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Exam 5: Net Present Value and Other Investment Rules

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Question 51

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A mutually exclusive project is a project whose:

A) acceptance or rejection has no effect on other projects.
B) NPV is always negative.
C) IRR is always negative.
D) acceptance or rejection affects other projects.
E) cash flow pattern exhibits more than one sign change.

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Question 52

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The two fatal flaws of the internal rate of return rule are:

A) arbitrary determination of a discount rate and failure to consider initial expenditures.
B) arbitrary determination of a discount rate and failure to correctly analyze mutually exclusive investment projects.
C) arbitrary determination of a discount rate and the multiple rate of return problem.
D) failure to consider initial expenditures and failure to correctly analyze mutually exclusive investment projects.
E) failure to correctly analyze mutually exclusive investment projects and the multiple rate of return problem.

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Question 53

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You are considering two independent projects both of which have been assigned a discount rate of 8%.Based on the profitability index, what is your recommendation concerning these projects?

You are considering an investment with the following cash flows.If the required rate of return for this investment is 13.5%, should you accept it based solely on the internal rate of return rule? Why or why not? $\begin{array}{ll}\underline{\text { Year }} & \underline{\text { Cash Flow} } \\0& -\$ 12,000 \\1 & \$ 5,500 \\2 & \$ 8,000 \\3 & -\$ 1,500\end{array}$

Based on the profitability index (PI) rule, should a project with the following cash flows be accepted if the discount rate is 8%? Why or why not? $\begin{array} { c c } \underline{\text { Year }} &\underline{ \text { Cash Flow }} \\ 0 & - \$ 18,600 \\1 & \$ 10,000 \\2 & \$ 7,300 \\3 & \$3,700\end{array}$

The Liberty Co.is considering two projects.Project A consists of building a wholesale book outlet on lot #169 of the Englewood Retail Center.Project B consists of building a sit-down restaurant on lot #169 of the Englewood Retail Center.When trying to decide whether to build the book outlet or the restaurant, management should rely most heavily on the analysis results from the _____ method of analysis.

Graham and Harvey (2001) found that ___ and ___ were the two most popular capital budgeting methods.

The internal rate of return may be defined as:

Based on the profitability index of _____ for this project, you should _____ the project.

Accepting positive NPV projects benefits the stockholders because:

The internal rate of return (IRR) : I.rule states that a typical investment project with an IRR that is less than the required rate should be accepted. II.is the rate generated solely by the cash flows of an investment. III.is the rate that causes the net present value of a project to exactly equal zero. IV.can effectively be used to analyze all investment scenarios.

It will cost $2,600 to acquire a small ice cream cart.Cart sales are expected to be $1,400 a year for three years.After the three years, the cart is expected to be worthless as that is the expected remaining life of the cooling system.What is the payback period of the ice cream cart?

The discounted payback rule may cause:

The Walker Landscaping Company can purchase a piece of equipment for $3,600.The asset has a two-year life, and will produce a cash flow of $600 in the first year and $4,200 in the second year.The interest rate is 15%.Calculate the project's payback assuming steady cash flows.Also calculate the project's IRR.Should the project be taken? Check your answer by computing the project's NPV.

List and briefly discuss the advantages and disadvantages of the internal rate of return (IRR) rule.

Matt is analyzing two mutually exclusive projects of similar size and has prepared the following data.Both projects have 5 year lives. $\begin{array} { l l l } & \frac { \text { Project } \mathrm { A } } { } & \frac { \text { Project B } } { } \\\text { Net present value } & \$ 15,090 & \$ 14,693 \\\text { Payback period } & 2.76 \text { years } & 2.51 \text { years } \\\text { Required return } & 8.3 \% & 8.0 \%\end{array}$ Matt has been asked for his best recommendation given this information.His recommendation should be to accept:

The elements that cause problems with the use of the IRR in projects that are mutually exclusive are: