TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

1) Deciding which product markets to enter is a capital budgeting decision.

Answer: True False

2) If a project has a net present value equal to zero, then the project is expected to produce only the
minimally required cash inflows.
Answer: True False

3) Net present value is highly independent of the rate of return assigned to a particular project.
Answer: True False

4) The capital budgeting process addresses what products or services are offered or sold, in what
markets to compete, and what new products to introduce.
Answer: True False

5) An increased availability of computers and financial calculators to handle the more complex
computations may have contributed to the change in the primary methods used by chief financial
officers to evaluate projects over the past forty years.
Answer: True False

6) An increasing emphasis by financial executives on accounting values rather than financial values
may have contributed to the change in the primary methods used by chief financial officers to
evaluate projects over the past forty years.
Answer: True False

7) Determining whether to sell bonds or issue stock is a capital budgeting decision.

Answer: True False

8) If a project has a net present value equal to zero, then any delay in receiving the projected cash
inflows will cause the project to have a negative net present value.
Answer: True False

9) If a project has a net present value equal to zero, then the present value of the cash inflows exceeds
the initial cost of the project.
Answer: True False

10) Net present value is affected by the timing of each and every cash flow related to a project.
Answer: True False

11) Net present value is the preferred method of analyzing a project even though the cash flows are only
estimates.
Answer: True False

12) NPV lets you know in today's dollars how much better off or worse off you will be if you accept a
project.
Answer: True False

1
13) The NPV method quickly determines the discount rate that changes an accept decision into a reject
decision and vice versa.
Answer: True False

14) A payback period that is less than the required period signals an accept decision.
Answer: True False

15) The advantages of the payback method of project analysis include the bias towards liquidity.
Answer: True False

16) In actual practice, managers frequently use the payback because of its simplicity.
Answer: True False

17) The advantages of the payback method of project analysis include the bias towards arbitrary cutoff
point.
Answer: True False

18) The advantages of the payback method of project analysis include the application of a discount rate
to each separate cash flow.
Answer: True False

19) The payback calculation takes the time value of money into account.
Answer: True False

20) A project which has a discounted payback period longer than its life also has a positive NPV.
Answer: True False

21) When comparing the payback and discounted payback from a financial point of view, the
discounted payback method is preferred over the payback method.
Answer: True False

22) When comparing the payback and discounted payback, both methods are biased towards liquidity.
Answer: True False

23) Whencomparing the payback and discounted payback, the discounted payback is more difficult to
compute and thus is not as widely used as the payback method.
Answer: True False

24) For most projects, the average accounting return (AAR) should be less than the IRR.
Answer: True False

25) Adisadvantage with the average accounting return is the accounting basis of the values used in the
computation.
Answer: True False

2
26) A disadvantage with the average accounting return is the difficulty in obtaining necessary
information to do computation.
Answer: True False

27) A disadvantage with the average accounting return is the exclusion of time value of money
considerations.
Answer: True False

28) A project is accepted if the target AAR exceeds the project AAR.
Answer: True False

29) AAR is biased in favour of liquid investments.

Answer: True False

30) Averageaccounting return employs some sort of arbitrary value against which the project
measurement must be compared when determining whether to accept or reject a project.
Answer: True False

31) In actual practice, managers frequently use the AAR because the information is so readily available.
Answer: True False

32) Lackof consideration of the time value of money is a weakness of the average accounting return
method of analysis.
Answer: True False

33) The AAR is based on cash flows and market values.

Answer: True False

34) The average accounting return calculation takes the time value of money into account.
Answer: True False

35) The average accounting return could lead to incorrect decisions when comparing mutually exclusive
investments.
Answer: True False

36) Ifthe internal rate of return on a project is 11.24%, and the project is assigned a 9.5% discount rate,
then the profitability index will be greater than 1.0.
Answer: True False

37) The payback period and discounted payback are biased in favour of liquid investments.
Answer: True False

38) Two projects that are mutually exclusive are said to be independent.
Answer: True False

3
39) IRR uses an arbitrary cutoff number in its decision rule.
Answer: True False

40) Afirm that only accepts projects for which the IRR is equal to the firm's required return will, on
average, neither create nor destroy wealth for its shareholders.
Answer: True False

41) Tim is considering two projects, both of which have an initial cost of $12,000 and total cash inflows
of $15,000. The cash inflows of project A are $1,000, $2,000, $4,000, and $8,000 over the next four
years, respectively. The cash inflows for project B are $8,000, $4,000, $2,000 and $1,000 over the
next four years, respectively. Which one of the following statements is correct if Tim requires a 10
percent rate of return and has a required discounted payback period of 3 years? Given this
information, Tim should accept project A because it has a payback period of 2.65 years.
Answer: True False

42) NPV and IRR can lead to different decisions in situations investment decision involves mutually
exclusive choices.
Answer: True False

43) NPV and IRR can lead to different decisions in situations where project cash flow are conventional.
Answer: True False

44) NPV and IRR can lead to different decisions in situations where the IRR is negative.
Answer: True False

45) The initial cost of an investment is not an element in computing the internal rate of return method.
Answer: True False

46) The internal rate of return (IRR) is the rate that causes the net present value of a project to exactly
equal zero.
Answer: True False

47) The internal

rate of return method of analysis should not be used to analyze projects with
conventional cash flows.
Answer: True False

48) The internal rate of return method of analysis works best for independent projects with conventional
cash flows.
Answer: True False

49) When multiple IRRs exist, a project must have a negative NPV at the highest IRR.
Answer: True False

50) An element of the IRR concept is the rate designated as the minimum acceptable rate for a project to
be accepted.
Answer: True False

4
51) In
actual practice, managers frequently use the IRR because the results are easy to communicate and
understand.
Answer: True False

52) The crossover point occurs where the IRR of two projects are equal.
Answer: True False

53) The internal rate of return (IRR) is the rate generated solely by the cash flows of an investment.
Answer: True False

54) The internalrate of return (IRR) rule states that a project with an IRR that is less than the required
rate should be accepted.
Answer: True False

55) The internal rate of return method of analysis is generally more popular in practice than NPV.
Answer: True False

56) The internal

rate of return method of analysis may lead to incorrect decisions when comparing
mutually exclusive projects.
Answer: True False

57) The internal rate of return method of analysis may produce multiple rates of return for a single
project.
Answer: True False

58) The internalrate of return method of analysis should not be used for comparing two independent
projects of differing sizes.
Answer: True False

59) The internal

rate of return method of analysis should not be used for comparing two mutually
exclusive projects of similar size.
Answer: True False

60) The IRR is the most widely used capital budgeting technique.
Answer: True False

61) The IRR method can produce multiple rates of return if the cash flows are nonconventional.
Answer: True False

62) The use ofthe internal rate of return could lead to incorrect decisions in comparing mutually
exclusive investments.
Answer: True False

5
63) You are comparing two mutually exclusive projects. The crossover point is 9 percent. You
determine that you should accept project A if the required return is 6 percent. This implies that you
should always accept project A anytime the discount rate is less than 9 percent.
Answer: True False

64) You are comparing two mutually exclusive projects. The crossover point is 9 percent. You
determine that you should accept project A if the required return is 6 percent. This implies that you
should always reject project B if the required return is 6 percent.
Answer: True False

65) You are comparing two mutually exclusive projects. The crossover point is 9 percent. You
determine that you should accept project A if the required return is 6 percent. This implies that you
should always accept project A and always reject project B.
Answer: True False

66) Ifthe internal rate of return on a project is 11.24%, and the project is assigned a 9.5% discount rate,
then the project will have a negative net present value.
Answer: True False

67) AAR and payback use an arbitrary cutoff number in their decision rules.
Answer: True False

68) Iffinancial managers only invest in projects that have a profitability index greater than one, then
share price will be maximized.
Answer: True False

69) The profitability index calculation takes the time value of money into account.
Answer: True False

70) Projects should be accepted when the profitability index is less than 1.
Answer: True False

71) Inactual practice, managers frequently use the net present value because it is considered by many to
be the best method of analysis.
Answer: True False

72) The use ofthe profitability index could lead to incorrect decisions in comparing mutually exclusive
investments.
Answer: True False

73) If financial managers only invest in projects that have a profitability index greater than one, then
firm value will be maximized.
Answer: True False

6
 74) Iffinancial managers only invest in projects that have a profitability index greater than one, then
shareholder wealth will be maximized.
Answer: True False

75) Profitability index

employs some sort of arbitrary value against which the project measurement must
be compared when determining whether to accept or reject a project.
Answer: True False

76) The use of

either the internal rate of return or the profitability index could lead to incorrect decisions
when comparing mutually exclusive investments.
Answer: True False

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

77) Calculate the NPV of a 20-year project with a cost of $400,000 and annual cash flows of $50,000 in
years 1-10 and $25,000 in years 11-20. The company's required rate of return is 10%.
A) $0 B) $33,547 C) ($33,547) D) ($18,547) E) $18,547
Answer: C

78) You are considering a project that costs $300 and has expected cash flows of $110, $121, and
$133.10 over the next three years. If the appropriate discount rate for the project's cash flows is
10%, what is the net present value of this project?
A) $0.71 B) $0.00 C) ($8.58) D) $64.10 E) $19.79
Answer: B

79) A 25- year project has a cost of $1,500,000 and has annual cash flows of $400,000 in years 1-15,
and $200,000 in years 16-25. The company's required rate is 14%. Given this information, calculate
the NPV of the project.
A) $0.70 million
B) $0.87 million
C) $0.50 million
D) $1.10 million
E) $1.00 million
Answer: D

80) A project costs $12,500 to initiate. Cash flows are estimated as $2,500 a year for the first two years
and $3,100 a year for the next three years. The discount rate is 11.25%. The net present value for
this project is ________ and the internal rate of return is ________ the discount rate.
A) $1,800.00; more than
B) -$2,138.52; less than
C) -$2,138.52; more than
D) $1,800.00; less than
E) $2,138.52; less than
Answer: B

7
81) Fora project with an initial investment of $40,000 and cash inflows of $11,000 a year for five years,
calculate NPV given a required return of 11.65%.
A) $567 B) -$1,205 C) $1,218 D) -$1.23 E) -$1,103
Answer: D

82) Calculate
the NPV of the following project using a discount rate of 12%: Yr 0 = -$500; Yr 1 = -$50;
Yr 2 = $50; Yr 3 = $200; Yr 4 = $400; Yr 5 = $400
A) $61.22 B) $208.04 C) $269.21 D) $15.00 E) $118.75
Answer: E

83) FloydClymer is the CFO of Bonavista Mustang, a manufacturer of parts for classic automobiles.
Floyd is considering the purchase of a two-ton press which will allow the firm to stamp out auto
fenders. The equipment costs $250,000. The project is expected to produce after-tax cash flows of
$60,000 the first year, and increase by $10,000 annually; the after-tax cash flow in year 5 will reach
$100,000. Liquidation of the equipment will net the firm $10,000 in cash at the end of five years,
making the total cash flow in year five $110,000.

