Ross12e Chapter05 TB Answerkey

Corporate Finance, 12e (Ross)
Chapter 5 Net Present Value and Other Investment Rules
1) The difference between the present value of an investment's future cash flows and its initial
cost is the:
A) net present value.
B) internal rate of return.
C) payback period.
D) profitability index.
E) discounted payback period.
Answer: A
Difficulty: 1 Easy
Section: 5.1 Why Use Net Present Value?
Topic: Net present value
Bloom's: Remember
AACSB: Reflective Thinking
Accessibility: Keyboard Navigation
2) If a project is assigned a required rate of return of zero, then:

A) the timing of the project's cash flows has no bearing on the value of the project.
B) the project will always be accepted.
C) the project will always be rejected.
D) whether the project is accepted or rejected will depend on the timing of the cash flows.
E) the project can never add value for the shareholders.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
1
Copyright © 2019 McGraw-Hill Education. All rights reserved.
No reproduction or distribution without the prior written consent of McGraw-Hill Education.
3) Which statement concerning the net present value (NPV) of an investment or a financing
project is correct?
A) A financing project should be accepted if, and only if, the NPV is exactly equal to zero.
B) An investment project should be accepted only if the NPV is equal to the initial cash flow.
C) Any type of project should be accepted if the NPV is positive and rejected if it is negative.
D) Any type of project with greater total cash inflows than total cash outflows, should always be
accepted.
E) An investment project that has positive cash flows for every time period after the initial
investment should be accepted.
Answer: C
Difficulty: 1 Easy
Bloom's: Remember
4) All else constant, the net present value of a typical investment project increases when:
A) the discount rate increases.
B) each cash inflow is delayed by one year.
C) the initial cost of a project increases.
D) the required rate of return decreases.
E) all cash inflows occur during the last year instead of periodically throughout the project's life.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
5) Proposed projects should be accepted when those projects:

A) create value for the owners of the firm.
B) have a positive rate of return.
C) return the initial cash outlay within the life of the project.
D) have required cash inflows that exceed the actual cash inflows.
E) have an initial cost that exceeds the present value of the future cash flows.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
2
6) If a project has a net present value equal to zero, then:
A) the initial cost of the project exceeds the present value of the project's subsequent cash flows.
B) the internal rate of return exceeds the discount rate.
C) the project produces cash inflows that exceed the minimum required inflows.
D) any delay in receiving the projected cash inflows will cause the project's NPV to be negative.
E) the discount rate exceeds the internal rate of return.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
7) Net present value:

A) cannot be relied upon when deciding between two mutually exclusive projects.
B) rule for project acceptance must be modified when comparing projects of varying sizes.
C) is less commonly used in business than the profitability index method of analysis.
D) is not as widely used in practice as payback and discounted payback.
E) provides the means for considering the risks associated with a specific project.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
8) A project has an initial cost of $26,000, a discount rate of 11.7 percent, a life of 5 years, and
an NPV of $11,216. Given this, you know that the project is expected to earn a return:
A) equal to 11.7 percent of $26,000 plus an additional $11,216.
B) of $11,216 in total.
C) equal to 11.7 percent of $37,216 (= $26,000 + 11,216).
D) of 11.7 percent of $11,216.
E) of $26,000 minus $11,216.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
3
9) When a firm commences a positive net present value project, you know:
A) the project will pay back within the required payback period.
B) the present value of the expected cash flows is equal to the project's cost.
C) the inherent risks within the project have been ignored.
D) that all the projected cash flows will occur as expected.
E) the stockholders' value in the firm is expected to increase.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
10) The net present value method of capital budgeting analysis does all of the following except:
A) incorporate risk into the analysis.
B) consider all relevant cash flow information.
C) discount all future cash flows to their current value.
D) consider the initial cost of the project.
E) provide a specific anticipated rate of return.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
11) The payback method of analysis:

A) discounts cash flows.
B) ignores the initial cost.
C) considers all project cash flows.
D) applies an industry-standard recoupment period.
E) has a timing bias.
Answer: E
Difficulty: 1 Easy
Section: 5.2 The Payback Period Method
Topic: Payback
Bloom's: Understand
4
12) The payback method:
A) is the most frequently used method of capital budgeting analysis.
B) is a more sophisticated method of analysis than the profitability index.
C) considers the time value of money.
D) applies mainly to projects where the actual results will be known relatively soon.
E) generally results in decisions that conflict with the decision suggested by NPV analysis.
Answer: D
Difficulty: 1 Easy
Topic: Payback
Bloom's: Understand
13) If a firm is more concerned about the quick return of its initial investment than it is about the
amount of value created, then the firm is most apt to evaluate a capital project using the
________ method of analysis.
A) internal rate of return
B) net present value
C) modified internal rate of return
D) payback
E) profitability index
Answer: D
Difficulty: 1 Easy
Topic: Payback
Bloom's: Understand
14) Payback is frequently used to analyze independent projects because:

A) it considers the time value of money.
B) all relevant cash flows are included in the analysis.
C) it is easy and quick to calculate.
D) it is the most desirable of all the available analytical methods from a financial perspective.
E) it produces better decisions than those made using either NPV or IRR.
Answer: C
Difficulty: 1 Easy
Topic: Payback
Bloom's: Understand
5
15) One characteristic of the payback method of project analysis is the:
A) use of variable discount rates.
B) standardized cutoff point for cash flow consideration.
C) bias towards liquidity.
D) consideration of the risk level of each project.
E) discounting of all cash flows.
Answer: C
Difficulty: 1 Easy
Topic: Payback
Bloom's: Understand
16) All else equal, the payback period for a project will decrease whenever the:
A) initial cost increases.
B) required return for a project increases.
C) assigned discount rate decreases.
D) cash inflows are moved earlier in time.
E) duration of a project is lengthened.
Answer: D
Difficulty: 1 Easy
Topic: Payback
Bloom's: Understand
17) The length of time required for an investment to generate cash flows sufficient to recover the
initial cost of the investment is called the:
A) cash period.
B) net working capital period.
C) payback period.
Answer: C
Difficulty: 1 Easy
Topic: Payback
Bloom's: Remember
6
18) An investment is acceptable if the payback period:
A) is less than some pre-specified period of time.
B) exceeds the life of the investment.
C) is negative.
D) is equal to or greater than some pre-specified period of time.
E) is equal to, and only if it is equal to, the investment's life.
Answer: A
Difficulty: 1 Easy
Topic: Payback
Bloom's: Remember
19) Which method(s) of project analysis is(are) best suited for use by a department manager who
has no knowledge of time value of money but can estimate the cash flows of small projects with
short lives fairly accurately?
A) Payback
B) Discounted payback
C) Profitability index
D) Net present value
E) Either payback or profitability index
Answer: A
Difficulty: 1 Easy
Topic: Payback
Bloom's: Remember
7
20) The payback method:
A) determines a cutoff point so that all projects accepted by the NPV rule will be accepted by the
payback period rule.
B) determines a cutoff point equal to the point where all initial capital investments have been
fully depreciated.
C) requires an arbitrary choice of a cutoff point.
D) varies the cutoff point with the market rate of interest.
E) is irrelevant to the accept/reject decision.
Answer: C
Difficulty: 1 Easy
Topic: Payback
Bloom's: Understand
21) Which of the following methods of project analysis are biased towards short-term projects?
A) Profitability index and internal rate of return
B) Discounted payback and payback
C) Net present value and payback
D) Payback and profitability index
E) Profitability index and discounted payback
Answer: B
Difficulty: 1 Easy
Section: 5.3 The Discounted Payback Period Method
Topic: Discounted payback
Bloom's: Understand
22) The length of time required for a project's discounted cash flows to equal the initial cost of
the project is called the:
A) net present value.
B) discounted net present value.
C) payback period.
D) discounted profitability index.
Answer: E
Difficulty: 1 Easy
Bloom's: Remember
8
23) The discounted payback period of a project will decrease whenever the:
A) discount rate applied to the project is increased.
B) initial cash outlay of the project is increased.
C) time period of the project is increased.
D) amount of each cash inflow is increased.
E) costs of the fixed assets utilized in the project increase.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
24) The discounted payback method:

A) considers the time value of money.
B) discounts the cutoff point.
C) discounts the initial cost.
D) is preferred to the NPV method.
E) ignores project risks.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
25) The discounted payback rule may cause:

A) projects with discounted payback periods in excess of the project's life to be accepted.
B) the most liquid projects to be rejected in favor of less liquid projects.
C) projects to be incorrectly accepted due to ignoring the time value of money.
D) some projects with negative net present values to be accepted.
E) some positive net present value projects to be rejected.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
9
26) For investment projects, the internal rate of return (IRR):
A) rule indicates acceptance of an investment when the IRR is less than the discount rate.
B) is the rate generated solely by the cash flows of the investment.
C) is used primarily to rank projects of varying sizes.
D) is the rate that causes the net present value of a project to equal the project's initial cost.
E) can effectively be used to compare all types and sizes of mutually exclusive projects.
Answer: B
Difficulty: 1 Easy
Section: 5.4 The Internal Rate of Return
Topic: Internal rate of return
Bloom's: Understand
27) The internal rate of return for a project will increase if:
A) the initial cost of the project can be reduced.
B) the total amount of the cash inflows is reduced.
C) each cash inflow is moved such that it occurs one year later than originally projected.
D) the required rate of return is reduced.
E) the discount rate is increased.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
28) You are considering an investment project with an internal rate of return of 8.7 percent, a net
present value of $393, and a payback period of 2.44 years. Which one of the following is correct
given this information?
A) The discount rate used in computing the net present value was less than 8.7 percent.
B) The discounted payback period will be less than 2.44 years.
C) The discount rate used to compute the net present value is equal to the internal rate of return.
D) The required payback period must be greater than 2.44 years.
E) This project should be rejected based on the net present value.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
10
29) The internal rate of return is:
A) more reliable than net present value whenever you are considering mutually exclusive
projects.
B) equivalent to the discount rate that makes the net present value equal to 1.0.
C) computed using a project's cash flows as the only source of inputs.
D) dependent on the interest rates offered in the marketplace.
E) a better methodology than net present value when dealing with unconventional cash flows.
Answer: C
Difficulty: 1 Easy
Bloom's: Understand
30) The internal rate of return tends to be:

A) easier for managers to comprehend than the net present value.
B) extremely accurate even when cash flow estimates are faulty.
C) ignored by most financial managers.
D) used primarily to differentiate between mutually exclusive projects.
E) utilized in project analysis only when multiple net present values apply.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
31) The discount rate that makes the net present value of an investment exactly equal to zero is
called the:
A) external rate of return.
B) internal rate of return.
C) average accounting return.
E) equalizer.
Answer: B
Difficulty: 1 Easy
Bloom's: Remember
11
32) Using the internal rate of return method, a conventional investment project should be
accepted if the internal rate of return is:
A) equal to, and only if it is equal to, the discount rate.
B) equal to or greater than the discount rate.
C) less than the discount rate.
D) negative.
E) positive.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
33) The internal rate of return for an investment project is best defined as the:
A) discount rate that causes the net present value to equal zero.
B) difference between the market rate of interest and the discount rate.
C) market rate of interest less the risk-free rate.
D) minimum project acceptance rate set by management.
E) maximum rate that can be earned for a project to be accepted.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
34) Which one of the following statements is true?

A) You must know the discount rate to compute the NPV but not the IRR.
B) You must have a discount rate to compute, NPV, IRR, PI, and discounted payback.
C) Payback uses the same discount rate as that applied in the NPV calculation.
D) Financing projects can only ever have one IRR.
E) Financing projects are acceptable if the NPV is negative.
Answer: A
Difficulty: 1 Easy
Bloom's: Understand
12
35) A financing project is acceptable if its internal rate of return is:
A) exactly equal to its net present value.
B) exactly equal to zero.
C) greater than the discount rate.
D) less than the discount rate.
E) negative.
Answer: D
Difficulty: 1 Easy
Section: 5.5 Problems with the IRR Approach
Bloom's: Understand
36) The elements that cause problems with the use of the IRR in projects that are mutually
exclusive are referred to as the:
A) discount rate and scale problems.
B) timing and scale problems.
C) discount rate and timing problems.
D) scale and reversing flow problems.
E) timing and reversing flow problems.
Answer: B
Difficulty: 1 Easy
Topic: Mutually exclusive projects
Bloom's: Understand
37) Assume you use all available methods to evaluate projects. If there is a conflict in the
indicated accept/reject decision between two mutually exclusive projects due to the IRR-based
indicator, you should:
A) accept both projects if both are acceptable according to NPV.
B) combine both projects into one larger project.
C) ignore the IRR and rely on the decision indicated by the NPV method.
D) base the final decision on the payback method.
E) reject both projects due to ambiguity in the decision-making process.
Answer: C
Difficulty: 1 Easy
Bloom's: Understand
13
38) Project A is opening a bakery at 10 Center Street. Project B is opening a specialty coffee
shop at the same address. Both projects have unconventional cash flows, that is, both projects
have positive and negative cash flows that occur following the initial investment. When trying to
decide which project to accept, given sufficient funding to accept either project, you should rely
most heavily on the ________ method of analysis.
A) profitability index
B) internal rate of return
C) payback
D) net present value
E) discounted payback
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
39) The possibility that more than one discount rate will make the NPV of an investment equal to
zero presents the problem referred to as:
A) net present value profiling.
B) operational ambiguity.
C) the mutually exclusive investment decision.
D) issues of scale.
E) multiple rates of return.
Answer: E
Difficulty: 1 Easy
Bloom's: Remember
14
40) A situation in which accepting one investment prevents the acceptance of another investment
is called the:
A) net present value profile.
B) operational ambiguity decision.
C) mutually exclusive investment decision.
D) issues of scale problem.
E) multiple rates of return decision.
Answer: C
Difficulty: 1 Easy
Bloom's: Remember
41) The modified internal rate of return:

A) is used as the discount rate for all NPV calculations.
B) applies only to profitability calculations.
C) is used to make accept/reject decisions when no discount rate can be assigned.
D) is computed by combining cash flows until only one change in sign remains.
E) assumes all projects are financing projects.
Answer: D
Difficulty: 1 Easy
Topic: Modified internal rate of return
Bloom's: Understand
42) A mutually exclusive project is a project whose:

A) acceptance or rejection has no effect on the acceptance of other projects.
B) NPV is always negative.
C) IRR is always negative.
D) acceptance or rejection affects the acceptance of other projects.
E) cash flow pattern exhibits more than one sign change.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
15
43) A project will have more than one IRR if, and only if, the:
A) primary IRR is positive.
B) primary IRR is negative.
C) NPV is zero.
D) cash flow pattern exhibits more than one sign change.
E) cash flow pattern exhibits exactly one sign change.
Answer: D
Difficulty: 1 Easy
Bloom's: Understand
44) You are trying to determine whether to accept Project A or Project B. These projects are
mutually exclusive. As part of your analysis, you should compute the incremental IRR by
determining the:
A) internal rate of return for the cash flows of each project.
B) net present value of each project using the internal rate of return as the discount rate.
C) discount rate that equates the discounted payback periods for each project.
D) discount rate that makes the net present value of each project equal to 1.0.
E) internal rate of return for the differences in the cash flows of the two projects.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
45) Comparing the NPV profile of an investment project to that of a financing project
demonstrates why the:
A) incremental IRR is computed differently for financing projects than for investment projects.
B) IRR decision rule for investment projects is the opposite of the rule for financing projects.
C) life span of a project affects the decision as to which project to accept.
D) NPV rule for financing projects is the opposite of the rule for investment projects.
E) profitability index and the net present value are related.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
16
46) Blue Bird Café is considering a project with an initial cost of $46,800, and cash flows of
$8,500, $25,000, $19,000, and −$4,500 for Years 1 to 4, respectively. How many internal rates
of return do you expect this project to have?
A) 0
B) 1
C) 4
D) 3
E) 2
Answer: E
Difficulty: 2 Medium
Bloom's: Apply
AACSB: Knowledge Application
47) Which one of the following is the best example of two mutually exclusive projects?
A) Planning to build a warehouse and a retail outlet side by side
B) Buying sufficient equipment to manufacture both desks and chairs simultaneously
C) Renting out a company warehouse or selling it outright
D) Using the company's sales force to promote sales of both shoes and socks
E) Buying both inventory and fixed assets using funds from the same bank loan
Answer: C
Difficulty: 1 Easy
Bloom's: Understand
17
48) An investment with an initial cost of $4,000 produces cash flows of $3,400, −$500, $2,800,
−$100, and $6,000 for Years 1 to 5, respectively. How many IRRs does this project have?
A) 4
B) 3
C) 5
D) 6
E) 2
Answer: C
Bloom's: Apply
49) How should a profitability index of zero be interpreted?

A) The present value of the cash flows subsequent to the initial cash flow is equal to (−1 × Initial
cash flow).
B) The project has an internal rate of return equal to the discount rate.
C) The project produces a net income of zero for every year of its life.
D) The project's cash flows subsequent to the initial cash flow have a present value of zero.
E) The project also has a net present value of zero.
Answer: D
Difficulty: 1 Easy
Section: 5.6 The Profitability Index
Topic: Profitability index
Bloom's: Understand
18
50) The profitability index:
A) rule often results in decisions that conflict with the decisions based on the net present value
rule.
B) is useful as a decision tool when investment funds are limited and all available funds are
allocated.
C) method is most commonly used when deciding between mutually exclusive projects of
varying size.
D) rule states that the project with the lower index value should be accepted.
E) produces results which typically are difficult to comprehend.
Answer: B
Difficulty: 1 Easy
Bloom's: Understand
51) If you want to review a project from a benefit-cost perspective, you should use the ________
method of analysis.
A) net present value
B) payback
C) internal rate of return
D) discounted payback
E) profitability index
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
19
52) The profitability index of an investment project is the ratio of the:
A) average net income from the project to the average investment cost.
B) internal rate of return to the current market rate of interest.
C) net present value of the project's cash outflows divided by the net present value of its inflows.
D) net present value of every cash flow related to the project compared to the initial cost.
E) present value of the cash flows subsequent to the initial cost compared to the initial cost.
Answer: E
Difficulty: 1 Easy
Bloom's: Understand
53) An independent investment is acceptable if the profitability index (PI) of the investment is:
A) greater than 1.0.
B) less than 1.0.
C) greater than the internal rate of return.
D) less than the internal rate of return.
E) greater than a pre-specified rate of return.
Answer: A
Difficulty: 1 Easy
Bloom's: Remember
54) No matter how many forms of investment analysis you employ:

A) the actual results from a project may vary significantly from the expected results.
B) the internal rate of return will always produce the most reliable results.
C) a project will never be accepted unless the payback period is met.
D) the initial costs will generally vary considerably from the estimated costs.
E) only the first three years of a project ever affect its final outcome.
Answer: A
Difficulty: 1 Easy
Section: 5.7 The Practice of Capital Budgeting
Topic: Capital budgeting
Bloom's: Understand
20
55) Why do managers suggest that ignoring all cash flows following the required payback period
is not a major flaw of the payback method of capital budgeting analysis?
A) Payback is never used in real practice so it makes no difference how academics apply the
method in their studies.
B) All projected cash flows after the required period are highly inaccurate so including them
lessens the reliability of the resulting decision.
C) If the cash flows after the required period are significant, managers will use their discretion to
override the payback rule.
D) All cash flows after the required period are relatively worthless in today's dollars so ignoring
them has no consequence.
E) Any consideration of the cash flows after the required period rarely has any effect on the
accept/reject decision.
Answer: C
Difficulty: 1 Easy
Topic: Payback
Bloom's: Understand
56) Graham and Harvey (2001) found that ________ were the two most popular capital
budgeting methods.
A) IRR and payback
B) IRR and NPV
C) NPV and PI
D) IRR and modified IRR
E) discounted payback and NPV
Answer: B
Difficulty: 1 Easy
Bloom's: Remember
21
57) What is the net present value of a project with an initial cost of $36,900 and cash inflows of
$13,400, $21,600, and $10,000 for Years 1 to 3, respectively? The discount rate is 13 percent.
A) −$287.22
B) −$1,195.12
C) −$1,350.49
D) $204.36
E) $797.22
Answer: B
Explanation: NPV = −$36,900 + $13,400/1.13 + $21,600/1.132 + $10,000/1.133
NPV = −$1,195.12
Bloom's: Apply
58) What is the net present value of a project that has an initial cash outflow of $7,670 and cash
inflows of $1,280 in Year 1, $6,980 in Year 3, and $2,750 in Year 4? The discount rate is 12.5
percent.
A) $86.87
B) $270.16
C) $68.20
D) $249.65
E) $371.02
Answer: A
Explanation: NPV = −$7,670 + $1,280/1.125 + $6,980/1.1253 + $2,750/1.1254
NPV = $86.87
Bloom's: Apply
22
59) A project costing $6,200 initially should produce cash inflows of $2,860 a year for three
years. After the three years, the project will be shut down and will be sold at the end of Year 4
for an estimated net cash amount of $3,300. What is the net present value of this project if the
required rate of return is 11.3 percent?
A) $2,474.76
B) $2,903.19
C) $935.56
D) $3,011.40
E) $1,980.02
Answer: B
Explanation: NPV = −$6,200 + $2,860[(1 - 1/1.1133)/.113] + $3,300/1.1134
NPV = $2,903.19
Bloom's: Analyze
AACSB: Analytical Thinking
60) Wilson's Market is considering two mutually exclusive projects that will not be repeated. The
required rate of return is 13.9 percent for Project A and 12.5 percent for Project B. Project A has
an initial cost of $54,500, and should produce cash inflows of $16,400, $28,900, and $31,700 for
Years 1 to 3, respectively. Project B has an initial cost of $69,400, and should produce cash
inflows of $0, $48,300, and $42,100, for Years 1 to 3, respectively. Which project, or projects, if
either, should be accepted and why?
A) Project A; because its NPV is positive while Project B's NPV is negative
B) Project A; because it has the higher required rate of return
C) Project B; because it has the largest total cash inflow
D) Project B; because it has a negative NPV which indicates acceptance
E) Neither project; because neither has an NPV equal to or greater than its initial cost
Answer: A
Explanation: NPVA = −$54,500 + $16,400/1.139 + $28,900/1.1392 + $31,700/1.1393
NPVA= $3,628.27
NPVB = −$69,400 + $48,300/1.1252 + $42,100/1.1253
NPVB = −$1,668.86
Bloom's: Analyze
23
61) You are considering two independent projects that have differing requirements. Project A has
a required return of 12 percent compared to Project B's required return of 13.5 percent. Project A
costs $75,000 and has cash flows of $21,000, $49,000, and $12,000 for Years 1 to 3,
respectively. Project B has an initial cost of $70,000 and cash flows of $15,000, $18,000, and
$41,000 for Years 1 to 3, respectively. Based on the NPV, you should:
A) accept both Project A and Project B.
B) accept Project A and reject Project B.
C) accept Project B and reject Project A.
D) reject both Project A and Project B.
E) accept whichever one you want but not both.
Answer: D
NPVA = −$8,646.14
NPVB = −$70,000 + $15,000/1.135 + $18,000/1.1352 + $41,000/1.1353
NPVB = −$14,770.25
Bloom's: Analyze
62) A food cart costs $4,500 and is expected to return $1,750 a year for three years and then be
worthless. What is the payback period for this cart?
A) 2.83 years
B) 3.14 years
C) 2.78 years
D) 2.57 years
E) 1.57 years
Answer: D
Explanation: PB = $4,500/$1,750
PB = 2.57 years
Topic: Payback
Bloom's: Apply
24
63) You are considering a project with an initial cost of $4,300. What is the payback period for
this project if the cash inflows are $550, $970, $2,600, and $500 a year for Years 1 to 4,
respectively?
A) 2.04 years
B) 2.36 years
C) 2.89 years
D) 3.04 years
E) 3.36 years
Answer: E
Explanation: PB = 3 + ($4,300 − 550 − 970 − 2,600)/$500
PB = 3.36 years
Topic: Payback
Bloom's: Apply
64) A project has an initial cost of $2,250. The cash inflows are $0, $500, $900, and $700 for
Years 1 to 4, respectively. What is the payback period?
A) 2.97 years
B) 2.84 years
C) 3.98 years
D) 3.92 years
E) Never
Answer: E
Explanation: Total cash inflows = $500 + 900 + 700
Total cash inflows = $2,100
The project never pays back.
Topic: Payback
Bloom's: Apply
25
65) Jack is considering adding toys to his general store. He estimates the cost of toy inventory
will be $4,200. The remodeling and shelving costs are estimated at $1,500. Toy sales are
expected to produce net annual cash inflows of $1,200, $1,500, $1,600, and $1,750 over the next
four years, respectively. Should Jack add toys to his merchandise if he requires a three-year
payback period? Why or why not?
A) Yes; because the payback period is 2.94 years
B) Yes; because the payback period is 2.02 years
C) Yes; because the payback period is 3.80 years
D) No; because the payback period is 2.02 years
E) No; because the payback period is 3.80 years
Answer: E
Explanation: PB = ([$4,200 + 1,500) − $1,200 − 1,500 − 1,600]/$1,750
PB = 3.80 years
Topic: Payback
Bloom's: Apply
66) Consider an investment with an initial cost of $20,000 that expected to last for 5 years. The
expected cash flows in Years 1 and 2 are $5,000 each, in Years 3 and 4 are $5,500 each, and the
Year 5 cash flow is $1,000. Assume each annual cash flow is spread evenly over its respective
year. What is the payback period?
A) 3.18 years
B) 3.82 years
C) 4.00 years
D) 4.55 years
E) None of these
Answer: B
Explanation: PB = 3 + ($20,000 − 5,000 − 5,000 − 5,500)/$5,500
PB = 3.82 years
Topic: Payback
Bloom's: Apply
26
67) A project costing $218,000 has equal annual cash inflows over its 7-year life. If the
discounted payback period is seven years and the discount rate is zero percent, what is the
amount of the cash flow in each of the seven years?
