than the
expected life of the project, the NPV is negative, indicating the project's return is less than
12 percent. The IRR is approximately 6.5 percent, which is much lower than the desired
 return of 12 percent. Therefore, the project should be rejected.

PTS: 1
32. ANS:
a. 2.5 years

Year Projected Net Cash Inflows

1 £40,000

2 30,000

3 _5,000 (1/2  10,000)

£75,000

b. Net present value: £14,010

____0___ ___1___ ___2___ ___3___ ___4___

Investment £(75,000)
Cash flows £40,000 £30,000 £10,000 £35,000
PV factors, 12% __.893 __.797 __.712 __.636
Present values __89,010 £35,720 £23,910 £ 7,120 £22,260
Net present value £ 14,010

PTS: 1
33. ANS:
a. 7 years £350,000/£50,000

b. 4.29% [£50,000 - (£350,000/10)]/£350,000

c. Approximately 7% £350,000/£50,000 = 7
Annuity discount factor, 10 years, 6% = 7.360
Annuity discount factor, 10 years, 8% = 6.710

The exact IRR can be determined using interpolation:

PV discount factor 6% 7.360 7.360

PV discount factor--IRR 7.000
PV discount factor 8% _____ 6.710
0.360 0.650

IRR = 6% + [2%  (.360/.650)] = 7.1%

d. NPV using a 14 percent discount rate:

Investment £(350,000)
 Present value of cash inflows (£50,000  5.216) __260,800
Net present value £ (89,200)

e. No, the project should not be accepted. Although the payback period of seven years is less
than the expected life of the project, the NPV is negative, indicating the project's return is
less than 14 percent. The IRR is approximately 7 percent, which is much lower than the
desired return of 14 percent. Therefore, the project should be rejected.

PTS: 1
34. ANS:
Capital investment decisions are concerned with the process of planning, setting goals and priorities,
arranging financing, and using certain criteria to select long-term assets.

Independent projects are projects that, if accepted or rejected, do not affect the cash flows of other projects.

Mutually exclusive projects are those projects that, if accepted, preclude the acceptance of all other competing
projects.

PTS: 1
35. ANS:
a. 5 years £450,000/£90,000

b. NPV using a 12 percent discount rate:

Investment £(450,000)
Present value of cash flow (£90,000  4.111) __369,990
Net present value £ (80,010)

c. No, the project should not be accepted. Although the payback period of five years is less
than the expected life of the project, the NPV is negative, indicating the project's return is
less than 12 percent. The IRR is approximately 5.5 percent, which is much lower than the
desired return of 12 percent; therefore, the project should be rejected.

PTS: 1
36. ANS:
a. Period Cash Flow Present Value Factor Present Value
1 £17,500 0.877 £15,347.50
2 25,000 0.769 19,255.00
3 15,000 0.675 _10,125.00
Total present value £44,697.50
Less original investment _45,000.00
Net present value £ (302.50)

b. Approximately 14%

c. 2 + £2,500/£15,000 = 2.167 years

PTS: 1