Assume the required return is 15%. What is the project's net present value?
A) $12,001 B) $13,853 C) ($4,950) D) $12,623 E) $15,226
Answer: B

84) Aproject is expected to produce cash inflows of $6,500 for three years. What is the maximum
amount that can be spent on costs to initiate this project and still consider the project as acceptable,
given an 11% discount rate?
A) $15,900.00 B) $15,967.39 C) $15,884.15 D) $19,500.00 E) $15,897.97
Answer: C

8
85) You are analyzing a project and have prepared the following data:

Based on the net present value of ________ for this project, you should ________ the project.
A) $22,317; accept
B) $2,908; reject
C) $22,317; reject
D) ($25,764); accept
E) ($25,764); reject
Answer: E

86) A30 year project is estimated to cost $35 million and provide annual cash flows of $5 million per
year in years 1-5; $4 million per year in years 6-20 and $2 million per year in years 21-30. If the
company's required rate of return is 10%, determine the NPV.
A) $0.67 million
B) $1.67 million
C) $3.67 million
D) $2.67 million
E) $4.67 million
Answer: E

87) You need to borrow $2,000 quickly, and the local pawn shop will give it to you if you promise to
repay them $200.92 monthly over the next year.

Suppose that the pawn shop's cost of funds is 12%, compounded monthly. From its viewpoint, what is
the NPV of this deal?
A) $292.01 B) $111.01 C) $226.17 D) $261.37 E) $44.11
Answer: D

9
88) What is the net present value of a project that has an initial cash outflow of $21,000 and the
following cash inflows? The required return is 12 percent.

A) -$130.09 B) $130.09 C) $28.16 D) -$29.67 E) $228.16

Answer: D

89) What is the net present value of a project with the following cash flows if the required rate of return
is 14 percent?

A) $3,788.44 B) $8,641.29 C) $9,240.38 D) $1,004.15 E) $2,886.30

Answer: E

90) Bill
plans to open a do-it-yourself dog bathing center in a storefront. The bathing equipment will cost
$160,000. Bill expects the after-tax cash inflows to be $40,000 annually for seven years, after which
he plans to scrap the equipment and retire to the beaches of Jamaica.

Assume the required return is 10%. What is the project's NPV?

A) $14,111 B) $45,001 C) $34,737 D) $27,322 E) $32,556
Answer: C

91) ProjectA has a five-year life and an initial cost of $2,000 and annual cash flows of $700 per year.
Project B also has a five-year life and an initial cost of $3,000 with annual cash flows of $950 per
year. Given this information, calculate the NPV that the IRR cross-over rate provides.
A) ($216.48) B) $1,041.50 C) $328.87 D) ($594.16) E) $800.00
Answer: E

92) Aproject has an initial cash outlay of $16,500. Cash inflows are $5,200 in year 1, $6,800 in year 2,
and $8,100 in year 3. What is the net present value if an 8.30% discount rate is applied to this
project?
A) $601.13 B) $574.76 C) $333.33 D) $475.88 E) $466.04
Answer: D

10
93) A project will produce cash inflows of $3,650 a year for four years. The start-up costs are $15,000.
In year five, the project will be closed and as a result should produce a cash inflow of $7,500. What
is the net present value of this project if the required rate of return is 11.5 percent?
A) $487.82 B) $608.18 C) $556.07 D) $533.23 E) $501.09
Answer: C

94) ProjectA has a five-year life and an initial cost of $1,600 and annual cash flows of $600 per year.
Project B also has a five-year life and an initial cost of $2,500 with annual cash flows of $850 per
year. Given this information, calculate the NPV that the IRR cross-over rate provides.
A) $400 B) $800 C) $700 D) $560 E) $600
Answer: D

95) A50- year project has a cost of $500,000 and has annual cash flows of $100,000 in years 1-25, and
$200,000 in years 26-50. The company's required rate is 8%. Given this information, calculate the
NPV of the project.
A) $879,219 B) $579,219 C) $679,219 D) $779,219 E) $479,219
Answer: A

96) You are analyzing a project and have prepared the following data:

Based on the net present value of ________ for this project, you should ________ the project.
A) $12,684.23; accept
B) $7,978.72; accept
C) -$2,021.28; reject
D) $9,836.74; accept
E) -$406.19; reject
Answer: B

11
 97) What is the NPV of the following set of cash flows if the required return is 14%?

A) $9,525 B) $3,034 C) $41,410 D) ($1,286) E) $10,376

Answer: B

98) A project has an initial cash outlay of $29,500. Cash inflows are estimated at $1,200, $6,900,
$7,800, $9,500, and $4,800 for years 1 through 5, respectively. What is the net present value of this
project given a 7% discount rate?
A) ($2,618.03) B) $1,806.33 C) ($5,677.15) D) $700.00 E) ($5,314.82)
Answer: E

99) What is the net present value of a project that has an initial cash outflow of $18,900 and the
following cash inflows? The required return is 13.25 percent.

A) ($3,840.60) B) $4,052.53 C) ($4,847.47) D) ($2,636.21) E) $3,109.16

Answer: C

100) What is the net present value of a project with the following cash flows if the required rate of return
is 14 percent?

A) ($4,229.91) B) $4,729.09 C) ($306.18) D) ($5,450.09) E) $9,450.09

Answer: A

101) A project has an initial investment of $10,000, with $3,500 annual inflows for each of the
subsequent four years. If the required return is 15%, what is the NPV?
A) $4.63 B) $5.49 C) ($7.58) D) ($32.48) E) ($435.26)
Answer: C

12
102) A project will produce cash inflows of $1,750 a year for four years. The project initially costs
$10,600 to get started. In year five, the project will be closed and as a result should produce a cash
inflow of $8,500. What is the net present value of this project if the required rate of return is 13.75
percent?
A) $1,011.40 B) ($1,011.40) C) ($935.56) D) $5,474.76 E) ($5,474.76)
Answer: B

103) Bill plans to open a do-it-yourself dog bathing center in a storefront. The bathing equipment will cost
$160,000. Bill expects the after-tax cash inflows to be $40,000 annually for seven years, after which
he plans to scrap the equipment and retire to the beaches of Jamaica.

Assume the required return is 15%. What is the project's PI? Should it be accepted?
A) 1.00; indifferent
B) 0.88; no
C) 1.04; yes
D) 1.04; no
E) 0.88; yes
Answer: C

104) Calculate the profitability index of a 20-year project with a cost of $400,000 and annual cash flows
of $50,000 in years 1-10 and $25,000 in years 11-20. The company's required rate of return is 10%.
A) 0.92 B) 1.02 C) 1.08 D) 0.98 E) 1.15
Answer: A

13
105) You are analyzing a project and have prepared the following data:

Based on the profitability index of ________ for this project, you should ________ the project.
A) 1.02; accept
B) 1.02; reject
C) 0.87; accept
D) 0.87; reject
E) 1.08; reject
Answer: D

106) What is the profitability index for an investment with the following cash flows given a 15 percent
required return?

A) 1.12 B) 1.03 C) 1.07 D) 0.94 E) 0.88

Answer: E

107) A project has been assigned a required annual accounting return of 14% and a required discount rate
of 9%. The initial cost of the project is $25,000. The project produces annual cash flows of $9,876 a
year for three years. What is the profitability index of this project?
A) 1.03 B) .92 C) 1.19 D) 1.09 E) 1.00
Answer: E

14
108) A project has an initial investment of $95,000. Its four year cash inflows are estimated to be $21,000
in year 1, $23,000 in year 2, $25,000 in year 3, and $27,000 in year 4. If the rate of return is 8%,
calculate the project's Profitability Index.
A) 1.03 B) 1.83 C) 1.53 D) 0.83 E) 0.53
Answer: D

109) It will cost $14,900 to acquire a hot dog cart. Cart sales are expected to be $16,200 a year for three
years. After the three years, the cart is expected to be worthless as that is the expected life of the
heating system. What is the payback period of the hot dog cart?
A) .92 year B) 1.14 year C) .87 year D) 1.03 year E) 1.09 year
Answer: A

110) Floyd Clymer is the CFO of Bonavista Mustang, a manufacturer of parts for classic automobiles.
Floyd is considering the purchase of a two-ton press which will allow the firm to stamp out auto
fenders. The equipment costs $250,000. The project is expected to produce after-tax cash flows of
$60,000 the first year, and increase by $10,000 annually; the after-tax cash flow in year 5 will reach
$100,000. Liquidation of the equipment will net the firm $10,000 in cash at the end of five years,
making the total cash flow in year five $110,000.

Assuming a required return is 15%, what is the project's profitability index?

A) 1.06 B) 1.28 C) 1.01 D) 1.12 E) 0.98
Answer: A

111) You are considering a project with an initial cost of $27,900. What is the payback period for this
project if the cash inflows are $14,650, $16,190, $12,480, and $9,500 a year over the next four
years, respectively?
A) 1.82 years B) 0.82 year C) 1.90 years D) 0.90 year E) 1.11 years
Answer: A

112) What is the profitability index of the following investment if the required return = 14%?

A) 1.93 B) 0.92 C) 1.13 D) 1.27 E) 1.11

Answer: E

15
113) You are analyzing a project and have prepared the following data:

Based on the profitability index of ________ for this project, you should ________ the project.
A) 0.97; accept
B) .97; reject
C) 1.18; accept
D) 1.05; accept
E) 1.05; reject
Answer: D

114) A 25- year project has a cost of $1,500,000 and has annual cash flows of $400,000 in years 1-15,
and $200,000 in years 16-25. The company's required rate is 14%. Given this information, calculate
the profitability index of the project.
A) 1.25 B) 1.74 C) 1.50 D) 0.75 E) 1.00
Answer: B

115) A project has an initial investment of $150,000. Its four year cash inflows are estimated to be
$50,000 in year 1, $80,000 in years 2 and 3, and $50,000 in year 4. If the rate of return is 12%,
calculate the project's Profitability Index.
A) 1.31 B) 1.41 C) 1.51 D) 1.61 E) 1.71
Answer: A

116) A 30-year project is estimated to cost $35 million dollars and provide annual cash flows of $5
million per year in years 1-5; $4 million per year in years 6-20 and $2 million per year in years
21-30. Given this information, determine the IRR of the project.
A) 8.85% B) 12.85% C) 11.85% D) 9.85% E) 10.85%
Answer: C

16
117) You are analyzing the following two mutually exclusive projects and have developed the following
information. What is the crossover rate?

A) 7.23 percent
B) 12.21 percent
C) 6.02 percent
D) 14.47 percent
E) 10.92 percent
Answer: D

118) A 30 year project is estimated to cost $35 million dollars and provide annual cash flows of $5 per
year in years 1-5; $4 million per year in years 6-20 and $2 million per year in years 21-30. If the
company's required rate of return is 10%, determine the discounted payback for the project.
A) 11.90 years B) 7.90 years C) 15.90 years D) 13.90 years E) 9.90 years
Answer: C

119) What is the internal rate of return for a project with the following cash flows?

A) 12.3 percent
B) 12.5 percent
C) 12.7 percent
D) 11.9 percent
E) 12.1 percent
Answer: A

120) Project A has a five-year life and an initial cost of $1,600 and annual cash flows of $600 per year.
Project B also has a five-year life and an initial cost of $2,500 with annual cash flows of $850 per
year. Given this information, calculate the IRR cross-over rate.
A) 12.85% B) 12.25% C) 12.65% D) 12.45% E) 12.05%
Answer: E

17
121) The ABC Co. is considering the purchase of a $249,000 piece of equipment. This equipment is
expected to produce cash flows of $78,500, $149,000, and $80,000 over the next three years. The
rate of return on this equipment is:
A) 9.88% B) 11.26% C) 15.23% D) 23.49% E) 12.50%
Answer: B

122) A project produces the following cash flows over the next five years: $600, $200, $350, $400 and
$500, respectively. The initial cost of the project is $1,400. What is the internal rate of return on this
project?
A) - 4.56%
B) 14.39%
C) 3.67%
D) 12.87%
E) The rate cannot be computed with certainty.
Answer: B

123) Jackson Traders is considering two mutually exclusive projects with the following cash flows. The
crossover rate is ________ and if the required rate is lower than the crossover rate then project
________ should be accepted.

A) 10.90 percent; B
B) 14.14 percent; A
C) 13.87 percent; B
D) 14.14 percent; B
E) 10.90 percent; A
Answer: E

124) Project X has a cost of $750 and a three year annual cash flow of $350 per year. Project Y has a cost
of $500 and a three year annual cash flow of $300, $225 and $200. Given this information, calculate
the IRR cross-over rate.
A) 13.21% B) 12.21% C) 16.21% D) 14.21% E) 15.21%
Answer: B

18
125) You are analyzing the following two mutually exclusive projects and have developed the following
information. What is the crossover rate?

A) 16.750 percent
B) 14.901 percent
C) 11.113 percent
D) 13.008 percent
E) 17.899 percent
Answer: E

126)

What is the crossover rate for these two projects?

A) 12.2% B) 14.0% C) 15.4% D) 19.1% E) 18.3%
Answer: C

19
127) The Winston Co. is considering two mutually exclusive projects with the following cash flows. The
crossover rate is ________ and if the required rate is higher than the crossover rate then project
________ should be accepted.

A) 13.94 percent; B
B) 15.44 percent; B
C) 15.44 percent; A
D) 13.94 percent; A
E) 15.86 percent; A
Answer: A

128) A project produces annual net income of $14,600, $18,700, and $23,500 over three years,
respectively. The initial cost of the project is $310,800. This cost is depreciated straight-line to a
zero book value over three years. What is the average accounting rate of return if the required
discount rate is 9 percent?
A) 18.28 percent
B) 17.67 percent
C) 14.29 percent
D) 12.18 percent
E) 15.63 percent
Answer: D

129) Bill plans to open a do-it-yourself dog bathing center in a storefront. The bathing equipment will cost
$160,000. Bill expects the after-tax cash inflows to be $40,000 annually for seven years, after which
he plans to scrap the equipment and retire to the beaches of Jamaica.

Assume the required return is 17%. What is the project's IRR? Should it be accepted?
A) 12.2%; yes
B) 16.3%; no
C) 17.0%; indifferent
D) 16.3%; yes
E) 12.2%; no
Answer: B

20
130) Bodner Corporation purchased an asset costing $475,000. The asset has a 4 year life, no salvage
value, and is depreciated on a straight line method. During the past four years, Bodner posted net
income of $30,000, $25,000, $20,000 and $15,000. Given the following information, calculate the
company's average accounting return over the past four years.
A) 14.51% B) 16.45% C) 20.15% D) 12.63% E) 18.32%
Answer: D

131) Desiree, Inc. is considering adding a new product with a start-up cost of $540,000. This cost will be
depreciated over 3 years, which is the estimated life of the product. Desiree has a 34% marginal tax
rate. The net income for each of the three years is estimated at $15,000, $45,000, and $80,000. What
is the average accounting return for the new product?
A) 11.30% B) 8.64% C) 21.00% D) 25.93% E) 17.28%
Answer: E

132) Sun, Inc. is analyzing two projects. Project A requires an initial investment of $2,200 and produces
cash inflows of $500, $550, $700, and $900 respectively over four years. Project B requires an
initial investment of $2,400 and produces cash inflows of $550, $650, $700, and $1,100 respectively
over four years. What is the crossover point?
A) 14.14% B) 18.32% C) 19.76% D) 21.65% E) 16.88%
Answer: D

133) Martha's Cupboards just purchased $172,500 of new equipment. The equipment is expected to
increase the net income of the firm by $15,000, $35,000, $25,000, and $10,000 a year in each of the
next four years. Martha's uses straight-line depreciation over the projected life of each project. What
is the average accounting rate of return on this equipment?
A) 24.64% B) 18.37% C) 5.90% D) 12.32% E) 49.28%
Answer: A

134) The Jensen Company has compiled the following information about a project it is considering.

What is the average accounting rate of return on this project?

A) 19.39% B) 36.24% C) 16.00% D) 18.12% E) 32.00%
Answer: C

21
135) What is the payback period for the following investment?

A) 4 years
B) 3 years
C) 2 years
D) 1 year
E) The investment doesn't pay back
Answer: E

136) You need to borrow $2,000 quickly, and the local pawn shop will give it to you if you promise to
repay them $200.92 monthly over the next year.

From the pawn shop's viewpoint, what is the IRR of this transaction?
A) 1.7% per month
B) 2.0% per month
C) 3.0% per month
D) 1.0% per month
E) 2.5% per month
Answer: C

137) What is the payback period of a $40,000 investment with the following cash flows?

A) 2.00 years B) 2.25 years C) 1.80 years D) 1.00 years E) 3.50 years
Answer: C

138) The following four-year project has an initial cost of $1,000,000. The future cash inflows for the
next four years are $600,000, $500,000, $400,000, and $400,000, respectively. If the rate of return is
12%, determine the discounted payback period for this project.
A) 1.74 years B) 2.23 years C) 2.44 years D) 2.74 years E) 1.94 years
Answer: B

139) A 50- year project has a cost of $500,000 and has annual cash flows of $100,000 in years 1-25, and
$200,000 in years 26-50. The company's required rate is 8%. Given this information, calculate the
profitability index of the project.
A) 2.16 B) 2.46 C) 2.76 D) 2.06 E) 1.76
Answer: C

22
140) Use the following mutually exclusive investment cash flows for the question(s) below:

Compute the crossover rate for the two projects.

A) The NPV profiles of the two do not cross over
B) 0.0%
C) 2.2%
D) 3.5%
E) 8.7%
Answer: B

141) A project has an initial cost of $47,500 and produces cash inflows of $21,200, $24,800, and $21,500
over the next three years, respectively. What is the discounted payback period if the required rate of
return is 14 percent?
A) 2.07 years B) 2.13 years C) 2.46 years D) 2.68 years E) 2.74 years
Answer: D

142) You are analyzing a project and have prepared the following data:

Based on the payback period of ________ for this project, you should ________ the project.
A) 3.87 years; reject
B) 2.87 years; accept
C) 2.87 years; reject
D) 1.87 years; accept
E) 3.13 years; reject
Answer: C

23
143) 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 over the next four years,
respectively?
A) 3.04 years B) 2.36 years C) 3.36 years D) 2.89 years E) 2.04 years
Answer: C

144) What is the IRR of an investment that costs $77,500 and pays $27,500 a year for four years?
A) 20% B) 22% C) 18% D) 16% E) 24%
Answer: D

145) A 50- year project has a cost of $500,000 and has annual cash flows of $100,000 in years 1-25, and
$200,000 in years 26-50. The company's required rate is 8%. Given this information, calculate the
IRR of the project.
A) 21.21% B) 23.23% C) 20.20% D) 22.22% E) 19.19%
Answer: C

146) Martin is analyzing a project and has gathered the following data. Based on this data, what is the
average accounting rate of return? The firm depreciates its assets using straight-line depreciation to
a zero book value over the life of the asset.

A) 13.08 percent
B) 31.54 percent
C) 15.77 percent
D) 21.83 percent
E) 26.17 percent
Answer: A

147) Project A and B have 4 year timelines. Project A has an initial investment of $100,000 and cash
inflows of $60,000, $50,000 $40,000 and $40,000. Project B has an initial investment of $75,000
and cash inflows of $50,000, $40,000, $30,000 and $30,000. At what rate of interest would a
company be indifferent at choosing project A or B?
A) 19.01% B) 23.88% C) 24.44% D) 21.86% E) 17.95%
Answer: D

24
148) Project A and B have 4 year timelines. Project A has an initial investment of $120,000 and cash
inflows of $50,000, $50,000 $30,000 and $30,000. Project B has an initial investment of $190,000
and cash inflows of $80,000, $70,000, $70,000 and $60,000. At what rate of interest would a
company be indifferent at choosing project A or B?
A) 21.33% B) 25.77% C) 22.44% D) 24.66% E) 23.55%
Answer: D

149) Suppose a project costs $300 and produces cash flows of $100 over each of the following six years.
What is the IRR of the project?
A) There is not enough information; a discount rate is required
B) 38.1%
C) 24.3%
D) 10.0%
E) 34.9%
Answer: C

150) ABC Corporation purchased an asset costing $450,000. The asset has an 8 year life, a $50,000
salvage value, and is depreciated on a straight line method. During the past four years, ABC posted
net income of $98,000, $112,000, $134,000 and $122,000. Given the following information,
calculate the company's average accounting return over the past four years.
A) 25.85% B) 35.85% C) 15.85% D) 20.15% E) 30.15%
Answer: B

151) A 25-year project has a cost of $1,500,000 and has annual cash flows of $400,000 in years 1-15, and
$200,000 in years 16-25. The company's required rate is 14%. Given this information, calculate the
IRR of the project.
A) 26.22% B) 24.25% C) 30.25% D) 22.25% E) 28.28%
Answer: A

152) A four-year project that has an initial cost of $60,000. The future cash inflows are $40,000, $30,000,
$20,000, and $10,000, respectively. Given this information, what is the IRR?
A) 31.38% B) 30.03% C) 29.35% D) 25.68% E) 27.14%
Answer: A

25
153) Floyd Clymer is the CFO of Bonavista Mustang, a manufacturer of parts for classic automobiles.
Floyd is considering the purchase of a two-ton press which will allow the firm to stamp out auto
fenders. The equipment costs $250,000. The project is expected to produce after-tax cash flows of
$60,000 the first year, and increase by $10,000 annually; the after-tax cash flow in year 5 will reach
$100,000. Liquidation of the equipment will net the firm $10,000 in cash at the end of five years,
making the total cash flow in year five $110,000.

What is the payback period for the proposed investment?

A) 3.0 years
B) 2.4 years
C) 2.0 years
D) 3.4 years
E) The investment doesn't pay back
Answer: D

154) A project has an initial cost of $72,500. The cash inflows are $11,500, $36,900, $22,900, and
$18,200 over the next four years, respectively. What is the payback period?
A) 2.98 years B) 3.13 years C) 3.07 years D) 3.01 years E) 2.67 years
Answer: C

155) A project has an initial cost of $1,900. The cash inflows are $0, $500, $900, and $700 over the next
four years, respectively. What is the payback period?
A) 3.71 years B) 2.71 years C) 3.11 years D) 2.98 years E) never
Answer: A

156) A 25- year project has a cost of $1,500,000 and has annual cash flows of $400,000 in years 1-15,
and $200,000 in years 16-25. The company's required rate is 14%. Given this information, calculate
the payback of the project.
A) 2.75 years B) 2.25 years C) 3.25 years D) 4.25 years E) 3.75 years
Answer: E

157) Bill plans to open a do-it-yourself dog bathing center in a storefront. The bathing equipment will cost
$160,000. Bill expects the after-tax cash inflows to be $40,000 annually for seven years, after which
he plans to scrap the equipment and retire to the beaches of Jamaica.

What is the project's payback period?

A) 1.5 years B) 3.3 years C) 2.0 years D) 4.0 years E) 4.3 years
Answer: D

26
158) You are analyzing a project and have prepared the following data:

Based on the payback period of ________ years for this project, you should ________ the project.
A) 3.27; accept
B) 3.27; reject
C) 3.42; reject
D) 3.51; reject
E) 3.42; accept
Answer: E

159) The following four-year project has an initial cost of $1,000,000. The future cash inflows for the
next four years are $400,000, $300,000, $200,000, and $200,000, respectively. What is the payback
period for this project?
A) 3.0 years. B) 3.5 years. C) 4.5 years. D) 2.5 years. E) 4.0 years.
Answer: B

160) Yancy is considering a project which will produce cash inflows of $900 a year for 4 years. The
project has a 9 percent required rate of return and an initial cost of $2,800. What is the discounted
payback period?
A) 4.18 years B) never C) 3.11 years D) 3.82 years E) 3.18 years
Answer: D

161) You are considering a project with an initial cost of $6,400. What is the payback period for this
project if the cash inflows are $900, $1,350, $2,800, and $1,500 a year over the next four years,
respectively?
A) 3.48 years B) 4.90 years C) 4.21 years D) 3.90 years E) 3.21 years
Answer: D

27
162) Annmarie is considering a project which will produce cash inflows of $1,200 a year for 6 years. The
project has a 15 percent required rate of return and an initial cost of $3,400. What is the discounted
payback period?
A) 2.92 years B) 4.13 years C) 2.83 years D) 3.96 years E) 3.99 years
Answer: D

163) You are evaluating two mutually exclusive projects, A and B. Project A costs $350 and has cash
flows of $250 in each of the next two years. Project B costs $300 and generates cash flows of $300
and $100 for the next two years, respectively. What is the crossover rate for these projects?
A) 83.48% B) 61.80% C) 26.38% D) 27.47% E) 30.28%
Answer: E

164) Jinny's Ice Cream is considering opening a new outlet for a period of three years. The up-front costs
are $288,000. The outlet is expected to earn net income of $31,500 a year. What is the expected
average accounting rate of return on this venture?
A) 21.88% B) 31.25% C) 43.75% D) 14.93% E) 38.76%
Answer: A

165) Suppose a firm invests $600 in a project. The initial cost is depreciated straight-line to zero over 3
years. Net income from the project is $100, $125, and $140 in each of the three years of the project's
life. What is the average accounting return?
A) 20.28% B) 40.56% C) 18.25% D) 60.83% E) 35.49%
Answer: B

166) If the required return is 12%, what is the discounted payback period of the following cash flows?

A) 2 years
B) 3 years
C) 5 years
D) 4 years
E) The project does not pay back on a discounted basis.
Answer: D

28
167) What is the discounted payback of the following project if the required return is 14%?

Year 0 1 2 3 4 5
Cash Flow -$60 $22 $22 $25 $10 $5

A) 2 years
B) 3 years
C) 4 years
D) 5 years
E) It doesn't pay back on a discounted basis.
Answer: D

168) You are looking at an investment which has an initial cost of $400,000 and a salvage value of zero
after five years. What is the average accounting return for this investment given the following
annual net incomes:

A) 1% B) 36% C) 55% D) 44% E) 48%

Answer: C

169) A 50- year project has a cost of $500,000 and has annual cash flows of $100,000 in years 1-25, and
$200,000 in years 26-50. The company's required rate is 8%. Given this information, calculate the
payback of the project.
A) 7 years B) 6 years C) 5 years D) 4 years E) 3 years
Answer: C

170) A project costs $475 and has cash flows of $100 for the first three years and $75 in each of the
project's last five years. What is the payback period of the project?
A) The project never pays back.
B) 4.75 years
C) 5.00 years
D) 5.33 years
E) 6.00 years
Answer: D

171) A 25- year project has a cost of $1,500,000 and has annual cash flows of $400,000 in years 1-15,
and $200,000 in years 16-25. The company's required rate is 14%. Given this information, calculate
the discounted payback of the project.
A) 5.90 years B) 6.30 years C) 6.10 years D) 5.5 years E) 5.70 years
Answer: E

29
172) Calculate the payback of a 20-year project with a cost of $400,000 and annual cash flows of $50,000
in years 1-10 and $25,000 in years 11-20. The company's required rate of return is 10%.
A) 4 B) 5 C) 6 D) 7 E) 8
Answer: E

173) A project costs $475 and has cash flows of $100 for the first three years and $75 in each of the
project's last five years. If the discount rate is 10%, what is the discounted payback period?
A) The project never pays back on a discounted basis
B) 5 years
C) 6 years
D) 7 years
E) 8 years
Answer: A

174) A project produces annual net income of $11,500, $13,700, and $16,900 over the three years of its
life, respectively. The initial cost of the project is $257,000. This cost is depreciated straight-line to
a zero book value over three years. What is the average accounting rate of return if the required
discount rate is 6.75 percent?
A) 5.46 percent
B) 13.90 percent
C) 10.92 percent
D) 5.33 percent
E) 6.58 percent
Answer: C

175) What is the internal rate of return on an investment with the following cash flows?

A) 7.67 percent
B) 6.87 percent
C) 7.50 percent
D) 6.33 percent
E) 6.75 percent
Answer: C

176) Matthew's Construction is considering a project that will cost $1.2 million to start. The project is
expected to produce cash flows starting in year 2 of $269,000 a year for the following six years.
What is the internal rate of return on this project?
A) 5.62% B) 6.97% C) 4.09% D) 8.32% E) 9.19%
Answer: A

30
177) Hayolom is analyzing a project and has gathered the following data. The firm depreciates its assets
using straight-line depreciation to a zero book value over the life of the asset. What is the project's
average accounting rate of return?

A) 6.02 percent
B) 8.34 percent
C) 6.41 percent
D) 7.21 percent
E) 8.54 percent
Answer: B

178) Fulton Corporation purchased an asset costing $525,000. The asset has a 4-year life, $90,000
salvage value, and is depreciated on a straight line method. During the past four years, Fulton posted
net income of $15,000, $18,500, $20,000 and $21,000. Given the following information, calculate
the company's average accounting return over the past four years.
A) 9.60% B) 7.36% C) 6.24% D) 5.12% E) 8.48%
Answer: B

179) A 30-year project is estimated to cost $35 million and provide annual cash flows of $5 million per
year in years 1-5; $4 million per year in years 6-20 and $2 million per year in years 21-30. If the
company's required rate of return is 10%, determine the payback of the project.
A) 6.50 years B) 7.50 years C) 8.50 years D) 8.00 years E) 7.00 years
Answer: B

180) A 50- year project has a cost of $500,000 and has annual cash flows of $100,000 in years 1-25, and
$200,000 in years 26-50. The company's required rate is 8%. Given this information, calculate the
discounted payback of the project.
A) 9.95 years B) 7.75 years C) 6.65 years D) 5.55 years E) 8.85 years
Answer: C

181) Peter is considering a project with an initial cost of $42,000 and annual cash inflows of $9,100 a
year for six years. What discount rate, when applied to this project, will produce a profitability index
of 1.0?
A) 8.11% B) 7.65% C) 8.05% D) 7.00% E) 7.88%
Answer: C

31
182) Project A has a five-year life and an initial cost of $2,000 and annual cash flows of $700 per year.
Project B also has a five-year life and an initial cost of $3,000 with annual cash flows of $950 per
year. Given this information, calculate the IRR cross-over rate.
A) 8.93% B) 7.93% C) 5.93% D) 9.93% E) 6.93%
Answer: B

183) A project has an initial cost of $61,000 and a 5-year life. The company uses straight-line
depreciation to a zero book value over the life of the project. The projected net income from the
project is $1,500, $1,600, $1,900, $2,100, and $2,200 a year for the next five years, respectively.
What is the average accounting rate of return?
A) 8.48 percent
B) 7.62 percent
C) 6.10 percent
D) 9.42 percent
E) 7.97 percent
Answer: C

184) Kim Lee is analyzing two projects. The first requires a $1,200 initial investment and returns $600 a
year for four years. The second project requires a $1,500 initial investment and returns $700 a year
for four years. What is the crossover point for these two projects?
A) 4.25%
B) 6.37%
C) 8.14%
D) 12.59%
E) The crossover point cannot be computed based on the information provided.
Answer: D

185) Freeley Co. is considering an expansion project costing $390,000 up front. The expansion is
expected to produce cash flows of $120,000 a year for two years. In Year 3, the project is expected
to produce a cash flow of $225,000. The expected return on this expansion project is:
A) 8.16% B) 8.47% C) 8.33% D) 7.12% E) 8.51%
Answer: C

32
186) You are analyzing a project and have prepared the following data:

Based on the internal rate of return of ________ for this project, you should ________ the project.
A) 10.33 percent; reject
B) 10.75 percent; accept
C) 8.95 percent; accept
D) 9.67 percent; reject
E) 8.44 percent; reject
Answer: B

187) Calculate the IRR of a 20-year project with a cost of $400,000 and annual cash flows of $50,000 in
years 1-10 and $25,000 in years 11-20. The company's required rate of return is 10%.
A) 8.53% B) 10.53% C) 12.53% D) 6.53% E) 4.53%
Answer: A

188) Project A has a cost of $300 and a three year annual cash flow of $100, $200 and $300. Project B
has a cost of $400 and a three year annual cash flow of $185, $215 and $315. Given this
information, calculate the IRR cross-over rate.
A) 7.77% B) 10.77% C) 6.77% D) 8.77% E) 9.77%
Answer: B

33
189) You are analyzing a project and have prepared the following data:

Based on the internal rate of return of ________ percent for this project, you should ________ the
project.
A) 3.45; reject
B) 9.45; reject
C) 8.79; accept
D) 9.96; accept
E) 5.68; reject
Answer: A

190) A project produces annual net income of $9,500, $12,500, and $15,500 over the three years of its
life, respectively. The initial cost of the project is $260,400. This cost is depreciated straight-line to
a zero book value over three years. What is the average accounting rate of return if the required
discount rate is 7 percent?
A) 7.32 percent
B) 4.80 percent
C) 8.97 percent
D) 9.60 percent
E) 10.27 percent
Answer: D

34
191) Yuliis analyzing the following two mutually exclusive projects and has developed the following
cash flow information. What is the crossover rate?

A) 8.70 percent
B) 10.66 percent
C) 8.39 percent
D) 10.02 percent
E) 9.69 percent
Answer: B

192) Without using formulas, provide a definition of "internal rate of return" (IRR).
A) A project analysis tool that measures the acceptability of a project by determining the amount
of profit that can be expected based on an investment made.
B) A graphical representation of the relationship between varying rates of return and the
corresponding NPV value.
C) The rate of return provided by a project. The value is compared with a company's rate of return
to determine viability of a project.
D) A situation whereby a choice has to be made between two or more projects, and choosing
multiple projects is not an option.
E) A project analysis tool that measures the acceptability of a project through the difference
between a project's initial investment and whether the present value of its cash flow will repay
the investment.
Answer: C

193) "Net present value" can be defined as:

A) A measure of the value created or added today by undertaking a project.
B) The cash outflows from a project subtracted from the cash inflows for the project.
C) The discount rate that causes the current value of cash inflows to exceed the current value of
cash outflows.
D) The rate of return that causes the present value of all cash flows associated with a project to
equal zero.
E) The net costs of a project subtracted from the net income generated from the project.
Answer: A

35
194) Without using formulas, provide a definition of "net present value" (NPV).
A) A project analysis tool that measures the acceptability of a project by determining the length of
time required for an investment's discounted cash flows to equal its initial cost.
B) A ranking method used to assess projects. PI greater than 1 signify positive NPV projects,
while PI less than 1 signify negative NPV projects.
C) A project analysis tool that determines the amount of time required for an investment to
generate cash flows to recover its initial cost.
D) A project analysis tool that measures the acceptability of a project through the difference
between a project's initial investment and whether the present value of its cash flow will repay
the investment.
E) A project analysis tool that measures the acceptability of a project by determining the amount
of profit that can be expected based on an investment made.
Answer: D

195) Without using formulas, provide a definition of "payback period."

A) A ranking method used to assess projects. PI greater than 1 signify positive NPV projects,
while PI less than 1 signify negative NPV projects.
B) A project analysis tool that determines the amount of time required for an investment to
generate cash flows to recover its initial cost.
C) A project analysis tool that measures the acceptability of a project through the difference
between a project's initial investment and whether the present value of its cash flow will repay
the investment.
D) A project analysis tool that measures the acceptability of a project by determining the amount
of profit that can be expected based on an investment made.
E) A project analysis tool that measures the acceptability of a project by determining the length of
time required for an investment's discounted cash flows to equal its initial cost.
Answer: B

196) Without using formulas, provide a definition of "discounted payback period."

A) A project analysis tool that determines the amount of time required for an investment to
generate cash flows to recover its initial cost.
B) A project analysis tool that measures the acceptability of a project by determining the length of
time required for an investment's discounted cash flows to equal its initial cost.
C) A project analysis tool that measures the acceptability of a project through the difference
between a project's initial investment and whether the present value of its cash flow will repay
the investment.
D) A ranking method used to assess projects. PI greater than 1 signify positive NPV projects,
while PI less than 1 signify negative NPV projects.
E) A project analysis tool that measures the acceptability of a project by determining the amount
of profit that can be expected based on an investment made.
Answer: B

36
197) Without using formulas, provide a definition of "average accounting return" (AAR).
A) A project analysis tool that determines the amount of time required for an investment to
generate cash flows to recover its initial cost.
B) A project analysis tool that measures the acceptability of a project by determining the amount
of profit that can be expected based on an investment made.
C) A project analysis tool that measures the acceptability of a project through the difference
between a project's initial investment and whether the present value of its cash flow will repay
the investment.
D) A ranking method used to assess projects. PI greater than 1 signify positive NPV projects,
while PI less than 1 signify negative NPV projects.
E) A project analysis tool that measures the acceptability of a project by determining the length of
time required for an investment's discounted cash flows to equal its initial cost.
Answer: B

198) Without using formulas, provide a definition of "profitability index" (PI).

A) A project analysis tool that measures the acceptability of a project by determining the length of
time required for an investment's discounted cash flows to equal its initial cost.
B) A project analysis tool that measures the acceptability of a project through the difference
between a project's initial investment and whether the present value of its cash flow will repay
the investment.
C) A ranking method used to assess projects. PI greater than 1 signify positive NPV projects,
while PI less than 1 signify negative NPV projects.
D) A project analysis tool that determines the amount of time required for an investment to
generate cash flows to recover its initial cost.
E) A project analysis tool that measures the acceptability of a project by determining the amount
of profit that can be expected based on an investment made.
Answer: C

199) Ranking conflicts can arise if one relies on IRR instead of NPV when:
A) Projects are independent of one another.
B) A project has more than one NPV.
C) The first cash flow is negative and the remaining cash flows are positive.
D) Projects are mutually exclusive.
E) The profitability index is greater than one.
Answer: D

200) Which of the following can cause a project to have multiple IRRs?
A) A ten-year project has a negative cash flow in the last year of the project's life.
B) With mutually exclusive investments.
C) Whenever project cash flows are conventional.
D) The project has a large initial outlay.
E) A project has negative cash flows in the first three years, but positive cash flows thereafter.
Answer: A

37
201) No matter how many forms of investment analysis you do:
A) A project will never be accepted unless the payback period is met.
B) The internal rate of return will always produce the most reliable results.
C) Only the first three years of a project ever affect its final outcome.
D) The actual results from a project may vary significantly from the expected results.
E) The initial costs will generally vary considerably from the estimated costs.
Answer: D

202) Which one of the following statements is correct?

A) If the accounting rate of return exceeds the required discount rate, the project should be
accepted.
B) When the internal rate of return is less than the required rate, the project should be accepted.
C) A project with a net present value of zero is earning exactly the required rate of return.
D) A profitability index that is less than 1.0 indicates that a project is acceptable.
E) A negative net present value indicates that a project is acceptable.
Answer: C

203) A negative net present value indicates that:

A) The discount rate applied to the project is less than the project's internal rate of return.
B) A project's cash inflows must be less than the project's initial cost.
C) A project's initial cash outflow is greater than the present value of the project's cash inflows.
D) The discount rate is greater than the current market rate of return.
E) A project is acceptable.
Answer: C

204) Under the payback method of analysis:

A) The initial cash outlay is ignored.
B) A project will be acceptable whenever the payback period exceeds the pre-specified number of
years.
C) The cash flow in year 3 is ignored if the required payback period is 4 years.
D) The cash flow in year 2 is valued just as highly as the cash flow in year 1 as long as the
required payback period is 3 years or more.
E) A project's initial cost is discounted.
Answer: D

205) You are going to choose between two investments. Both cost $80,000, but investment A pays
$35,000 a year for four years while investment B pays $30,000 a year for five years. If your required
return is 13%, which should you choose?
A) B, because it has a higher NPV.
B) A, because the IRR exceeds 13%.
C) B, because the IRR exceeds 13%.
D) A, because the project has a higher IRR.
E) A, because the pays back sooner.
Answer: A

38
206) For which capital investment evaluation technique is the following a complete list of its
disadvantages when compared to NPV analysis? (1) Ignores cash flows beyond the cutoff date; (2)
Requires an arbitrary cutoff point; (3) Biased against long-term projects; (4) May reject positive
NPV projects.
A) NPV
B) IRR
C) AAR
D) Payback period
E) Discounted payback
Answer: E

207) Which capital investment evaluation technique offers the following advantages? (1) Easy to
calculate; (2) Needed information will usually be available.
A) NPV
B) IRR
C) AAR
D) Payback period
E) Discounted payback
Answer: C

208) Which capital investment evaluation technique is described by the following characteristics? (1)
Closely related to NPV; (2) Easy to understand and communicate; (3) May lead to incorrect
decisions when comparing mutually exclusive investments; (4) May be useful when the available
investment funds are limited.
A) AAR
B) NPV
C) IRR
D) Payback period
E) PI
Answer: E

209) A firm seeks to accept projects with a high degree of liquidity, avoid the higher forecasting error
associated with cash flows occurring in the distant future, and avoid projects that require a large
amount of research and development expenses. This firm may be justified in using the ________ to
evaluate its projects.
A) IRR rule.
B) AAR rule.
C) NPV rule.
D) Payback rule.
E) PI rule.
Answer: D

39
210) Which capital investment evaluation technique is described by the following characteristics? (1)
Easy to understand and communicate; (2) May result in multiple answers; (3) May lead to incorrect
decisions when applied to mutually exclusive investments.
A) IRR.
B) AAR.
C) NPV.
D) Payback period.
E) Discounted payback.
Answer: A

211) You are considering two mutually exclusive projects with the following cash flows. Which
project(s) should you accept if the discount rate is 7 percent? What if the discount rate is 10
percent?

A) Accept project A as it always has the higher NPV.

B) Accept project B as it always has the higher NPV.
C) Accept A at 7 percent and neither at 10 percent.
D) Accept A at 7 percent and B at 10 percent.
E) Accept B at 7 percent and A at 10 percent.
Answer: A

212) You are considering two independent projects with the following cash flows, both of which have
been assigned a discount rate of 9.5 percent. Based on the profitability index (PI), what is your
recommendation concerning these projects?

A) Accept Project A only.

B) Accept Project B only.
C) Accept both Project A and B.
D) Reject both Project A and B.
E) You cannot use the PI method of analysis in this situation.
Answer: C

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213) Your company accepts projects with a two year or less payback period. What should you do based
on the following information?

A) Accept project A and reject project B.

B) Accept project B and reject project A.
C) Accept both project A and project B.
D) Reject both project A and project B.
E) Extend the payback period for project A since it has a higher initial cost, which would make.
Answer: D

214) You are considering the following two mutually exclusive projects. Both projects will be depreciated
using straight-line depreciation to a zero book value over the life of the project.

Neither project has any salvage value.

Based upon the payback period and the information provided in the problem, you should:
A) Accept project B and reject project A.
B) Reject both project A and project B.
C) Accept project A and reject project B.
D) Accept both project A and project B.
E) Require that management extend the payback period for project A since it has a higher initial
cost.
Answer: B

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215) You are considering the following two mutually exclusive projects. Both projects will be depreciated
using straight-line depreciation to a zero book value over the life of the project.

Neither project has any salvage value.

Based upon the internal rate of return (IRR) and the information provided in the problem, you should:
A) reject both project A and project B.
B) accept project B and reject project A.
C) accept project A and reject project B.
D) accept both project A and project B.
E) Ignore the IRR rule and use another method of analysis.
Answer: B

42
216) You are considering the following two mutually exclusive projects. Both projects will be depreciated
using straight-line depreciation to a zero book value over the life of the project.

Neither project has any salvage value.

Based on the net present value method of analysis and given the information in the problem, you
should:
A) Accept project A and reject project B.
B) Accept both project A and project B.
C) Accept project B and reject project A.
D) Reject both project A and project B.
E) Accept whichever one you want as they represent equal opportunities.
Answer: C

43
217) You are considering the following two mutually exclusive projects. Both projects will be depreciated
using straight-line depreciation to a zero book value over the life of the project.

Neither project has any salvage value.

Based upon the profitability index (PI) and the information provided in the problem, you should:
A) Accept project B and reject project A.
B) Accept project A and reject project B.
C) Accept both project A and project B.
D) Reject both project A and project B.
E) Disregard the PI method in this case.
Answer: A

218) You would like to invest in the following project.

Victoria, your boss, insists that only projects that can return at least $1.10 in today's dollars for every
$1 invested can be accepted. She also insists on applying a 10 percent discount rate to all cash flows.
Based on these criteria, you should:
A) Accept the project because it has a positive PI.
B) Accept the project because the NPV is $2,851.
C) Reject the project because the PI is 1.05.
D) Reject the project because the IRR exceeds 10 percent.
E) Accept the project because it returns almost $1.22 for every $1 invested.
Answer: C

44
219) Sal is considering a project that costs $15,000. The project produces cash inflows of $3,000, $5,000,
$7,000, and $3,000 respectively for the next four years. Sal wants to recoup his money within 3
years after applying a 6% discount rate. Sal should:
A) Accept this project because the discounted payback period is 2.78 years.
B) Accept the project because it produces $15,534 on a discounted payback basis.
C) Reject this project because the discounted payback period is 3.78 years.
D) Reject this project because the payback period is 2.78 years.
E) Accept this project because the payback period is exactly 3 years.
Answer: C

220) A project has average net income of $2,100 a year over its 4-year life. The initial cost of the project
is $65,000 which will be depreciated using straight-line depreciation to a book value of zero over
the life of the project. The firm wants to earn a minimal average accounting return of 8.5 percent.
The firm should ________ the project based on the AAR of ________
A) Accept; 9.69 percent.
B) Reject; 6.46 percent.
C) Accept; 6.46 percent.
D) Accept; 12.92 percent.
E) Reject; 12.92 percent.
Answer: B

221) Elderkin & Martin is considering an investment which will cost $259,000. The investment produces
no cash flows for the first year. In the second year, the cash inflow is $58,000. This inflow will
increase to $150,000 and then $200,000 for the following two years before ceasing permanently.
The firm requires a 14 percent rate of return and has a required discounted payback period of three
years. The firm should ________ the project because the discounted payback period is ________
years.
A) reject; 3.26
B) accept; 3.96
C) accept; 2.49
D) reject; 3.96
E) accept; 2.26
Answer: D

222) Ginny Trueblood is considering an investment which will cost her $120,000. The investment
produces no cash flows for the first year. In the second year the cash inflow is $35,000. This inflow
will increase to $55,000 and then $75,000 for the following two years before ceasing permanently.
Ginny requires a 10 percent rate of return and has a required discounted payback period of three
years. Ginny should ________ this project because the discounted payback period is ________.
A) Reject; 3.97 years.
B) Accept; 2.03 years.
C) Accept; 3.97 years.
D) Reject; 3.03 years.
E) Accept; 2.97 years.
Answer: A

45
223) When the present value of the cash inflows exceeds the initial cost of a project, then the project
should be:
A) Rejected because the internal rate of return is negative.
B) Accepted because the profitability index is greater than 1.
C) Accepted because the profitability index is negative.
D) Rejected because the net present value is negative.
E) Accepted because the internal rate of return is positive.
Answer: B

224) Shawn's Health Care is considering a project which will produce sales of $1.7 million a year for the
next ten years. The profit margin is estimated at 8 percent. The project will cost $2.9 million and
will be depreciated straight-line to a zero book value over the life of the project. Shawn's has a
required accounting return of 9 percent. This project should be ________ because the AAR is
________.
A) Rejected; 8.44 percent
B) Rejected; 9.38 percent
C) Accepted; 8.44 percent
D) Accepted; 9.82 percent
E) Accepted; 9.38 percent
Answer: E

225) Which one of the following methods of analysis is most applicable to those situations where small
dollar, short-term, independent projects are evaluated by low level managers on a daily basis?
A) Accounting rate of return.
B) Profitability index.
C) Payback.
D) Net present value.
E) Internal rate of return.
Answer: C

226) An investment's average net income divided by its average book value defines the average:
A) Accounting return.
B) Internal rate of return.
C) Net present value.
D) Profitability index.
E) Payback period.
Answer: A

46
227) The payback period is defined as the length of time it requires for an investment to generate
sufficient cash flows to recoup:
A) All of the initial cost plus the ongoing maintenance costs of the fixed assets required by the
investment.
B) The future value of the initial cost of the investment.
C) Both the initial cost of the investment and the amount needed to provide the required rate of
return.
D) The initial cost of the investment.
E) The required rate of return on the investment.
Answer: D

228) The payback method:

A) Always applies a ten year cut-off point for cash flows.
B) Adjusts for the risk level inherent in a project.
C) Is prejudiced towards short-term projects.
D) Is generally used only for large projects.
E) Entails difficult computations.
Answer: C

229) The average accounting return (AAR) rule can be best stated as:
A) An investment is acceptable if its AAR is less than the firm's return on assets (ROA).
B) An investment is acceptable if its AAR exceeds the firm's return on equity (ROE).
C) An investment is acceptable if its AAR is less than a target AAR.
D) An investment is acceptable if its AAR exceeds a target AAR.
Answer: D

230) The internal rate of return (IRR) rule can be best stated as:
A) An investment is acceptable if its IRR exceeds its depreciation rate.
B) An investment is acceptable if its IRR exceeds the required return, or else it should be rejected.
C) An investment is acceptable if its IRR is exactly equal to its net present value (NPV).
D) An investment is acceptable if its IRR is exactly equal to zero.
E) An investment is acceptable if its IRR is less than the required return, or else it should be
rejected.
Answer: B

231) The profitability index (PI) rule can be best stated as:
A) An investment is acceptable if its PI is less than its payback.
B) An investment is acceptable if its PI is greater than the internal rate of return (IRR).
C) An investment is acceptable if its PI is greater than one.
D) An investment is acceptable if its PI is less than one.
E) An investment is acceptable if its PI is less than the net present value (NPV).
Answer: C

47
232) The net present value (NPV) rule can be best stated as:
A) An investment with greater cash inflows than cash outflows, regardless of when the cash flows
occur, will always have a positive NPV and therefore should always be accepted.
B) An investment should be rejected if the NPV is positive and accepted if it is negative.
C) An investment should be accepted if it equals its depreciation value.
D) An investment should be accepted if the NPV is positive and rejected if it is negative.
E) An investment should be accepted if, and only if, the NPV is exactly equal to zero.
Answer: D

233) Which one of the following statements concerning net present value (NPV) is correct?
A) An investment should be accepted if the NPV is positive and rejected if it is negative.
B) Any project that has positive cash flows for every time period after the initial investment
should be accepted.
C) An investment with greater cash inflows than cash outflows, regardless of when the cash flows
occur, will always have a positive NPV and therefore should always be accepted.
D) An investment should be accepted only if the NPV is equal to the initial cash flow.
E) An investment should be accepted if, and only if, the NPV is exactly equal to zero.
Answer: A

234) The discounted payback rule can be best stated as:

A) An investment is acceptable if its discounted payback period is greater than some pre-specified
number of years.
B) An investment should be rejected if the discounted payback is positive and accepted if it is
negative.
C) An investment is acceptable if its discounted payback period is less than some pre-specified
number of years.
D) An investment should be accepted if the discounted payback is positive and rejected if it is
negative.
Answer: C

235) The payback rule can be best stated as:

A) An investment is acceptable if its calculated payback period is equal to its deprecation useful
life.
B) An investment is acceptable if its calculated payback period is less than some pre-specified
number of years.
C) An investment should be accepted if the payback is positive and rejected if it is negative.
D) An investment should be rejected if the payback is positive and accepted if it is negative.
E) An investment is acceptable if its calculated payback period is greater than some pre-specified
number of years.
Answer: B

48
236) Which one of the following statements is correct concerning the payback period?
A) An investment is acceptable if its calculated payback period is less than some pre-specified
period of time.
B) An investment is acceptable if its calculated payback period is greater than some pre-specified
period of time.
C) An investment should be accepted any time the payback period is less than the discounted
payback period, given a positive discount rate.
D) An investment should be accepted if the payback is positive and rejected if it is negative.
E) An investment should be rejected if the payback is positive and accepted if it is negative.
Answer: A

237) Capital budgeting decisions generally:

A) Have minimal effects on a firm's operations.
B) Focus solely on whether or not a particular asset should be purchased.
C) Are of short-duration.
D) Are easy to revise once implemented.
E) Have long-term effects on a firm.
Answer: E

238) All else equal, the payback period for a project will decrease whenever the:
A) Initial cost increases.
B) Assigned discount rate decreases.
C) Cash inflows are moved forward in time.
D) Duration of a project is lengthened.
E) Required return for a project increases.
Answer: C

239) Which of the following decision rules has the advantage that the information needed for the
calculation is readily available?
A) Payback period
B) Net present value
C) Discounted payback
D) Internal rate of return
E) Average accounting return
Answer: E

240) The ________ decision rule is considered the "best" in principle.

A) Profitability index.
B) Net present value.
C) Average accounting return.
D) Internal rate of return.
E) Payback period.
Answer: B

49
241) Which of the following decision rules is best for evaluating projects for which cash flows beyond a
specified point in time, and the time value of money, can both be ignored?
A) Average accounting return.
B) Profitability index.
C) Payback.
D) Internal rate of return.
E) Net present value.
Answer: C

242) An investment's average net income divided by its average book value is the:
A) Average accounting return.
B) Internal rate of return.
C) Net present value.
D) Profitability index.
E) Payback period.
Answer: A

243) The discount rate that makes the net present value of an investment exactly equal to zero is called
the:
A) Profitability index.
B) External rate of return.
C) Equalizer.
D) Internal rate of return.
E) Average accounting return.
Answer: D

244) The discount rate that makes the net present value of investment exactly equal to zero is the:
A) Average accounting return.
B) Internal rate of return.
C) Profitability index.
D) Discounted payback period.
E) Payback period.
Answer: B

245) The present value of an investment's future cash flows divided by its initial cost is the:
A) Internal rate of return.
B) Profitability index.
C) Average accounting return.
D) Net present value.
E) Payback period.
Answer: B

50
246) The process of valuing an investment by determining the present value of its future cash flows is
called (the):
A) Constant dividend growth model.
B) Capital Asset Pricing Model.
C) Discounted cash flow valuation.
D) Expected earnings model.
E) Average accounting valuation.
Answer: C

247) The process of valuing an investment by determining the present value of its future cash flows is
called (the):
A) Discounted cash flow valuation.
B) Expected earnings model.
C) Average accounting valuation.
D) Capital Asset Pricing Model.
E) Constant dividend growth model.
Answer: A

248) Average accounting return is defined as:

A) Average cash inflow divided by average book value.
B) Average cash inflow divided by average cash outflow.
C) Average net income divided by average project cost.
D) Average sales divided by average total assets.
E) Average net income divided by average book value.
Answer: E

51
249) You are considering the following two mutually exclusive projects with the following cash flows.
Both projects will be depreciated using straight-line depreciation to a zero book value over the life
of the project. Neither project has any salvage value.

You should accept Project ________ because its net present value exceeds that of the other project by
________.
A) A; $418.02 B) A; $897.13 C) B; $656.94 D) B; $778.11 E) B; $813.27
Answer: C

250) You are considering the following two mutually exclusive projects. The required rate of return is 13
percent for project A and 10.5 percent for project B. You should accept Project ________ because
its NPV is ________ greater than that of the other project.

A) A; $874.91 B) A; $901.18 C) B; $866.61 D) B; $921.02 E) B; $924.08

Answer: C

52
251) You are considering the following two mutually exclusive projects with the following cash flows.
Both projects will be depreciated using straight-line depreciation to a zero book value over the life
of the project. Neither project has any salvage value.

You should accept Project ________ because its internal rate of return (IRR) is ________ percent.
A) A; 13.22
B) A; 14.67
C) B; 13.92
D) B; 17.79
E) The IRR should not be used to determine which of these projects should be accepted.
Answer: E

252) You are considering two mutually exclusive projects with the following cash flows. If the discount
rate is 7.5 percent, you prefer Project ________ and if the discount rate is 12 percent, you prefer
Project ________.

A) A; A
B) A; B
C) B; A
D) B; B
E) B; A or B as you are indifferent.
Answer: B

53
253) You should accept Project ________ because it has the ________ average accounting return.
A) A; higher
B) A; lower
C) B; higher
D) B; lower
E) The average accounting return cannot be used to determine which of these projects should be
accepted.
Answer: E

254) You are considering the following two mutually exclusive projects with the following cash flows.
Both projects will be depreciated using straight-line depreciation to a zero book value over the life
of the project. Neither project has any salvage value.

You should accept Project ________ because it has the ________ profitability index of the two
projects.
A) A; higher
B) A; lower
C) B; higher
D) B; lower
E) The profitability index should not be used to determine which of these projects should be
accepted.
Answer: E

54
255)

If the discount rate is 14% and the firm has limited funds, which of the following is true?
A) The PI of project A is less than 1.0.
B) The PI of project B is less than 1.0.
C) Based on the PI rule, project A is preferable.
D) Both projects would be rejected based on the PI rule.
E) The project with the smaller initial investment always has the higher PI.
Answer: C

256) Use the following mutually exclusive investment cash flows for the question(s) below:

If the discount rate is 14%, using profitability index which of the following is true?
A) The PI of project A is less than 1.0
B) The PI of project B is less than 1.0
C) Based on the PI, project A is preferable
D) Both projects would be rejected based on the PI criterion
E) Based on the two PIs, it is obvious the IRR for both projects is less than 14%
Answer: C

257) The internal rate of return should:

A) Be relied upon more heavily than the net present value.
B) Not be used for ranking mutually exclusive projects.
C) Lead to correct decisions when comparing mutually exclusive projects.
D) Only be applied to small projects.
E) Always result in the same decision as discounted payback.
Answer: B

258) Assuming that straight line depreciation is used, the average accounting return for a project is
computed as the average:
A) Book value of a project multiplied by the average profit margin of the project.
B) Net income of the firm divided by the average investment in a project.
C) Book value of a project divided by the average net income of the project.
D) Net income of a project divided by the average investment in the project.
E) Net income of a project divided by the average total assets of a firm.
Answer: D

55
259) The Commodore Co. is trying to decide between the following two mutually exclusive projects:

The only requirement the company has is that any project that is accepted must produce a minimum
rate of return of 11%. What should the company do and why?
A) Project II should be accepted because it has an IRR of 28.45%, which is greater than Project I's
IRR.
B) Both projects should be accepted because they both have positive NPVs.
C) Both projects should be accepted because their payback periods are only about 2 years.
D) Both projects should be accepted because they have IRRs of 22.87% and 28.45%, which
exceed the 11% requirement.
E) Project I should be accepted because it has an NPV of $3,908.58. Project II cannot also be
accepted.
Answer: E

260) You are considering two independent projects with the following cash flows. The required return for
both projects is 12 percent. You should accept:

A) ProjectA only.
B) ProjectB only.
C) Both projects.
D) Neither project.
E) Whichever project you prefer as their values are equal today.
Answer: A

56
261) You are considering the following projects but have limited funds to invest and can't take them all.
Using the profitability index, rank the projects in the order in which you would accept them. That is,
rank them from best to worst.

A) C, B, A B) A, B, C C) A, C, B D) C, A, B E) B, C, A
Answer: A

262) Which of the following is considered to be a redeeming feature of average accounting return
analysis?
A) It is relatively easy to calculate.
B) Calculation relies on net income and not cash flows or asset values.
C) Estimation of the appropriate cutoff rate is straightforward and easy.
D) Calculation relies on book values and not market values or cash flows.
E) It incorporates time value of money.
Answer: A

263) The purchase of new equipment is classified as a ________ decision.

A) Capital budgeting.
B) Capital growth.
C) Capital structure.
D) Working capital.
E) Capital return.
Answer: A

264) The essence of ________ is determining whether a proposed investment or project will generate
positive wealth for the owners of the firm once it is in place.
A) Capital budgeting.
B) Internal rate of return analysis.
C) The profitability index.
D) Cash flow analysis.
E) Payback analysis.
Answer: A

57
265) The net present value of a project will increase when the:
A) Cash inflows are received sooner.
B) Tax rate applied to the project's profits is increased.
C) Estimated salvage value of the equipment is lowered.
D) Initial investment increases in amount.
E) Discount rate increases.
Answer: A

266) An advantage of the payback method is its:

A) Long-term perspective.
B) Time value of money considerations.
C) Application of readily available accounting data.
D) Simplicity.
E) Cut-off point.
Answer: D

267) Generally, the most difficult part of utilizing the net present value concept is:
A) Computing the net present value once the discount rate and cash flows are determined.
B) Determining the initial cash outflow required to start a project.
C) Estimating the future cash flows given the initial investment in the project.
D) Making the accept/reject decision once the net present value is computed.
E) Determining whether the discount rate used is higher or lower than the internal rate of return.
Answer: C

268) The internal rate of return is:

A) Difficult to compute without the use of either a financial calculator or a computer.
B) Equivalent to the discount rate that makes the net present value equal to one.
C) More reliable as a decision making tool than net present value whenever you are considering
mutually exclusive projects.
D) Dependent upon the interest rates offered in the marketplace.
E) A better methodology than net present value when dealing with unconventional cash flows.
Answer: A

269) The length of time needed to recover the initial investment once time value of money is considered
is called the:
A) Discounted net present value period.
B) Internal time interval.
C) Payback period.
D) Average accounting return period.
E) Discounted payback period.
Answer: E

58
270) Which of the following is a correct statement?
A) The IRR is considered to be the most important project analysis technique.
B) Discounted payback analysis requires use of a discount rate.
C) The AAR is considered preferable to the PI.
D) Regular payback analysis is preferable to discounted payback analysis.
E) It is reasonable to use IRR to analyze mutually exclusive investments.
Answer: B

271) From a finance perspective, discounted payback is considered to be a superior method of analysis as
compared to payback. Why then, is discounted payback used less frequently than payback?
A) Discounted payback is more difficult to compute and explain.
B) Discounted payback applies only to long-term projects.
C) Discounted payback is liquidity biased where payback is not.
D) Discounted payback is based on net income rather than cash flows.
E) Discounted payback requires knowledge of a project's internal rate of return.
Answer: A

272) A manager will prefer the IRR rule over the NPV rule if the manager:
A) Is considering mutually exclusive projects.
B) Prefers to talk in terms of rates of return.
C) Can accurately forecast future cash flows.
D) Dislikes the discounted payback analysis.
E) Also prefers use of payback analysis.
Answer: B

273) 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) The salvage value of the project is omitted from the analysis.
D) Each cash inflow is moved such that it occurs one year later than originally projected.
E) The required rate of return is reduced.
Answer: A

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274) You have a choice between two mutually exclusive investments. If you require a 14% return, which
investment should you choose?

A) Project B, because it has the higher internal rate of return.

B) Project B, because it pays back faster.
C) Project A, because it has a higher NPV.
D) Project B, because it has a smaller initial investment.
E) Either one, because they have the same profitability indexes.
Answer: C

275) You run a small bagel shop and are considering replacing your four employees with automated
machines that allow customers to buy their bagels without any human interaction. Of the following,
the most difficult task you face in computing the NPV of this change is the:
A) Estimation of the cost of installing the new equipment.
B) Estimation of the reduction in taxes you will get from the increase in depreciation.
C) Estimation of the total change in sales that will result from the change.
D) Estimation of the cost of purchasing the new equipment.
E) Estimation of the reduction in wages you will have from the decrease in work force.
Answer: C

276) An investment is acceptable if its average accounting return (AAR):

A) Exceeds the firm's return on equity (ROE).
B) Is less than the firm's return on assets (ROA).
C) Is less than a target AAR.
D) Exceeds a target AAR.
E) Is equal to zero and only when it is equal to zero.
Answer: D

277) When computing the net present value of a project, the net amount received from salvaging the
fixed assets used in the project is:
A) Excluded from the analysis since it occurs only when the project ends.
B) Included in the final cash flow of the project.
C) Added to the net present value of the project to determine if the project is acceptable.
D) Subtracted from the initial cash outlay.
E) Subtracted from the original cost of the assets.
Answer: B

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278) Bill plans to open a do-it-yourself dog bathing center in a storefront. The bathing equipment will cost
$160,000. Bill expects the after-tax cash inflows to be $40,000 annually for seven years, after which
he plans to scrap the equipment and retire to the beaches of Jamaica.

Assume the required return is 10%. What is the project's discounted payback period?
A) three years B) four years C) five years D) six years E) seven years
Answer: D

279) Floyd Clymer is the CFO of Bonavista Mustang, a manufacturer of parts for classic automobiles.
Floyd is considering the purchase of a two-ton press which will allow the firm to stamp out auto
fenders. The equipment costs $250,000. The project is expected to produce after-tax cash flows of
$60,000 the first year, and increase by $10,000 annually; the after-tax cash flow in year 5 will reach
$100,000. Liquidation of the equipment will net the firm $10,000 in cash at the end of five years,
making the total cash flow in year five $110,000.

Assume the required return is 15%. What is the project's discounted payback period?
A) two years
B) three years
C) four years
D) five years
E) Longer than the project's life.
Answer: D

280) A financial manager who consistently underestimates the ________ will tend to incorrectly reject
projects that would actually create wealth for the stockholders.
A) Future cash inflows associated with projects.
B) Required return on projects.
C) Initial cost of projects.
D) Marginal income tax rate.
E) Future cash outlays associated with projects.
Answer: A

281) Ginny is considering two independent projects. Each project costs $10,000. Project A produces cash
inflows of $3,000 a year for four years. Project B produces no cash flows for the first two years and
$6,000 a year for the following two years. Ginny wants to recoup her money within 3 years. Should
Ginny accept these projects?
A) Ginny should reject Project A and accept Project B.
B) Ginny should accept both projects.
C) Ginny should reject both projects.
D) Ginny should accept Project A and reject Project B.
E) Ginny cannot make that decision based on the information provided.
Answer: C

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282) An investment is acceptable if the profitability index (PI) of the investment is:
A) Greater than a pre-specified rate of return.
B) Greater than one.
C) Less than one.
D) Less than the net present value (NPV).
E) Greater than the internal rate of return (IRR).
Answer: B

283) Graphing the crossover point helps explain:

A) How decisions concerning mutually exclusive projects are derived.
B) How the profitability index and the net present value are related.
C) Why one project is always superior to another project.
D) How the duration of a project affects the decision as to which project to accept.
E) How the net present value and the initial cash outflow of a project are related.
Answer: A

284) Which of the following statements is false?

A) If a project has a profitability index greater than one the project should be accepted.
B) If the cost of capital is greater than the IRR, the project should be accepted.
C) If a project has a payback which is faster than the company requires the project should be
accepted.
D) If a firm's target average accounting return is less than that calculated for a given project then
the project should be accepted.
E) If the NPV of a project is positive, it should be accepted.
Answer: B

285) If the required return is zero, then:

A) The payback period exceeds the discounted payback period.
B) The NPV equals the difference between the undiscounted future cash flows and the initial cost.
C) The project will be acceptable according to the AAR criteria.
D) If the NPV is negative, the IRR will be greater than zero.
E) The PI will be less than one.
Answer: B

286) The internal rate of return tends to be:

A) Extremely accurate even when cash flow estimates are faulty.
B) Ignored by most financial analysts.
C) Used primarily to differentiate between mutually exclusive projects.
D) Easier for managers to comprehend than the net present value.
E) Utilized in project analysis only when multiple net present values apply.
Answer: D

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287) When the decision to accept or reject one project does not affect the decision to accept or reject any
other project, the project is said to be:
A) Acceptable.
B) Mutually exclusive.
C) Independent.
D) Mutually inclusive.
E) A crossover project.
Answer: C

288) The crossover point is defined as the discount rate that:

A) Causes the IRR of one project to exceed the IRR of a second project.
B) Makes the net present values of two projects equal.
C) Indicates the point where the IRR equals zero as IRR moves in a downward direction.
D) Causes the net present value of a project to equal zero.
E) Causes a project to move from a positive net present value to a negative net present value.
Answer: B

289) The present value created per dollar invested is called the:
A) Internal rate of return.
B) Net present value.
C) Profitability index.
D) Accounting return.
E) Discounted payback.
Answer: C

290) To find the ________ we begin by setting the NPV of a project equal to zero.
A) Average accounting return.
B) Payback period.
C) Discounted payback period.
D) Profitability index.
E) Internal rate of return.
Answer: E

291) If an investment has a(n) ________ of 1.2 it can be said that the investment generates $1.20 in
present value benefits for each dollar of invested costs.
A) Internal rate of return.
B) Net present value.
C) Average accounting return.
D) Profitability index.
E) Payback period.
Answer: D

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292) If you want to review a project from a benefit-cost perspective, you should use the ________
method of analysis.
A) Payback
B) Net present value.
C) Average accounting return.
D) Profitability index.
E) Internal rate of return.
Answer: D

293) If a firm uses the ________ as an investment criterion, one of the risks it takes is that it may ignore
some future cash flows.
A) NPV
B) IRR
C) AAR
D) Profitability. index
E) Payback rule
Answer: E

294) An NPV of zero implies that an investment's ________.