A) $31,142.86 per year for each of the seven years
B) $0 for Years 1 to 6 and $218,000 in Year 7
C) Any amount between $0 and $218,000 for any one year, provided the sum of the seven cash
flows totals $218,000.
D) $218,000 for Year 1 and $0 for Years 2 through 7.
E) $0 for each of the seven years
Answer: A
Explanation: C = $218,000/7
C = $31,142.86
Bloom's: Apply
68) A project has an initial cost of $10,600 and produces cash inflows of $3,700, $4,900, and
$2,500 for Years 1 to 3, respectively. What is the discounted payback period if the required rate
of return is 7.5 percent?
A) 2.65 years
B) 2.78 years
C) 2.94 years
D) 2.88 years
E) Never
Answer: E
Explanation: PV = $3,700/1.075 + $4,900/1.0752 + $2,500/1.0753
PV = $9,694.39
The project will never pay back on a discounted basis.
Bloom's: Analyze
27
69) An investment project has an initial cost of $260 and cash flows $75, $105, $100, and $50
for Years 1 to 4, respectively. The cost of capital is 12 percent. What is the discounted payback
period?
A) 3.76 years
B) Never
C) 3.42 years
D) 3.68 years
E) 3.92 years
Answer: B
Explanation: Total discounted cash inflows = $75/1.12 + $105/1.122 + $100/1.123 + $50/1.124
Total discounted cash inflows = $253.62
The project never pays back on a discounted basis.
Bloom's: Analyze
70) An investment project has an initial cost of $382 and cash flows $105, $130, $150, and $150
for Years 1 to 4, respectively. The cost of capital is 9 percent. What is the discounted payback
period?
A) 2.76 years
B) 3.57 years
C) 3.42 years
D) 3.68 years
E) 2.92 years
Answer: B
Explanation: DPB = 3 + ($382 - $105/1.09 + $130/1.092 + $150/1.093)/($150/1.094)
DPB = 3.57 years
Bloom's: Apply
28
71) Homer is considering a project with cash inflows of $950 a year for Years 1 to 4,
respectively. The project has a required discount rate of 11 percent and an initial cost of $2,100.
What is the discounted payback period?
A) 3.05 years
B) 2.68 years
C) 3.39 years
D) 2.21 years
E) Never
Answer: B
Explanation: DPB = 2 + ($2,100 − $950/1.11 − $950/1.112)/($950/1.113)
DPB = 2.68 years
Bloom's: Apply
29
72) Leslie is charged with determining which small projects should be funded. Along with this
assignment, she has been granted the use of $15,000 for a maximum of two years on a
discounted basis. She is considering three projects. Project A costs $7,500 and has cash flows of
$4,000 a year for Years 1 to 3. Project B costs $8,000 and has cash flows of $3,000, $4,000, and
$3,000 for Years 1 to 3, respectively. Project C costs $2,000 and has a cash inflow of $2,500 in
Year 2. What decisions should she make regarding these projects if she assigns them a
mandatory discount rate of 8.5 percent? Explain why.
A) Accept either Projects A and C or Projects B and C, but not all three as there is insufficient
financing
B) Accept Project C and reject Projects A and B because only Project C has a discounted
payback that is less than two years
C) Accept Projects A and C and reject Project B as they have the shortest discounted payback
periods that fit within the $15,000 allocation
D) Accept Projects A and C and reject Project B as A and B payback within two years
E) Accept Projects B and C and reject Project A as this combination uses the most initial capital
Answer: B
Explanation: DPBA = 2 + ($7,500 − $4,000/1.085 − $4,000/1.0852)/($4,000/1.0853)
DPBA = 2.13 years
DPBB = 2 + ($8,000 − $3,000/1.085 − $4,000/1.0852)/($3,000/1.0853)
DPBB = 2.78 years
DPBC = 1 + $2,000/($2,500/1.0852)
DPBC = 1.94 years
Bloom's: Analyze
30
73) An investment with an initial cost of $15,000 produces cash flows of $5,000 annually for 5
years. At a discount rate of 10 percent, what is the discounted payback period?
A) 3.00 years
B) 3.21 years
C) 3.75 years
D) 3.89 years
E) Never
Answer: C
Explanation: DPB = 3 + ($15,000 − $5,000/1.10 − $5,000/1.102 − $5,000/1.103)/($5,000/1.104)
DPB = 3.75 years
Bloom's: Apply
74) An investment cost $10,000 with expected cash flows of $3,000 a year for 5 years. At what
discount rate will the project's IRR equal its discount rate?
A) 15.24 percent
B) 27.22 percent
C) 0 percent
D) 16.67 percent
E) 21.08 percent
Answer: A
Explanation: 0 = −$10,000 + $3,000{[1 − 1/(1 + IRR)5]/IRR}
IRR = 15.24%
Bloom's: Analyze
31
75) An investment costing $25 returns $27.50 at the end of one year with no risk. Given this, you
know that the NPV:
A) is zero at any given discount rate.
B) is negative if the required return is less than 10 percent.
C) equals 1.0 if the required return is 10 percent.
D) is zero if the required rate of return is 10 percent.
E) must be positive at any given discount rate.
Answer: D
Explanation: 0 = −$25 + $27.50/(1 + IRR)
IRR = 10%
The NPV will equal zero when the discount rate equals the IRR of 10 percent.
Bloom's: Analyze
76) Lucie is reviewing a project with an initial cost of $38,700 and cash inflows of $9,800,
$16,400, and $21,700 for Years 1 to 3, respectively. Should the project be accepted if it has been
assigned a required return of 9.75 percent? Why or why not?
A) Yes; because the IRR exceeds the required return by .34 percent
B) Yes; because the IRR is less than the required return by .28 percent
C) Yes; because the IRR exceeds the required return by .28 percent
D) No; because the IRR exceeds the required return by .34 percent
E) No; because the IRR is only 9.69 percent
Answer: A
Explanation: 0 = −$38,700 + $9,800/(1 + IRR) + $16,400/(1 + IRR)2 + $21,700/(1 + IRR)3
IRR = 10.09%
Excess return = 10.09% − 9.75
Excess return = .34%
Bloom's: Analyze
32
77) Sun Lee's is considering two mutually exclusive projects that have been assigned the same
discount rate of 10.5 percent. Project A has an initial cost of $54,500, and should produce cash
inflows of $16,400, $28,900, and $31,700 for Years 1 to 3, respectively. Project B has an initial
cost of $79,400, and should produce cash inflows of $0, $48,300, and $42,100, for Years 1 to 3,
respectively. What is the incremental IRR?
A) −15.40 percent
B) −11.23 percent
C) 4.08 percent
D) 7.83 percent
E) 13.89 percent
Answer: A
Explanation: 0 = [−$79,400 − (−$54,500)] + ($0 − 16,400)/(1 + IRR) + ($48,300 − 28,900)/(1 +
IRR)2 + ($42,100 − 31,700)/(1 + IRR)3
IRR = −15.40%
Bloom's: Analyze
78) Project A costs $84,500 and has cash flows of $32,300, $36,400, and $30,000 for Years 1 to
3, respectively. Project B has an initial cost of $79,000 and has cash flows of $30,000, $36,000,
and $29,000 for Years 1 to 3, respectively. What is the incremental IRR of these two mutually
exclusive projects?
A) 18.11 percent
B) −13.01 percent
C) 14.91 percent
D) 16.75 percent
E) −20.37 percent
Answer: E
Explanation: 0 = [−$84,500 − (−$79,000)] + ($32,300 − 30,000)/(1 + IRR) + ($36,400 −
36,000)/(1 + IRR)2 + ($30,000 − 29,000)/(1 + IRR3)
IRR = −20.37%
Bloom's: Analyze
33
79) Project A has an initial cost of $75,000 and annual cash flows of $33,000 for three years.
Project B costs $60,000 and has cash flows of $25,000, $30,000, and $25,000 for Years 1 to 3,
respectively. Projects A and B are mutually exclusive. The incremental IRR is ________ and if
the required rate is higher than the crossover rate then Project ________ should be accepted.
A) 13.94 percent; A
B) 12.89 percent; B
C) 12.89 percent; A
D) 13.94 percent; B
E) 15.86 percent; A
Answer: B
Explanation: 0 = [−$75,000 − (−$60,000)] + ($33,000 − 25,000)/(1 + IRR) + ($33,000 −
30,000)/(1 + IRR)2 + ($33,000 − 25,000)/(1 + IRR)3
IRR = 12.89%

Using a discount rate of 15 percent:
NPVA = −$75,000 + $33,000{1 − [1/(1 + .15)3]}/.15
NPVA = $346.43
NPVB = −$60,000 + $25,000/1.15 + $30,000/1.152 + $25,000/1.153
NPVB = $861.35
Bloom's: Analyze
80) Bernstein's proposed project has an initial cost of $128,600 and cash flows of $64,500,
$98,300, and −$15,500 for Years 1 to 3 respectively. If all negative cash flows are moved to
Time 0 at a discount rate of 10 percent, what is the modified internal rate of return?
A) 10.00 percent
B) 9.82 percent
C) 10.04 percent
D) 9.69 percent
E) 9.97 percent
Answer: B
Explanation: 0 = [−$128,600 + (−$15,500/1.103)] + $64,500/(1 + IRR) + $98,300/(1 + IRR)2
IRR = 9.82%
Bloom's: Analyze
34
81) You are considering two independent projects with the same discount rate of 11 percent.
Project A costs $284,700 and has cash flows of $75,900, $106,400, and $159,800 for Years 1 to
3, respectively. Project B costs $115,000, and has a cash flow of $50,000 a year for Years 1 to 3.
You have sufficient funds to finance any decision you make. Which project or projects, if either,
should you accept and why?
A) Project A; because it is the larger-sized project with a positive IRR
B) Project A; because it has the larger NPV
C) Neither project; because their NPVs are less than their initial costs
D) Project B; because its IRR exceeds the discount rate
E) Both projects; because their NPVs are both positive
Answer: D
NPVA= −$13,120.61
NPVB = −$115,000 + $50,000[(1 − 1/1.113)/.11]
NPVB = $7,185.74
0A = −$284,700 + $75,900/(1 + IRR) + $106,400/(1 + IRR)2 + $159,800/(1 + IRR)3
IRRA = 8.63%
0B = −$115,000 + $50,000{[1 − 1/(1 + IRR)3]/IRR}
IRRB = 14.56%
Bloom's: Analyze
35
82) A financing project has an initial cash inflow of $42,000 and cash flows of −$15,600, −
$22,200, and −$18,000 for Years 1 to 3, respectively. The required rate of return is 13 percent.
What is the internal rate of return? Should the project be accepted?
A) 15.26 percent; accept
B) 15.26 percent; reject
C) 13.44 percent; reject
D) 13.44 percent; accept
E) 10.33 percent; accept
Answer: B
Explanation: 0 = $42,000 − $15,600/(1 + IRR) − $22,200/(1 + IRR)2 − $18,000/(1 + IRR)3
IRR = 15.26%
Since this is a financing project, an IRR greater than the required rate indicates rejection.
Bloom's: Analyze
83) Down Under Stores is considering an investment with an initial cost of $236,000. In Year 4,
the project will require an additional investment and finally, the project will be shut down in
Year 7. The annual cash flows for Years 1 to 7, respectively, are projected as $64,000, $87,000,
$91,000, −$48,000, $122,000, $154,000, and −$30,000. If all negative cash flows are moved to
Time 0 using a discount rate of 13 percent, what is the project's modified IRR?
A) 15.44 percent
B) 17.67 percent
C) 18.54 percent
D) 14.91 percent
E) 22.08 percent
Answer: C
Explanation: 0 = [(−$236,000 + (−$48,000/1.134) + (−$30,000/1.137)] + $64,000/(1 + IRR) +
$87,000/(1 + IRR)2 + $91,000/(1 + IRR)3 + $122,000/(1 + IRR)5 + $154,000/(1 + IRR)6
IRR = 18.54%
Bloom's: Analyze
36
84) Project X has an initial cost of $20,000 and a cash inflow of $25,000 in Year 3. Project Y
costs $40,700 and has cash flows of $12,000, $25,000, and $10,000 in Years 1 to 3, respectively.
The discount rate is 6 percent and the projects are mutually exclusive. Based on the individual
project's IRRs you should accept Project ________; based on NPV you should accept Project
________; the final decision should be to accept Project ________.
A) Y; Y; Y
B) Y; X; X
C) X; Y; Y
D) X; X; X
E) Y; X: Y
Answer: C
Explanation: 0X = −$20,000 + $25,000/(1 + IRR)3
IRR = 7.72%
NPVx = −$20,000 + $25,000/1.063
NPVx = $990.48
0Y = −$40,700 + $12,000/(1 + IRR) + $25,000/(1 + IRR)2 + $10,000/(1 + IRR)3
IRR = 7.70%
NPVY = −$40,700 + $12,000/1.06 + $25,000/1.062 + $10,000/1.063
NPVY = $1,266.86
Topic: Mutually exclusive
Bloom's: Analyze
37
85) Two mutually exclusive projects have 3-year lives and a required rate of return of 10.5
percent. Project A costs $75,000 and has cash flows of $18,500, $42,900, and $28,600 for Years
1 to 3, respectively. Project B costs $72,000 and has cash flows of $22,000, $38,000, and
$26,500 for Years 1 to 3, respectively. Using the IRR, which project, or projects, if either, should
be accepted?
A) Accept both projects
B) Select either project as there is no significant difference between them
C) Accept Project A and reject Project B.
D) Accept Project B and reject Project A.
E) Reject both projects
Answer: E
Explanation: 0 = −$75,000 + $18,500/(1 + IRR) + $42,900/(1 + IRR)2 + $28,600/(1 + IRR)3
IRR = 9.12%
0 = −$72,000 + $22,000/(1 + IRR) + $38,000/(1 + IRR)2 + $26,500/(1 + IRR)3
IRR = 9.48%
Both projects should be rejected because their IRR's are less than the required rate of return.
Thus, both projects also have negative NPVs. There is no reason to do incremental analysis as
neither project is acceptable.
Topic: Mutually exclusive
Bloom's: Analyze
86) Flo's Flowers has a proposed project with an initial cost of $40,000 and cash flows of $8,500,
$15,600, and $22,700 for Years 1 to 3, respectively. Based on the profitability index rule, should
the project be accepted if the discount rate is 9.5 percent? Why or why not?
A) Yes; because the PI is 1.03
B) Yes; because the PI is .95
C) Yes; because the PI is negative
D) No; because the PI is 1.03
E) No; because the PI is .95
Answer: E
Explanation: PI = ($8,500/1.095 + $15,600/1.0952 + $22,700/1.0953)/$40,000
PI = .95
Bloom's: Apply
38
87) Anne is considering two independent projects with 2-year lives. Both projects have been
assigned a discount rate of 13 percent. She has sufficient funds to finance one or both projects.
Project A costs $38,500 and has cash flows of $19,400 and $28,700 for Years 1 and 2,
respectively. Project B costs $41,000, and has cash flows of $25,000 and $22,000 for Years 1
and 2, respectively. Which project, or projects, if either, should you accept based on the
profitability index method and what is the correct reason for that decision?
A) You should accept both projects since both of their PIs are positive.
B) You should accept Project A since it has the higher PI and you can only select one project.
C) You should accept both projects since both of their PIs are greater than 1.
D) You should only accept Project A since it is the only project with a PI greater than 1.
E) Neither project is acceptable.
Answer: D
Explanation: PIA = ($19,400/1.13 + $28,700/1.132)/$38,500
PIA = 1.03
PIB = ($25,000/1.13 + $22,000/1.132)/$41,000
PIB= .96
Bloom's: Analyze
88) Roy's Welding projects cash flows of $13,500, $20,400, and $32,900 for Years 1 to 3 for a
project with an initial cost of $45,000. What is the profitability index given an assigned discount
rate of 15 percent?
A) .92
B) .97
C) 1.03
D) 1.08
E) 1.14
Answer: D
Explanation: PI = ($13,500/1.15 + $20,400/1.152 + $32,900/1.153)/$45,000
PI = 1.08
Bloom's: Apply
39
89) Ted, a project manager, wants to invest in a project with an initial cost of $58,500 and cash
flows of $32,400 and $38,500 in Years 1 and 2. Rosita, his boss, requires a discount rate of 10
percent and also a return of $1.10 in today's dollars for every $1 invested. Will Ted get his
project approved? Why or why not?
A) Yes; because the NPV is positive
B) Yes; because the PI is greater than 1
C) Yes; because both criteria are met
D) No; because the project does not meet either requirement
E) No; while the project returns more than 10 percent it does meet $1.10 per $1 requirement.
Answer: E
Explanation: NPV = −$58,500 + $32,400/1.10 + $38,500/1.102
NPV = $2,772.73
PI = ($32,400/1.10 + $38,500/1.102)/$58,500
PI = 1.05

