You are on page 1of 12

Chapter 08 - Net Present Value and Other Investment Criteria

Multiple Choice Questions

105. Baker's Supply imposes a payback cutoff of 3.5 years for its international investment
projects. If the company has the following two projects available, should it accept either of
them?

A. Accept both Projects A and B


B. Accept Project A but not Project B
C. Accept Project B but not Project A
D. Both Project A and B are acceptable but you can only select one project
E. Reject both Projects A and B

PaybackA = 3 + [($57,000 - $9,000 - $14,800 - $18,900)/$19,600] = 3.73 years


PaybackB = 3 + [($61,000 - $16,500 - $26,300 - $15,600)/$4,900 = 3.53 years
The firm should reject both projects.

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 08-01 Summarize the payback rule and some of its shortcomings.
Section: 8.2
Topic: Payback period
106. You're trying to determine whether or not to expand your business by building a new
manufacturing plant. The plant has an installation cost of $26 million, which will be depreciated
straight-line to zero over its three-year life. If the plant has projected net income of $2,348,000,
$2,680,000, and $1,920,000 over these three years, what is the project's average accounting
return (AAR)?
A. 11.69 percent
B. 14.14 percent
C. 15.08 percent
D. 17.82 percent
E. 19.21 percent

AAR = [($2,348,000 + $2,680,000 + $1,920,000)/3] + [($26,000,000 + $0)/2] = 17.82 percent

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 08-02 Discuss accounting rates of return and some of the problems with them.
Section: 8.3
Topic: Average accounting return
107. What is the IRR of the following set of cash flows?

A. 12.93 percent
B. 14.90 percent
C. 15.81 percent
D. 16.33 percent
E. 17.78 percent

The IRR is the rate that makes the NPV equal zero.

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 08-03 Explain the internal rate of return criterion and its associated strengths and weaknesses.
Section: 8.4
Topic: Internal rate of return
108. What is the NPV of the following set of cash flows at a discount rate of zero percent? What
if the discount rate is 15 percent?

A. -$41,700; -$8,665.07
B. -$41,700; $1,208.19
C. $0; $1,208.19
D. $2,500; $1,208.19
E. $2,500; -$8,665.07

NPV0 percent = -$41,700 + $13,200 + $11,900 + $19,100 = $2,500

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 08-04 Evaluate proposed investments by using the net present value criterion.
Section: 8.1
Topic: Net present value
109. Chestnut Tree Farms has identified the following two mutually exclusive projects:

Over what range of discount rates would you choose Project A?


A. 8.28 percent or less
B. 8.28 percent or more
C. 9.33 percent or more
D. 9.55 percent or less
E. 9.55 percent or more

Project A should is preferred if the discount rate is 9.55 percent, or less.

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 08-03 Explain the internal rate of return criterion and its associated strengths and weaknesses.
Section: 8.4
Topic: NPV Profile
110. Jefferson International is trying to choose between the following two mutually exclusive
design projects:

The required return is 12 percent. If the company applies the profitability index (PI) decision
rule, which project should the firm accept? If the company applies the NPV decision rule, which
project should it take? Given your first two answers, which project should the firm actually
accept?
A. Project A; Project B; Project A
B. Project A; Project B; Project B
C. Project B; Project A; Project A
D. Project B; Project A; Project B
E. Project B; Project B, Project B

The firm should select project A because the PI rule should not be applied to mutually exclusive
projects.

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 08-04 Evaluate proposed investments by using the net present value criterion. and 08-06 Calculate the profitability index
and understand its relation to net present value.
Section: 8.1 and 8.5
Topic: Net present value and profitability index
111. Consider the following two mutually exclusive projects:

Whichever project you choose, if any, you require a 14 percent return on your investment. If you
apply the payback criterion, you will choose investment _____, if you apply the NPV criterion,
you will choose investment _____; if you apply the IRR criterion, you will choose investment
____; if you choose the profitability index criterion, you will choose investment ____. Based on
your first four answers, which project will you finally choose?
A. A; B; A; A; B
B. A; A; B; B; A
C. A; A; B; B; B
D. B; A; B; A; A
E. B; A; B; B; A

PaybackA = ($54,000 - $12,700 - $23,200)/$27,600 = 2.66 years


PaybackB = ($23,000 - $11,600 - $11,200)/$12,500 = 2.02 years

The company should select Project A based on net present value. Payback ignores some cash
flows and the time value of money. Neither the internal rate of return nor the profitability ratio
are reliable methods when projects are mutually exclusive.
AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 08-01 Summarize the payback rule and some of its shortcomings.; 08-03 Explain the internal rate of return criterion and its
associated strengths and weaknesses.; 08-04 Evaluate proposed investments by using the net present value criterion. and 08-06 Calculate the
profitability index and understand its relation to net present value.
Section: 8.1, 8.2, 8.4, and 8.5
Topic: Comparing investment criteria
112. Textiles Unlimited has gathered projected cash flows for two projects. At what interest rate
would the company be indifferent between the two projects? Which project is better if the
required return is above this interest rate?

A. 11.76 percent; A
B. 12.49 percent; A
C. 12.49 percent; B
D. 13.15 percent; A
E. 13.15 percent: B

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 08-03 Explain the internal rate of return criterion and its associated strengths and weaknesses.
Section: 8.4
Topic: Net present value profile
113. Quattro, Inc. has the following mutually exclusive projects available. The company has
historically used a 4-year cutoff for projects. The required return is 11 percent.

The payback for Project A is ____ while the payback for Project B is _____. The NPV for
Project A is _____ while the NPV for Project B is _____. Which project, if any, should the
company accept?
A. 3.92 years; 3.64 years; $780.85; $1,211.48; accept both Project A and B
B. 3.92 years; 3.79 years; -$211.60; $1,211.48; accept Project B only
C. 3.92 years; 3.79 years; $780.85; -$7,945.93; accept Project A only
D. 4.06 years; 3.64 years; $780.85; $1,211.48; accept both Project A and B
E. 4.06 years; 3.79 years; -$211.60; -$7,945.93; reject both projects

Payback A = 3 + ($82,000 - $15,700 - $18,300 - $23,900)/$26,200 = 3.92 years


Payback B = 3 + ($125,000 - $38,600 - $33,400 - $31,200)/$27,500 = 3.79 years

AACSB: Analytic
Bloom's: Analysis
Difficulty: Basic
Learning Objective: 08-01 Summarize the payback rule and some of its shortcomings. and 08-04 Evaluate proposed investments by using the net
present value criterion.
Section: 8.1 and 8.2
Topic: Payback and net present value
114. Miller and Sons is evaluating a project with the following cash flows:

The company uses a 10 percent interest rate on all of its projects. What is the MIRR of the
project using the reinvestment approach? The discounting approach? The combination
approach?
A. 8.46 percent; 7.29 percent; 8.59 percent
B. 8.46 percent; 7.38 percent; 8.61 percent
C. 8.54 percent; 7.29 percent; 8.61 percent
D. 8.54 percent; 7.38 percent; 8.59 percent
E. 8.54 percent; 8.23 percent; 8.61 percent
Reinvestment approach:

Discounting approach:

Combination approach: