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Exam 13: Weighing Net Present Value and Other Capital Budgeting Criteria

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Question 1

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Compute the PI statistic for Project X and note whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent. $\begin{array} { l l l l l l l } \text { Time: } & 0 & 1 & 2 & 3 & 4 & 5 \\\text { Cash flow: } & - 250 & 75 & 0 & 100 & 75 & 50\end{array}$

A) -0.0977 percent, reject
B) -9.77 percent, reject
C) -24.41 percent, reject
D) 24.41 percent, accept

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Question 2

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Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively. $\begin{array} { l l l l l } \text { Time } & 0 & 1 & 2 & 3 \\\text { Project A Cash Flow } & - 1,000 & 300 & 400 & 700 \\\text { Project B Cash Flow } & - 500 & 200 & 400 & 300\end{array}$ Use the PI decision rule to evaluate these projects; which one(s) should be accepted or rejected?

A) Accept both A and B
B) Accept neither A nor B
C) Accept A, reject B
D) Reject A, accept B

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Question 3

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Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively. $\begin{array} { l l l l l } \text { Time } & 0 & 1 & 2 & 3 \\\text { Project A Cash Flow } & - 1,000 & 300 & 400 & 700 \\\text { Project B Cash Flow } & - 500 & 200 & 400 & 300\end{array}$ Use the NPV decision rule to evaluate these projects; which one(s) should be accepted or rejected?

Compute the MIRR statistic for Project J and advise whether to accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent.Project J $\begin{array} { | r | l | l | l | l | l | l | } \hline \text { Time } & 0 & 1 & 2 & 3 & 4 & 5 \\\hline \text { Cash Flow } & - \$ 1,000 & \$ 300 & \$ 1,480 & - \$ 500 & \$ 300 & - \$ 100 \\\hline\end{array}$

Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 10 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the discounted payback decision to evaluate this project; should it be accepted or rejected? $\begin{array} { | l | l | l | l | l | l | l | l | } \hline \text { Time } & 0 & 1 & 2 & 3 & 4 & 5 & 6 \\\hline \begin{array} { l } \text { Cash } \\\text { Flow }\end{array} & - 85,000 & \$ 12,000 & \$ 11,000 & \$ 13,000 & \$ 21,000 & \$ 31,000 & \$ 32,000 \\\hline\end{array}$

A project costs $101,000 today and is expected to generate cash flows of $31,000 per year for the next 15 years. At what rate is the NPV equal to zero?

All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT:

Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half four and a half years, respectively. Use the payback decision to evaluate this project; should it be accepted or rejected? $\begin{array} { | l | l | l | l | l | l | l | l | } \hline \text { Time } & 0 & 1 & 2 & 3 & 4 & 5 & 6 \\\hline \begin{array} { l } \text { Cash } \\\text { Flow }\end{array} & - \$ 5,000 & \$ 1,300 & \$ 1,400 & \$ 1,600 & \$ 1,600 & \$ 1,100 & \$ 2,000 \\\hline\end{array}$

How many possible IRRs could you find for the following set of cash flows? $\begin{array} { | r | l | l | l | l | l | } \hline \text { Time } & 0 & 1 & 2 & 3 & 4 \\\hline \text { Cash Flow } & - \$ 201,000 & - \$ 37,350 & \$ 460,180 & \$ 217,020 & - \$ 5,000 \\\hline\end{array}$

Which of the following is a technique for evaluating capital projects that tells how long it will take a firm to earn back the money invested in a project plus interest at market rates?

When choosing between two mutually exclusive projects using the payback period method for evaluating capital projects, one would choose:

All of the following capital budgeting tools are suitable for firms facing time constraints EXCEPT:

Compute the MIRR statistic for Project I and note whether to accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 15 percent.Project I $\begin{array} { | r | l | l | l | l | l | l | } \hline \text { Time } & 0 & 1 & 2 & 3 & 4 & 5 \\\hline \text { Cash Flow } & - \$ 1,000 & \$ 400 & \$ 300 & \$ 200 & \$ 300 & \$ 50 \\\hline\end{array}$

Compute the NPV for Project X and accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 9 percent. $\begin{array} { l l l l l l l } \text { Time: } & 0 & 1 & 2 & 3 & 4 & 5 \\\text { Cash flow: } & - 1000 & - 75 & 100 & 100 & 0 & 2000\end{array}$

All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT:

Of the capital budgeting techniques discussed, which works equally well with normal and non-normal cash flows and with independent and mutually exclusive projects?

Suppose your firm is considering two mutually exclusive, required projects with the cash flows shown as follows. The required rate of return on projects of both of their risk class is 10 percent, and the maximum allowable payback and discounted payback statistic for the projects are two and a half and three and a half years, respectively. $\begin{array} { l l l l l } \text { Time } & 0 & 1 & 2 & 3 \\\text { Project A Cash Flow } & - 1,000 & 300 & 400 & 700 \\\text { Project B Cash Flow } & - 500 & 200 & 400 & 300\end{array}$ Use the MIRR decision rule to evaluate these projects; which one(s) should be accepted or rejected?

Compute the discounted payback statistic for Project X and recommend whether the firm should accept or reject the project with the cash flows shown as follows if the appropriate cost of capital is 10 percent and the maximum allowable discounted payback is three years. $\begin{array} { l l l l l l l } \text { Time: } & 0 & 1 & 2 & 3 & 4 & 5 \\\text { Cash flow: } & - 1000 & 500 & 480 & 400 & 300 & 150\end{array}$

The net present value decision technique may not be the only pertinent unit of measure if the firm is facing:

Suppose your firm is considering investing in a project with the cash flows shown as follows, that the required rate of return on projects of this risk class is 8 percent, and that the maximum allowable payback and discounted payback statistics for the project are three and a half and four and a half years, respectively. Use the NPV decision to evaluate this project; should it be accepted or rejected? $\begin{array} { | l | l | l | l | l | l | l | l | } \hline \text { Time } & 0 & 1 & 2 & 3 & 4 & 5 & 6 \\\hline \text { Cash } & - \$ 5,000 & \$ 1,200 & \$ 1,400 & \$ 1,600 & \$ 1,600 & \$ 1,100 & \$ 2,000 \\\text { Flow } & & & & & & & \\\hline\end{array}$