While the project has a positive NPV at discount rate of 10 percent, the PI indicates the project
will only return $1.05 for every $1 invested at that discount rate. Thus, Ted will not get his
project approved.
Bloom's: Analyze
40
90) Juan is considering two independent projects. Project A costs $74,600 and has projected cash
flows of $18,700, $46,300, and $12,200 for Years 1 to 3, respectively. Project B costs $70,000
and has cash flows of $10,600, $15,800, and $67,900 for Years 1 to 3, respectively. Juan assigns
a discount rate of 10 percent to Project A and 12 percent to Project B. Which project or projects,
if either, should he accept based on the profitability index rule?
A) Accept both projects.
B) Accept Project A and reject Project B.
C) Accept either A or B, but not both.
D) Reject both projects.
E) Accept Project B and reject Project A.
Answer: E
Explanation: PIA = ($18,700/1.10 + $46,300/1.102 + $12,200/1.103)/$74,600
PIA = .86
PIB = ($10,600/1.12 + $15,800/1.122 + $67,900/1.123)/$70,000
PIB = 1.01
Accept Project B and reject Project A because only B has a PI greater than 1.
Bloom's: Analyze
91) A proposed project costs $300 and has cash flows of $80, $200, $75, and $90 for Years 1 to
4, respectively. Because of its high risk, the project has been assigned a discount rate of 16
percent. In dollars, how much will this project return in today's dollars for every $1 invested?
A) $1.01
B) $.99
C) $1.05
D) $.97
E) $1.03
Answer: C
Explanation: PI = ($80/1.16 + $200/1.162 + $75/1.163 + $90/1.164)/$300
PI = 1.05
For every $1 invested, the project will return $1.05 in today's dollars.
Bloom's: Apply
41
92) Ginny is considering an investment costing $55,000 that has cash flows of $35,000 in Year
2, $36,000 in Year 3, and −$5,000 in Year 4. She requires a rate of return of 8 percent and has a
required discounted payback period of three years. Should this project be accepted? Why?
A) Yes; The project pays back on a discounted basis within the assigned time period and also
produces a positive NPV.
B) Yes; The discounted payback requirement is met and other methods of analysis are less
desirable.
C) No; Although the project earns more than 8 percent, there is no situation where the project
can pay back on a discounted basis within three years.
D) No; The discounted payback period is too short.
E) No; The NPV indicates rejection as does DPB when all cash flows are considered.
Answer: E
Explanation: NPV = −$55,000 + $35,000/1.082 + $36,000/1.083 + (−$5,000/1.084)
NPV = −$90.33
The project should be rejected based on NPV.
IRR = 0 = −$55,000 + $35,000/(1 + IRR)2 + $36,000/(1 + IRR)3 + (−$5,000)/(1 + IRR)4

IRR = 7.93%
The project should be rejected based on IRR.
DPB = 2 + [($55,000 − $35,000/1.082)/($36,000/1.083)]

DPB = 2.87 years
At first glance, the project appears to be acceptable based on the discounted payback method.
However, if you consider all of the cash flows, the project never pays back on a discounted basis.

Total discounted cash flows = $35,000/1.082 + $36,000/1.083 + (−$5,000/1.084)
Total discounted cash flows = $54,909.67
Bloom's: Analyze
42
93) A proposed new venture will cost $175,000 and should produce annual cash flows of
$48,500, $85,000, $40,000, and $40,000 for Years 1 to 4, respectively. The required payback
period is 3 years and the discounted payback period is 3.5 years. The required rate of return is 9
percent. Which methods indicate project acceptance and which indicate project rejection?
A)
Accept: NPV, IRR, PI, payback; Reject: discounted payback
B)
Accept: NPV, IRR, PI; Reject: payback, discounted payback
C)
Accept: payback, PI; Reject: NPV, IRR, discounted payback
D)
Accept: payback, discounted payback; Reject: NPV, IRR, PI
E)
Accept: NPV, IRR; Reject: PI, payback, discounted payback
Answer: B
Explanation: NPV = −$175,000 + $48,500/1.09 + $85,000/1.092 + $40,000/1.093 +
$40,000/1.094
NPV = $262.56
NPV indicates acceptance because it is a positive value.

0 = −$175,000 + $48,500/(1 + IRR) + $85,000/(1 + IRR)2 + $40,000/(1 + IRR)3 + $40,000/(1 +
IRR)4
IRR = 9.07%
IRR indicates acceptance because it exceeds the required rate of return.

PI = [$48,500/1.09 + $85,000/1.092 + $40,000/1.093 + $40,000/1.094]/$175,000
PI = 1.002
PI indicates acceptance because its value is greater than 1.0.

PB = 3 + ($175,000 − 48,500 − 85,000 − 40,000)/$40,000
PB = 3.04 years
Payback indicates rejection because its value is greater than the required period of time.

DPB = 3 + [$175,000 − ($48,500/1.09 + $85,000/1.092 + $40,000/1.093)]/($40,000/1.094)
DPB = 3.99 years
Discounted payback indicates rejection because its value is greater than the required period of
time.
Bloom's: Analyze
43
94) Given the goal of maximization of firm value and shareholder wealth, we have stressed the
importance of net present value (NPV). And yet, some financial decision-makers continue to use
less desirable measures such as the payback method. Why do you think this is the case?
Answer: This is an open-ended question which allows the creative student to speculate on the
reasons why other methods of analysis might be more expedient or applicable in various
situations. For example, firms may rely on the IRR because it is easier to explain to board
members than NPV and produces the same results as NPV as long as the projects are
independent, similar in size, and the cash flows are conventional. For small projects of short
duration, payback is often sufficient as it allows lower-level managers to develop management
skills and also allows decisions to be made quickly while keeping the evaluation costs below the
level of potential benefits that might be realized.
Topic: Payback
Bloom's: Analyze
95) List and briefly discuss the advantages and disadvantages of the internal rate of return (IRR).
Answer: The advantages of IRR are its close relationship with NPV and the ease with which it is
understood and communicated. The primary disadvantages are that there may be multiple
solutions and IRR may lead to a ranking conflict in evaluating mutually exclusive investments of
differing sizes.
Difficulty: 1 Easy
Bloom's: Understand
96) The IRR rule is said to be a special case of the NPV rule. Explain why this is so and why
IRR has some limitations NPV does not.
Answer: At some rate, R, NPV = $0; by definition, when NPV = $0, R = IRR. Problems occur
with IRR when mutually exclusive projects of varying size are encountered. Also, projects with
unconventional cash flows present unique challenges due to the occurrence of multiple changes
in cash flow direction which create multiple IRRs. The IRR accept/reject rule also has to be
reversed for financing projects which have a positive initial cash flow.
Bloom's: Analyze
44
97) Explain the differences and similarities between net present value (NPV) and the profitability
index (PI).
Answer: The NPV and PI are closely related as both use the present value of all cash flows
subsequent to the initial cash flow in their computations and both lead to the same accept/reject
decision for independent projects. The main difference between the two is that the PI may be
useful in determining which project(s) to accept if funds are limited; however, the PI may lead to
incorrect decisions when considering mutually exclusive investments of differing sizes.
Difficulty: 1 Easy
Bloom's: Understand
98) Most financial experts will agree that net present value is the best capital budgeting method.
However, even NPV can be unreliable when projecting project results. Explain why this is so.
Answer: Given all of its benefits, NPV is still only as reliable as the accuracy of its inputs
allows. If the cash flows and assigned discount rate are unrealistic, or turn out to be inaccurate,
then the NPV results will likewise be inaccurate. As always, analysis output is always reliant
upon the assumptions and values underlying the calculations and the absence of unforeseen
future events.
Bloom's: Analyze
45

Ross12e Chapter05 TB Answerkey

Uploaded by

Copyright:

Available Formats

Ross12e Chapter05 TB Answerkey

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ross12e Chapter05 TB Answerkey

Uploaded by

Copyright:

Available Formats

Corporate Finance, 12e (Ross)

Chapter 5 Net Present Value and Other Investment Rules

2) If a project is assigned a required rate of return of zero, then:

5) Proposed projects should be accepted when those projects:

7) Net present value:

11) The payback method of analysis:

14) Payback is frequently used to analyze independent projects because:

24) The discounted payback method:

25) The discounted payback rule may cause:

30) The internal rate of return tends to be:

34) Which one of the following statements is true?

41) The modified internal rate of return:

42) A mutually exclusive project is a project whose:

49) How should a profitability index of zero be interpreted?

54) No matter how many forms of investment analysis you employ:

IRR = 0 = −$55,000 + $35,000/(1 + IRR)2 + $36,000/(1 + IRR)3 + (−$5,000)/(1 + IRR)4

DPB = 2 + [($55,000 − $35,000/1.082)/($36,000/1.083)]

You might also like