Fundamentals of corporate finance 8th edition brealey test bank download

Fundamentals of Corporate Finance 8th Edition Brealey

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Chapter 08

Net Present Value and Other Investment Criteria

True / False Questions

1. As the opportunity cost of capital decreases, the net present value of a project increases.

True False

2. The IRR is the rate of return on the cash flows of the investment, also known as the opportunity cost of capital.

True False

3. Projects with an NPV of zero decrease shareholders' wealth by the cost of the project.

True False

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4. When calculating IRR with a trial and error process, discount rates should be raised when NPV is positive.

True False

5. Unlike using IRR, selecting projects according to their NPV will always lead to a correct acceptreject decision.

True False

6. For mutually exclusive projects, the project with the higher IRR is the correct selection.

True False

7. When using a profitability index to select projects, a value of .63 is preferred over a value of 0.21.

True False

8. A project's payback period is the length of time necessary to generate an NPV of zero.

True False

9. The payback period considers all project cash flows.

True False

10. Both the NPV and the internal rate of return methods recognize that the timing of cash flows affects project value.

True False

11. If a project has multiple IRRs, the highest one is assumed to be correct.

True False

12. Because of deficiencies associated with the payback method, it is seldom used in corporate financial analysis today.

True False

13. A risky dollar is worth more than a safe one.

True False

14. When choosing among mutually exclusive projects, the choice is easy using the NPV rule. As long as at least one project has positive NPV, simply choose the project with the highest NPV.

True False

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15. When we compare assets with different lives, we should select the machine that has the lowest equivalent annual cost.

True False

16. For many firms the limits on capital funds are "soft." By this we mean that the capital rationing is not imposed by investors.

True False

17. Soft rationing should never cost the firm anything.

True False

18. For most managers, discounted cash-flow analysis is in fact the dominant tool for project evaluation.

True False

19. The payback rule states that a project is acceptable if you get your money back within a specified period.

True False

20. The payback rule always makes shareholders better off.

True False

21. When you have to choose between projects with different lives, you should put them on an equal footing by computing the equivalent annual annuity or benefit of the two projects.

True False

22. When you are considering whether to replace an aging machine with a new one, you should compare the annual cost of operating the old one with the equivalent annual annuity of the new one.

True False

Multiple Choice Questions

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23. A project's opportunity cost of capital is:

A. the foregone return from investing in the project.

B. the return earned by investing in the project.

C. equal to the average return on all company projects.

D. designed to be less than the project's IRR.

24. Which one of the following statements is correct for a project with a positive NPV?

A. The IRR must be greater than 0.

B. Accepting the project has an indeterminate effect on shareholders.

C. The discount rate exceeds the cost of capital.

D. The profitability index equals 1.

25. If the net present value of a project that costs $20,000 is $5,000 when the discount rate is 10%, then the:

A. project's IRR equals 10%.

B. project's rate of return is greater than 10%.

C. net present value of the cash inflows is $4,500.

D. project's cash inflows total $25,000.

26. What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%?

A. $13,397.57

B. $14,473.44

C. $16,081.60

D. $33,748.58

27. The decision rule for net present value is to:

A. accept all projects with cash inflows exceeding the initial cost.

B. reject all projects with rates of return exceeding the opportunity cost of capital.

C. accept all projects with positive net present values.

D. reject all projects lasting longer than 10 years.

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28. What should occur when a project's net present value is determined to be negative?

A. The discount rate should be decreased.

B. The profitability index should be calculated.

C. The present value of the project cost should be determined.

D. The project should be rejected.

29. Which one of the following changes will increase the NPV of a project?

A. A decrease in the discount rate

B. A decrease in the size of the cash inflows

C. An increase in the initial cost of the project

D. A decrease in the number of cash inflows

30. What is the maximum that should be invested in a project at time zero if the inflows are estimated at $50,000 annually for 3 years, and the cost of capital is 9%?

A. $101,251.79

B. $109,200.00

C. $126,564.73

D. $130,800.00

31. When a manager does not accept a positive-NPV project, shareholders face an opportunity cost in the amount of the:

A. project's initial cost.

B. project's NPV.

C. project's discounted cash inflows.

D. soft capital rationing budget.

32. What is the maximum amount a firm should pay for a project that will return $15,000 annually for 5 years if the opportunity cost is 10%?

A. $24,157.65

B. $56,861.80

C. $62,540.10

D. $48,021.19

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33. Which of the following projects would you feel safest in accepting? Assume the opportunity cost of capital to be 12% for each project.

A. "A" has a small, but negative, NPV.

B. "B" has a positive NPV when discounted at 10%.

C. "C's" cost of capital exceeds its rate of return.

D. "D" has a zero NPV when discounted at 14%.

34. As the discount rate is increased, the NPV of a specific project will:

A. increase.

B. decrease.

C. remain constant.

D. decrease to zero, then remain constant.

35. If the opportunity cost of capital for a lending project exceeds the project's IRR, then the project has a(n):

A. positive NPV.

B. negative NPV.

C. acceptable payback period.

D. positive profitability index.

36. The modified internal rate of return can be used to correct for:

A. negative NPV calculations.

B. multiple internal rates of return.

C. undefined payback periods.

D. borrowing projects.

37. The internal rate of return is most reliable when evaluating:

A. a single project with alternating cash inflows and outflows over several years.

B. mutually exclusive projects of differing sizes.

C. a single project with only cash inflows following the initial cash outflow.

D. a single project with cash outflows at time 0 and the final year and inflows in all other time periods.

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38. When a project's internal rate of return equals its opportunity cost of capital, then the:

A. project should be rejected.

B. project has no cash inflows.

C. net present value will be positive.

D. net present value will be zero.

39. Firms that make investment decisions based on the payback rule may be biased toward rejecting projects:

A. with short lives.

B. with long lives.

C. with late cash inflows.

D. that have negative NPVs.

40. One method that can be used to increase the NPV of a project is to decrease the:

A. project's payback period.

B. profitability index.

C. time until the receipt of cash inflows.

D. number of project IRRs.

41. What is the IRR for a project that costs $100,000 and provides annual cash inflows of $30,000 for 6 years starting one year from today?

A. 19.91%

B. 16.67%

C. 15.84%

D. 22.09%

42. What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years?

A. 0.57%

B. 1.21%

C. 5.69%

D. 12.10%

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43. What is the minimum number of years in which an investment costing $210,000 must return $65,000 per year at a discount rate of 13% in order to be an acceptable investment?

A. 8.69 years

B. 5.37 years

C. 7.51 years

D. 4.46 years

44. If a project costs $72,000 and returns $18,500 per year for 5 years, what is its IRR?

A. 8.98%

B. 7.39%

C. 8.50%

D. 7.67%

45. If the IRR for a project is 15%, then the project's NPV would be:

A. negative at a discount rate of 10%.

B. positive at a discount rate of 20%.

C. negative at a discount rate of 20%.

D. positive at a discount rate of 15%.

46. As long as the NPV of a project declines smoothly with increases in the discount rate, the project is acceptable if its:

A. internal rate of return is positive.

B. payback period is greater than one.

C. rate of return exceeds the cost of capital.

D. cash inflows equal the initial cost.

47. A project can have as many different internal rates of return as it has:

A. cash inflows.

B. cash outflows.

C. periods of cash flow.

D. changes in the sign of the cash flows.

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48. What is the NPV for the following project cash flows at a discount rate of 15%? C0 = ($1,000), C1 = $700, C2 = $700.

A. ($308.70)

B. ($138.00)

C. $138.00

D. $308.70

49. Evaluate the following project using an IRR criterion, based on an opportunity cost of 10%: C0 =$6,000, C1 = $3,300, C2 = $3,300.

A. Accept; because the IRR exceeds the opportunity cost

B. Reject; because the opportunity cost exceeds the IRR

C. Accept; because the opportunity cost exceeds the IRR

D. Reject; because the IRR exceeds the opportunity cost

50. A project costing $20,000 generates cash inflows of $9,000 annually for the first 3 years, followed by cash outflows of $1,000 annually for 2 years. At most, this project has ______ different IRR(s).

A. one

B. two

C. three

D. five

51. How many IRRs are possible for the following set of cash flows? CF0 = -$1,000, C1 = $500, C2 =$300, C3 = $1,000, C4 = $200.

A. One

B. Two

C. Three

D. Four

52. Given a particular set of project cash flows, which one of the following statements must be correct?

A. There can be only one NPV for the project, even with multiple discount rates.

B. There can be only one IRR for the project.

C. There can be more than one IRR for the project.

D. There can be only one profitability index for the project, even with multiple discount rates.

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53. When projects are mutually exclusive, selection should be made according to the project with the:

A. longer life.

B. larger initial size.

C. highest IRR.

D. highest NPV.

54. When managers select correctly from among mutually exclusive projects, they:

A. may give up rate of return for NPV.

B. may give up NPV for rate of return.

C. have a tendency to select the largest project.

D. focus on the payback method to avoid conflicting signals.

55. Why may the IRR criterion lead to an incorrect decision when applied to mutually exclusive projects?

A. The NPVs of mutually exclusive projects cross over at some discount rate.

B. Cash flows cannot be discounted when considering mutually exclusive projects.

C. Mutually exclusive projects produce negative IRR values.

D. Mutually exclusive projects have multiple IRRs.

56. When will you be indifferent between two mutually exclusive projects of similar size?

A. When the required return on the projects is equal to the crossover discount rate

B. When the time period of the projects are equal

C. When both projects have only cash inflows following the initial cash outflow

D. When both projects have IRR's that exceed the crossover discount rate

57. When managers cannot determine whether to invest now or wait until costs decrease later, the rule should be to:

A. postpone until costs reach their lowest level.

B. invest now to maximize the NPV.

C. postpone until the opportunity cost reaches its lowest level.

D. invest at the date that provides the highest NPV today.

58. You are analyzing a project that is equivalent to borrowing money. This project's:

A. NPV graph rises as discount rates decrease.

B. initial cash flow is an outflow of funds.

C. value increases when the cost of capital increases.

D. acceptance requires its IRR to exceed the cost of capital.

59. When mutually exclusive projects have different lives, the project that should be selected will have the:

A. highest IRR.

B. longest life.

C. lowest equivalent annual cost.

D. highest NPV, discounted at the opportunity cost of capital.

60. Which mutually exclusive project would you select, if both are priced at $1,000 and your required return is 15%: Project A with three annual cash flows of $1,000; or Project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually?

A. Project A

B. Project B

C. You are indifferent since the NPVs are equal.

D. Neither project should be selected.

61. Which one of the following best illustrates the problem imposed by capital rationing?

A. Accepting projects with the highest NPVs first

B. Accepting projects with the highest IRRs first

C. Bypassing projects that have positive NPVs

D. Bypassing projects that have zero IRRs

62. Soft capital rationing:

A. is costly to shareholders.

B. is used to evaluate mutually exclusive projects.

C. should be costless to the shareholders of the firm.

D. solves the problem of investment timing.

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63. Soft capital rationing is imposed upon a firm from _____ sources, while hard capital rationing is imposed from _____ sources.

A. internal; external

B. internal; internal

C. external; internal

D. external; external

64. If a project has a cost of $50,000 and a profitability index of .4, then:

A. its cash inflows are $70,000.

B. the present value of its cash inflows is $20,000.

C. its IRR is 20%.

D. its NPV is $20,000.

65. When hard capital rationing exists, projects may be accurately evaluated by use of:

A. the payback period.

B. mutually exclusive IRRs.

C. a profitability index.

D. borrowing, rather than lending, projects.

66. Use of a profitability index to evaluate mutually exclusive projects in the absence of capital rationing:

A. will provide the same rankings as an NPV criterion.

B. will maximize NPV, but not IRR.

C. can result in misguided selections.

D. is technically impossible.

67. The profitability index selects projects based on the:

A. highest net discounted value at time zero.

B. highest internal rate of return.

C. largest dollar investment per rate of return.

D. largest return per dollar invested.

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68. Which of the following investment criteria takes the time value of money into consideration?

A. Net present value only

B. Profitability index and net present value only

C. Internal rate of return and net present value only

D. Profitability index, internal rate of return, and net present value

69. When calculating a project's payback period, cash flows are discounted at:

A. the opportunity cost of capital.

B. the internal rate of return.

C. the risk-free rate of return.

D. a discount rate of zero.

70. What is the profitability index for a project costing $40,000 and returning $15,000 annually for 4 years at an opportunity cost of capital of 12%?

A. 0.139

B. 0.320

C. 0.500

D. 0.861

71. Which of the following statements is true for a project with a $20,000 initial cost, cash inflows of $5,800 per year for 6 years, and a discount rate of 15%?

A. Its payback period is 3.45 years.

B. Its NPV is $2,094.

C. Its IRR is 17.85%.

D. Its profitability index is 0.104.

72. The "gold standard" of investment criteria refers to the:

A. net present value.

B. internal rate of return.

C. payback period.

D. profitability index.

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73. Which of the following investment decision rules tends to improperly reject long-lived projects?

A. Net present value

B. Internal rate of return

C. Payback period

D. Profitability index

74. The ratio of net present value to initial investment is known as the:

A. net present value.

B. internal rate of return.

C. payback period.

D. profitability index.

75. For mutually exclusive projects, the IRR can be used to select the best project:

A. by calculating the modified internal rate of return.

B. by calculating the IRR based on incremental cash flows.

C. by using the discount rate to calculate the IRR.

D. never. IRR cannot be utilized for mutually exclusive projects.

76. The opportunity cost of capital is equal to:

A. the discount rate that makes the project NPV equal zero.

B. the return offered by other projects of equal risk.

C. a project's internal rate of return.

D. the average rate of return for a firm's projects.

77. Borrowing and lending projects usually can be distinguished by whether:

A. they have positive or negative IRRs.

B. the time-zero cash flow is positive or negative.

C. their IRR increases as the discount rate increases.

D. their rate of return is high or low.

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78. A project with an IRR that is less than the opportunity cost of capital should be:

A. accepted for all project types.

B. accepted for all lending projects.

C. accepted for all borrowing projects.

D. rejected for all projects.

79. If a project's expected rate of return exceeds its opportunity cost of capital, one would expect:

A. the profitability index to exceed 1.0.

B. the opportunity cost of capital to be too low.

C. the IRR to exceed the opportunity cost of capital.

D. the NPV to be zero.

80. Which one of the following should be assumed about a project that requires a $100,000 investment at time zero, then returns $20,000 annually for 5 years?

A. The NPV is negative.

B. The NPV is zero.

C. The profitability index is 1.0.

D. The IRR is negative.

81. If two projects offer the same positive NPV, then they:

A. also have the same IRR.

B. have the same payback period.

C. are mutually exclusive projects.

D. add the same amount of value to the firm.

82. What is the minimum cash flow that could be received at the end of year 3 to make the following project "acceptable"? Initial cost = $100,000; cash flows at end of years 1 and 2 = $35,000; opportunity cost of capital = 10%.

A. $29,494

B. $30,000

C. $39,256

D. $52,250

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83. According to the NPV rule, all projects should be accepted if NPV is positive when discounted at the:

A. internal rate of return.

B. opportunity cost of capital.

C. risk-free interest rate.

D. accounting rate of return.

84. If a project's IRR is 13% and the project provides annual cash flows of $15,000 for 4 years, how much did the project cost?

A. $44,617.07

B. $52,208.18

C. $41,909.29

D. $49,082.11

85. A project's payback period is determined to be 4 years. If it is later discovered that additional cash flows will be generated in years 5 and 6, then the project's payback period will:

A. be reduced.

B. be increased.

C. be unchanged.

D. change but the discount rate must be known to determine the nature of the change.

86. A polisher costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 10% and the polisher will last for 5 years, what is the equivalent annual cost of the tool?

A. $17,163.04

B. $22,187.84

C. $22,637.98

D. $19,411.15

87. NPV fails as a decision rule when the firm encounters:

A. capital rationing.

B. mutually exclusive projects.

C. long-lived projects.

D. independent projects.

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88. The investment timing decision is aimed at analyzing whether the:

A. cash flows occur at the beginning or end of each time period.

B. payback period or NPV analysis should be used.

C. project is a borrowing or lending project.

D. investment should occur now or at some future point.

89. In order for a manager to correctly decide to postpone an investment until one year into the future, the NPV of the investment should:

A. grow more rapidly than the IRR.

B. increase over that year.

C. not decrease.

D. remain stable.

90. To justify postponing a project for one year, the NPV needs to increase over that year by a rate that is equal to or greater than:

A. the project's IRR.

B. the risk-free rate.

C. the cost of capital.

D. zero.

91. What happens to the equivalent annual cost of a project as the opportunity cost of capital decreases?

A. It increases.

B. It decreases.

C. It is not affected.

D. It depends on whether or not the projects are mutually exclusive.

92. What is the equivalent annual cost for a project that requires a $40,000 investment at time zero, and a $10,000 annual expense during each of the next 4 years, if the opportunity cost of capital is 10%?

A. $20,000.00

B. $21,356.95

C. $22,618.83

D. $25,237.66

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93. A currently used machine costs $10,000 annually to run. What is the maximum that should be paid to replace the machine with one that will last 3 years and cost only $4,000 annually to run? The opportunity cost of capital is 12%.

A. $15,209.84

B. $9,607.33

C. $14,410.99

D. $10,338.56

94. Because of its age, your car costs $4,000 annually in maintenance expense. You could replace it with a newer vehicle costing $8,000. Both vehicles would be expected to last 4 more years. If your opportunity cost is 8%, by how much must maintenance expense decrease on the newer vehicle to justify its purchase?

A. $1,625.40

B. $1,584.63

C. $1,469.08

D. $1,409.54

95. Projects A and B are mutually exclusive lending projects. Project A has an IRR of 20% while Project B has an IRR of 30%. You would be most apt to select Project A if:

A. Project B has a longer life than Project A.

B. Project A has more risk than Project B.

C. Project A is twice the size of Project B.

D. Project B has a larger cash inflow in Year 1 than Project A.

96. What is the decision rule in the case of sign changes that produce multiple IRRs for a project?

A. Select the lowest IRR to be conservative

B. Select the highest IRR to maximize the benefits

C. Any or all of the IRRs are justified to use

D. Evaluate the project according to NPV

97. If a project has a payback period of 5 years and a cost of capital of 10%, then the discounted payback will:

A. exceed 5 years.

B. be less than 5 years.

C. decrease if the cost of capital increases.

D. decrease if the payback period increases due to revised cash flows.

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98. You can continue to use your less efficient machine at a cost of $8,000 annually for the next 5 years. Alternatively, you can purchase a more efficient machine for $12,000 plus $5,000 annual maintenance. At a cost of capital of 15%, you should:

A. buy the new machine and save $600 in equivalent annual costs.

B. buy the new machine and save $388 in equivalent annual costs.

C. keep the old machine and save $388 in equivalent annual costs.

D. keep the old machine and save $580 in equivalent annual costs.

99. A firm is considering a project with the following cash flows: Time 0 = +$20,000, Years 1-5 =$4,500. Should the project be accepted if the cost of capital is 10%?

A. Yes; The IRR of the project is 4.06%.

B. Yes; The IRR of the project is 12.5%.

C. No; The IRR of the project is 4.06%.

D. No; The IRR of the project is 12.5%.

100.A firm plans to use the profitability index to select between two mutually exclusive investments. If no capital rationing has been imposed, which project should be selected?

A. Select the project with the higher profitability index

B. Select the project with the lower profitability index

C. Without capital rationing, both projects can be selected

D. Without capital rationing, the NPV method must be used instead

Essay Questions

8-19

101.A project costs $200,000, produces annual cash inflows of $20,000, and has a discount rate of 8%. Explain how you can quickly determine the difference in the NPV of the project if the cash inflows last only 30 years rather than 40 years. Show the calculations needed to determine the amount of the NPV difference.

102.A new machine will cost $100,000 and generate after-tax cash inflows of $35,000 for 4 years. What is the minimum rate of return the project must earn to be acceptable? Prove that your rate is correct.

103.The use of NPV as an investment criterion is said to be more reliable than using IRR. Discuss potential problems with the use of IRR.

8-20

104.Spending $40,000 on a new truck would increase delivery revenues by $18,000 annually over the truck's 4-year life. Graph the relationship between NPV and the discount rate for this project. (Hint: Assume for simplicity that the relationship is linear and find two points on the line's graph.) Is this project acceptable at a discount rate of 16%? What is the highest discount rate at which this project is acceptable?

105.Evaluate the following mutually exclusive projects using IRR as a selection criterion. Assuming a discount rate of 14%, which project if either would be selected? Project A costs $50,000 and returns $15,000 after-tax annually. Project B costs $35,000 and returns $11,000 after-tax annually. Both projects have a 5-year life.

106.Why might a firm want to impose soft capital rationing?

8-21

107.ABC Corporation is experiencing hard capital rationing and will not be able to invest more than $1,000,000 this year. Develop a profitability index for the following four projects and indicate which projects will be accepted. All four projects will last 3 years and the firm uses a 10% discount rate.

108.Calculate the payback period for each of the following mutually exclusive projects, then comment on the advisability of selection based on the payback period criterion: Project A has a cost of $15,000, returns $4,000 after-tax the first year with this amount increasing by $1,000 annually over a 5-year life; Project B costs $15,000 and returns $13,000 after-tax the first year, followed by 4 years of $2,000 per year. The firm uses a 10% discount rate.

8-22

109.Low-energy light bulbs typically cost $3.50, have a life of 9 years, and use about $1.60 of electricity a year. Conventional light bulbs are cheaper to buy, for they cost only $.50. On the other hand, they last only about a year and use about $6.60 of energy. If the real discount rate is 5%, what is the relative cost of the two products?

110.What is the net present value of an investment, and how do you calculate it?

111.How is the internal rate of return of a project calculated and what must you look out for when using the internal rate of return rule?

8-23

112.Why doesn't the payback rule always make shareholders better off?

113.How can the net present value rule be used to analyze three common problems that involve competing projects: when to postpone an investment expenditure; how to choose between projects with unequal lives; and when to replace equipment?

114.How is the profitability index calculated and how can it be used to choose between projects when funds are limited?

8-24

115.Sometimes, comparing project NPVs properly can be surprisingly tricky. What are three important, but often challenging decisions which managers commonly face?

8-25

Chapter 08 Net Present Value and Other Investment Criteria Answer Key

True / False Questions

1. As the opportunity cost of capital decreases, the net present value of a project increases.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

2. The IRR is the rate of return on the cash flows of the investment, also known as the opportunity cost of capital.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

3. Projects with an NPV of zero decrease shareholders' wealth by the cost of the project.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

4. When calculating IRR with a trial and error process, discount rates should be raised when NPV is positive.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

8-26

TRUE

FALSE

TRUE

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

5. Unlike using IRR, selecting projects according to their NPV will always lead to a correct accept-reject decision.

TRUE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

6. For mutually exclusive projects, the project with the higher IRR is the correct selection.

FALSE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Mutually exclusive projects

7. When using a profitability index to select projects, a value of .63 is preferred over a value of 0.21.

TRUE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 08-03 Calculate the profitability index and use it to choose between projects when funds are limited.

Topic: Profitability index

8. A project's payback period is the length of time necessary to generate an NPV of zero.

FALSE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Remember

Difficulty: 2 Medium

Learning Objective: 08-04 Understand the payback rule and explain why it doesn't always make shareholders better off.

Topic: Payback

8-27

9 The payback period considers all project cash flows.

FALSE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 08-04 Understand the payback rule and explain why it doesn't always make shareholders better off.

Topic: Payback

10. Both the NPV and the internal rate of return methods recognize that the timing of cash flows affects project value. TRUE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

11. If a project has multiple IRRs, the highest one is assumed to be correct. FALSE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

12. Because of deficiencies associated with the payback method, it is seldom used in corporate financial analysis today.

AACSB: Communication

Accessibility: Keyboard Navigation

Blooms: Remember

Difficulty: 2 Medium

Learning Objective: 08-04 Understand the payback rule and explain why it doesn't always make shareholders better off.

Topic: Payback

13. A risky dollar is worth more than a safe one. FALSE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 1 Easy

8-28

FALSE

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

14. When choosing among mutually exclusive projects, the choice is easy using the NPV rule. As long as at least one project has positive NPV, simply choose the project with the highest NPV.

TRUE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Mutually exclusive projects

15. When we compare assets with different lives, we should select the machine that has the lowest equivalent annual cost.

TRUE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-05 Use the net present value rule to analyze three common problems that involve competing projects: (a) when to postpone an investment expenditure; (b) how to choose between projects with unequal lives; and (c) when to replace equipment.

Topic: Equivalent annual costs

16. For many firms the limits on capital funds are "soft." By this we mean that the capital rationing is not imposed by investors.

TRUE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-05 Use the net present value rule to analyze three common problems that involve competing projects: (a) when to postpone an investment expenditure; (b) how to choose between projects with unequal lives; and (c) when to replace equipment.

Topic: Capital rationing

17. Soft rationing should never cost the firm anything.

TRUE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-05 Use the net present value rule to analyze three common problems that involve competing projects: (a) when to postpone an investment expenditure; (b) how to choose between projects with unequal lives; and (c) when to replace equipment.

Topic: Capital rationing

8-29

18. For most managers, discounted cash-flow analysis is in fact the dominant tool for project evaluation.

TRUE

AACSB: Communication

Accessibility: Keyboard Navigation

Blooms: Remember

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

19. The payback rule states that a project is acceptable if you get your money back within a specified period.

TRUE

AACSB: Communication

Accessibility: Keyboard Navigation

Blooms: Remember

Difficulty: 2 Medium

Learning Objective: 08-04 Understand the payback rule and explain why it doesn't always make shareholders better off.

Topic: Payback

20. The payback rule always makes shareholders better off.

FALSE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-04 Understand the payback rule and explain why it doesn't always make shareholders better off.

Topic: Payback

21. When you have to choose between projects with different lives, you should put them on an equal footing by computing the equivalent annual annuity or benefit of the two projects.

TRUE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-05 Use the net present value rule to analyze three common problems that involve competing projects: (a) when to postpone an investment expenditure; (b) how to choose between projects with unequal lives; and (c) when to replace equipment.

Topic: Equivalent annual costs

8-30

22. When you are considering whether to replace an aging machine with a new one, you should compare the annual cost of operating the old one with the equivalent annual annuity of the new one TRUE

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-05 Use the net present value rule to analyze three common problems that involve competing projects: (a) when to postpone an investment expenditure; (b) how to choose between projects with unequal lives; and (c) when to replace equipment.

Topic: Equivalent annual costs

Multiple Choice Questions

23. A project's opportunity cost of capital is:

A. the foregone return from investing in the project.

B. the return earned by investing in the project.

C. equal to the average return on all company projects.

D. designed to be less than the project's IRR.

AACSB: Communication

Accessibility: Keyboard Navigation

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

24. Which one of the following statements is correct for a project with a positive NPV?

A. The IRR must be greater than 0.

B. Accepting the project has an indeterminate effect on shareholders.

C. The discount rate exceeds the cost of capital.

D. The profitability index equals 1.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

8-31

25. If the net present value of a project that costs $20,000 is $5,000 when the discount rate is 10%, then the:

A. project's IRR equals 10%.

B. project's rate of return is greater than 10%.

C. net present value of the cash inflows is $4,500.

D. project's cash inflows total $25,000.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

26. What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%?

A. $13,397.57

B. $14,473.44

C. $16,081.60

D. $33,748.58

NPV

AACSB: Analytic

Accessibility: Keyboard Navigation

Blooms: Analyze

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

27. The decision rule for net present value is to:

A. accept all projects with cash inflows exceeding the initial cost.

B. reject all projects with rates of return exceeding the opportunity cost of capital.

C. accept all projects with positive net present values.

D. reject all projects lasting longer than 10 years.

AACSB: Communication

Accessibility: Keyboard Navigation

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

8-32

= -$100,000 + $50,000[(1/0.14) - 1/0.14(1.14)

= $16,081.60

3]

28. What should occur when a project's net present value is determined to be negative?

A. The discount rate should be decreased.

B. The profitability index should be calculated.

C. The present value of the project cost should be determined.

D. The project should be rejected.

AACSB: Communication

Accessibility: Keyboard Navigation

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

29. Which one of the following changes will increase the NPV of a project?

A. A decrease in the discount rate

B. A decrease in the size of the cash inflows

C. An increase in the initial cost of the project

D. A decrease in the number of cash inflows

AACSB: Analytic

Accessibility: Keyboard Navigation

Blooms: Apply

Difficulty: 1 Easy

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

30. What is the maximum that should be invested in a project at time zero if the inflows are estimated at $50,000 annually for 3 years, and the cost of capital is 9%?

A. $101,251.79

B. $109,200.00

C. $126,564.73

D. $130,800.00

The maximum investment would equate CF0 with the present value of the inflows thereby producing a zero net present value.

CF0 = $50,000(1/0.09) - [1/0.09(1.09)3] = $126,564.73

AACSB: Analytic

Accessibility: Keyboard Navigation

Blooms: Analyze

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

8-33

31. When a manager does not accept a positive-NPV project, shareholders face an opportunity cost in the amount of the:

A. project's initial cost.

B. project's NPV.

C. project's discounted cash inflows.

D. soft capital rationing budget.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

32. What is the maximum amount a firm should pay for a project that will return $15,000 annually for 5 years if the opportunity cost is 10%?

A. $24,157.65

B. $56,861.80

C. $62,540.10

D. $48,021.19

The maximum investment would equate CF0 with the present value of the inflows thereby producing a zero net present value.

CF0 = $15,000(1/0.10) - [1/0.10(1.10)5] = $56,861.80

AACSB: Analytic

Accessibility: Keyboard Navigation

Blooms: Analyze

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

33. Which of the following projects would you feel safest in accepting? Assume the opportunity cost of capital to be 12% for each project.

A. "A" has a small, but negative, NPV.

B. "B" has a positive NPV when discounted at 10%.

C. "C's" cost of capital exceeds its rate of return.

D. "D" has a zero NPV when discounted at 14%.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

8-34

Topic: Net present value

34. As the discount rate is increased, the NPV of a specific project will:

A. increase.

B. decrease.

C. remain constant.

D. decrease to zero, then remain constant.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

35. If the opportunity cost of capital for a lending project exceeds the project's IRR, then the project has a(n):

A. positive NPV.

B. negative NPV.

C. acceptable payback period.

D. positive profitability index.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 1 Easy

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

36. The modified internal rate of return can be used to correct for:

A. negative NPV calculations.

B. multiple internal rates of return.

C. undefined payback periods.

D. borrowing projects.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Modified internal rate of return

8-35

37. The internal rate of return is most reliable when evaluating:

A. a single project with alternating cash inflows and outflows over several years.

B. mutually exclusive projects of differing sizes.

C. a single project with only cash inflows following the initial cash outflow.

D. a single project with cash outflows at time 0 and the final year and inflows in all other time periods.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

38. When a project's internal rate of return equals its opportunity cost of capital, then the:

A. project should be rejected.

B. project has no cash inflows.

C. net present value will be positive.

D. net present value will be zero.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

39. Firms that make investment decisions based on the payback rule may be biased toward rejecting projects:

A. with short lives.

B. with long lives.

C. with late cash inflows.

D. that have negative NPVs.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-04 Understand the payback rule and explain why it doesn't always make shareholders better off.

Topic: Payback

8-36

40. One method that can be used to increase the NPV of a project is to decrease the:

A. project's payback period.

B. profitability index.

C. time until the receipt of cash inflows.

D. number of project IRRs.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

41. What is the IRR for a project that costs $100,000 and provides annual cash inflows of $30,000 for 6 years starting one year from today?

A. 19.91%

B. 16.67%

C. 15.84%

D. 22.09%

Using a financial calculator: n = 6; PV = -$100,000; PMT = $30,000; FV = 0; CPT i = 19.91%

AACSB: Technology

Accessibility: Keyboard Navigation

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

42. What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years?

A. 0.57%

B. 1.21%

C. 5.69%

D. 12.10%

Using a financial calculator: n = 6; PV = -$100,000; PMT = $17,000; FV = 0; CPT i = 0.57%

8-37

AACSB: Technology

Accessibility: Keyboard Navigation

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

43. What is the minimum number of years in which an investment costing $210,000 must return $65,000 per year at a discount rate of 13% in order to be an acceptable investment?

A. 8.69 years

B. 5.37 years

C. 7.51 years

D. 4.46 years

NPV = 0 -$210,000 + $65,000(1/0.13) - 1/ 0.13(1.13)n; n = 4.46 years

AACSB: Analytic

Accessibility: Keyboard Navigation

Blooms: Analyze

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

44. If a project costs $72,000 and returns $18,500 per year for 5 years, what is its IRR?

A. 8.98%

B. 7.39%

C. 8.50%

D. 7.67% Using a financial calculator: n = 5; PV = -$72,000; PMT = $18,500; FV = 0; CPT i = 8.98%

AACSB: Technology

Accessibility: Keyboard Navigation

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

8-38

45. If the IRR for a project is 15%, then the project's NPV would be:

A. negative at a discount rate of 10%.

B. positive at a discount rate of 20%.

C. negative at a discount rate of 20%.

D. positive at a discount rate of 15%.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

46. As long as the NPV of a project declines smoothly with increases in the discount rate, the project is acceptable if its:

A. internal rate of return is positive.

B. payback period is greater than one.

C. rate of return exceeds the cost of capital.

D. cash inflows equal the initial cost.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

47. A project can have as many different internal rates of return as it has:

A. cash inflows.

B. cash outflows.

C. periods of cash flow.

D. changes in the sign of the cash flows.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

8-39

48. What is the NPV for the following project cash flows at a discount rate of 15%? C0 = ($1,000), C1 = $700, C2 = $700.

A. ($308.70)

B. ($138.00)

C. $138.00

D. $308.70

NPV = -$1,000 + $700[(1/0.15) - 1/0.15(1.15)2] = $138.00

AACSB: Analytic

Accessibility: Keyboard Navigation Blooms: Analyze

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

49. Evaluate the following project using an IRR criterion, based on an opportunity cost of 10%: C0 = -$6,000, C1 = $3,300, C2 = $3,300.

A. Accept; because the IRR exceeds the opportunity cost

B. Reject; because the opportunity cost exceeds the IRR

C. Accept; because the opportunity cost exceeds the IRR

D. Reject; because the IRR exceeds the opportunity cost

Using a financial calculator:

n = 2; PV = -$6,000; PMT = $3,300; FV = 0; CPT i = 6.60%, which is the IRR

AACSB: Technology

Accessibility: Keyboard Navigation Blooms: Analyze

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

8-40

50. A project costing $20,000 generates cash inflows of $9,000 annually for the first 3 years, followed by cash outflows of $1,000 annually for 2 years. At most, this project has ______ different IRR(s).

A. one

B. two

C. three

D. five

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

51. How many IRRs are possible for the following set of cash flows? CF0 = -$1,000, C1 = $500, C2 = -$300, C3 = $1,000, C4 = $200.

A. One

B. Two

C. Three

D. Four

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

52. Given a particular set of project cash flows, which one of the following statements must be correct?

A. There can be only one NPV for the project, even with multiple discount rates.

B. There can be only one IRR for the project.

C. There can be more than one IRR for the project.

D. There can be only one profitability index for the project, even with multiple discount rates.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Apply

Difficulty: 3 Hard

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

8-41

53. When projects are mutually exclusive, selection should be made according to the project with the:

A. longer life.

B. larger initial size.

C. highest IRR.

D. highest NPV.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Mutually exclusive projects

54. When managers select correctly from among mutually exclusive projects, they:

A. may give up rate of return for NPV.

B. may give up NPV for rate of return.

C. have a tendency to select the largest project.

D. focus on the payback method to avoid conflicting signals.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Mutually exclusive projects

55. Why may the IRR criterion lead to an incorrect decision when applied to mutually exclusive projects?

A. The NPVs of mutually exclusive projects cross over at some discount rate.

B. Cash flows cannot be discounted when considering mutually exclusive projects.

C. Mutually exclusive projects produce negative IRR values.

D. Mutually exclusive projects have multiple IRRs.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-02 Calculate the internal rate of return of a project and know what to look out for when using the internal rate of return rule.

Topic: Internal rate of return

8-42

56. When will you be indifferent between two mutually exclusive projects of similar size?

A. When the required return on the projects is equal to the crossover discount rate

B. When the time period of the projects are equal

C. When both projects have only cash inflows following the initial cash outflow

D. When both projects have IRR's that exceed the crossover discount rate

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 3 Hard

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Mutually exclusive projects

57. When managers cannot determine whether to invest now or wait until costs decrease later, the rule should be to:

A. postpone until costs reach their lowest level.

B. invest now to maximize the NPV.

C. postpone until the opportunity cost reaches its lowest level.

D. invest at the date that provides the highest NPV today.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-05 Use the net present value rule to analyze three common problems that involve competing projects:

(a) when to postpone an investment expenditure; (b) how to choose between projects with unequal lives; and (c) when to replace equipment.

Topic: Net present value

58. You are analyzing a project that is equivalent to borrowing money. This project's:

A. NPV graph rises as discount rates decrease.

B. initial cash flow is an outflow of funds.

C. value increases when the cost of capital increases.

D. acceptance requires its IRR to exceed the cost of capital.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 3 Hard

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

8-43

59. When mutually exclusive projects have different lives, the project that should be selected will have the:

A. highest IRR.

B. longest life.

C. lowest equivalent annual cost.

D. highest NPV, discounted at the opportunity cost of capital.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-05 Use the net present value rule to analyze three common problems that involve competing projects: (a) when to postpone an investment expenditure; (b) how to choose between projects with unequal lives; and (c) when to replace equipment.

Topic: Equivalent annual costs

60. Which mutually exclusive project would you select, if both are priced at $1,000 and your required return is 15%: Project A with three annual cash flows of $1,000; or Project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually?

A. Project A

B. Project B

C. You are indifferent since the NPVs are equal.

D. Neither project should be selected.

AACSB: Analytic

Accessibility: Keyboard Navigation

Blooms: Analyze

Difficulty: 3 Hard

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Net present value

61. Which one of the following best illustrates the problem imposed by capital rationing?

A. Accepting projects with the highest NPVs first

B. Accepting projects with the highest IRRs first

C. Bypassing projects that have positive NPVs

D. Bypassing projects that have zero IRRs

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 1 Easy

8-44

NPVA = -$1,000 + $1,000[(1/0.15) - 1/0.15(1.15)3] = $1,283.23 NPVB = -$1,000 + {$1,500[(1/0.15) - 1/0.15(1.15)3]}/1.153 = $1,251.89

Learning Objective: 08-01 Calculate the net present value of a project.

Topic: Capital rationing

62. Soft capital rationing:

A. is costly to shareholders.

B. is used to evaluate mutually exclusive projects.

C. should be costless to the shareholders of the firm.

D. solves the problem of investment timing.

AACSB: Reflective Thinking

Accessibility: Keyboard Navigation

Blooms: Understand

Difficulty: 2 Medium

Learning Objective: 08-03 Calculate the profitability index and use it to choose between projects when funds are limited.

Topic: Capital rationing

63. Soft capital rationing is imposed upon a firm from _____ sources, while hard capital rationing is imposed from _____ sources.

A. internal; external

B. internal; internal

C. external; internal

D. external; external

AACSB: Analytic

Accessibility: Keyboard Navigation

Blooms: Remember

Difficulty: 1 Easy

Learning Objective: 08-03 Calculate the profitability index and use it to choose between projects when funds are limited.

Topic: Capital rationing

64. If a project has a cost of $50,000 and a profitability index of .4, then:

A. its cash inflows are $70,000.

B. the present value of its cash inflows is $20,000.

C. its IRR is 20%.

D. its NPV is $20,000.

.4 = NPV/$50,000; NPV = $20,000

AACSB: Analytic

Accessibility: Keyboard Navigation

Blooms: Apply

Difficulty: 2 Medium

Learning Objective: 08-03 Calculate the profitability index and use it to choose between projects when funds are limited.

Topic: Profitability index

8-45

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