A) Cost exceeds the present value of its cash inflows.
B) Present value of cash inflows are positive.
C) Present value of cash inflows exceed the investment's cost.
D) Cost is equal to the present value of its cash inflows.
E) IRR is greater than the firm's required rate of return.
Answer: D

295) Consider a project with an initial investment and positive future cash flows. As the discount rate is
increased the ________.
A) IRR increases while the NPV remains constant
B) IRR remains constant while the NPV decreases
C) IRR decreases while the NPV remains constant
D) IRR remains constant while the NPV increases
E) IRR decreases while the NPV decreases
Answer: B

296) Which of the following ranks decision rules from worst to best in terms of their overall usefulness in
capital budgeting analysis.
A) Payback, IRR, NPV.
B) NPV, IRR, Payback.
C) IRR, Payback, NPV.
D) IRR, NPV, Payback.
E) Payback, NPV, IRR.
Answer: A

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297) The internal rate of return (IRR) is often preferred by managers over the net present value (NPV)
because the IRR:
A) Is more reliable given unconventional cash flows.
B) Is expressed as a rate while the NPV is expressed in dollar terms.
C) Is the discount rate that maximizes net profits.
D) Reveals the discount rate that maximizes the net present value.
E) Is contingent upon the current market rates of return.
Answer: B

298) Net present value:

A) Is very similar in its methodology to the average accounting return.
B) Is computed the same as present value when using excel spreadsheets to analyze a project.
C) Is more useful to decision makers than the internal rate of return when comparing different
sized projects.
D) Cannot be used when deciding between two mutually exclusive projects.
E) Is easy to explain to non-financial managers and thus is the primary method of analysis used by
the lowest levels of management.
Answer: C

299) Net present value ________.

A) Compares project cost to the present value of the project benefits
B) Is equal to the initial investment in a project
C) Is equal to zero when the discount rate used is less than the IRR
D) Is simplified by the fact that future cash flows are easy to estimate
E) Requires the firm set an arbitrary cutoff point for determining whether an investment is
acceptable
Answer: A

300) A project with an NPV of zero ________.

A) Is expected to earn a return equal to the firm's required return.
B) Has a discounted payback period that is shorter than the life of the project.
C) Should be accepted even if the firm has alternative investments with a positive NPV.
D) Has a profitability index that is greater than one.
E) Should be rejected.
Answer: A

301) The average accounting rate of return:

A) Is the primary methodology used in analyzing independent projects.
B) Is highly recommended by financial professionals as one of the two best methodologies used in
the analysis of independent projects.
C) Is similar to the return on assets ratio.
D) Measures net income against the market value of a firm.
E) Is actually based more on financial values than on accounting values.
Answer: C

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302) An investment is acceptable if it's IRR:
A) Is exactly equal to its net present value (NPV).
B) Is exactly equal to 100 percent.
C) Is exactly equal to zero.
D) Exceeds the required return.
E) Is less than the required return.
Answer: D

303) Analysis using the profitability index:

A) Produces results which typically are difficult to comprehend or apply.
B) Is useful when trying to determine which one of two mutually exclusive projects should be
accepted.
C) Frequently conflicts with the accept and reject decisions generated by the application of the net
present value rule.
D) Utilizes the same basic variables as those used in the average accounting return.
E) Is useful as a decision tool when investment funds are limited.
Answer: E

304) Net present value is a highly valued decision-making tool because:

A) It is computed using the internal rate of return.
B) It only includes information which is known with certainty.
C) It is affected by the magnitude rather than the timing of a project's cash flows.
D) It can be applied to either independent or mutually exclusive projects.
E) It reveals the rate of return which investors will earn on average over the lifetime of the project.
Answer: D

305) The profitability index will be:

A) Negative any time the net present value is negative.
B) Greater than 1.0 when the IRR is greater than the discount rate.
C) Greater than 1.0 whenever the net present value is negative.
D) Less than 1.0 any time the discount rate is less than the IRR.
E) Equal to 1 any time the IRR is less than the discount rate.
Answer: B

306) Which one of the following is the primary advantage of the payback method of analysis?
A) Current market rate of return considerations.
B) Liquidity bias.
C) Arbitrary cut-off point.
D) Easy to compute.
E) Inclusion of time value of money considerations.
Answer: D

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307) The internal rate of return will tell you the ________ which can be applied to a project while still
creating a situation where the project is acceptable.
A) minimum discount rate
B) minimum period of time
C) maximum period of time
D) maximum discount rate
E) accounting rate
Answer: D

308) Two projects which each ________ is an example of mutually exclusive projects.
A) Have differing internal rates of return.
B) Must start up in the same fiscal year.
C) Require the total use of the same limited economic resource.
D) Require an initial investment of $1.5 million.
E) Must occur during the same period of time.
Answer: C

309) A situation in which taking one investment prevents the taking of another is called:
A) Mutually exclusive investment decisions.
B) Net present value profiling.
C) Multiple rates of return.
D) Operational ambiguity.
E) Issues of scale.
Answer: A

310) The possibility that more than one discount rate will make the NPV of an investment zero is called
the ________ problem.
A) Operational ambiguity.
B) Net present value profiling.
C) Multiple rates of return.
D) Issues of scale.
E) Mutually exclusive investment decisions.
Answer: C

311) A project which has an initial cash outlay, with all future cash flows positive, is said to be:
A) Conventional.
B) Value-creating.
C) Independent.
D) Short term.
E) Mutually exclusive.
Answer: A

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312) When two projects both require the total use of the same limited economic resource, the projects are
generally considered to be:
A) Internally profitable.
B) Independent.
C) Mutually exclusive.
D) Marginally profitable.
E) Acceptable.
Answer: C

313) Monika's Café wants to expand its dining area and is considering two alternatives. Alternative 1
converts the existing dining area into a buffet line and then builds a new dining area. Alternative 2
builds a new dining area and remodels the current dining area so that one expansive area is created.
This is an example of:
A) A crossover point.
B) Mutually exclusive projects.
C) Multiple IRR projects.
D) Negatively correlated projects.
E) Independent projects.
Answer: B

314) The average accounting return is defined as the:

A) Average net income derived from a project divided by the average book value of the project's
fixed assets.
B) Present value of a project's cash flows divided by the initial investment in the project.
C) Average net income derived from a project divided by the initial investment in the project.
D) Net income derived from a project divided by the initial investment in the project.
E) Present value of a project's cash flows divided by the average book value of the project's assets.
Answer: A

315) Which of the following does NOT incorporate discounted cash flow (DCF) valuation in its
calculation?
A) Discounted payback
B) Average accounting return
C) Internal rate of return
D) Net present value
E) Profitability index
Answer: B

316) Which of the following is calculated using ONLY accounting numbers?

A) Average accounting return
B) Payback period
C) Profitability index
D) Internal rate of return
E) Net present value
Answer: A

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317) A project should be accepted when the:
A) Payback period is greater than the prescribed number of years.
B) Net present value is negative.
C) Profitability index is less than 1.0.
D) IRR exceeds the required rate.
E) AAR is less than the targeted AAR.
Answer: D

318) You are considering an investment with the following cash flows. If the required rate of return for
this investment is 13.5 percent, should you accept it based solely on the internal rate of return rule?
Why or why not?

A) no; because the IRR is a negative rate of return

B) no; because the IRR is less than the required return
C) yes; because the IRR is a positive rate of return
D) yes; because the IRR exceeds the required return
E) You cannot apply the IRR rule in this case because there are multiple IRRs.
Answer: E

319) Based on the profitability index (PI) rule, should a project with the following cash flows be accepted
if the discount rate is 8 percent? Why or why not?

A) No; because the PI is 1.03

B) Yes; because the PI is 1.03
C) Yes; because the PI is .98
D) No; because the PI is .95
E) No; because the PI is .98
Answer: B

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320) Atlantic, Inc. is considering a project that is expected to produce the following cash flows over the
next five years: $22,500, $27,900, $41,800, $33,000, and $15,000 respectively. Atlantic has $98,000
available, which is the amount needed to initiate the project. Should Atlantic accept this project if
the required rate of return is 12%? Why or why not?
A) No; The IRR is 13.47%, which is greater than the required return.
B) No; The PI is 1.04, which is considered a reject signal.
C) Yes; The PI is .96, which is considered an acceptance signal.
D) Yes; Atlantic will make $3,567 in today's dollars if they accept the project.
E) No; Atlantic would lose $2,407 in today's dollars if they accept the project.
Answer: D

321) A project has a required return of 15% and a five year life. Which of the following is inconsistent
with the other four?
A) NPV = $0
B) The discounted payback is five years.
C) IRR = 15%
D) PI = 0
E) The present value of the future cash flows equals the initial outlay.
Answer: D

322) The payback method assumes that the cash flows:

A) Are calculated with the consideration of the time value of money.
B) Are an annuity stream.
C) Are discounted at the IRR rate.
D) Occur evenly throughout the year.
E) Occur at the end of the year.
Answer: D

323) The discounted payback rule states that you should accept projects:
A) That have a discounted payback period that is greater than some pre-specified period of time.
B) If the discounted payback is positive and rejected if it is negative.
C) Only if the discounted payback period equals some pre-specified period of time.
D) Only if the discounted payback period is equal to zero.
E) If the discounted payback period is less than some pre-specified period of time.
Answer: E

324) Complete the following decision rule: A project should be accepted if its ________ exceeds the
firm's required rate of return.
A) discounted payback
B) IRR
C) payback
D) AAR
E) NPV
Answer: B

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325) The ________ produces a ranking of all projects.
A) Modified internal rate of return method.
B) IRR.
C) Profitability index.
D) Payback period method.
E) Discounted cash flow method.
Answer: C

326) ________ is the focus of corporate finance as it is concerned with making the optimal choice
between project alternatives.
A) Capital structure.
B) Short-term budgeting.
C) Capital budgeting.
D) Payback period.
E) Capital Allocation.
Answer: C

327) The difference between the market value of an investment and its cost is the:
A) Net present value.
B) Profitability index.
C) Discounted payback period.
D) Internal rate of return.
E) Payback period.
Answer: A

328) The difference between the present value of an investment and its cost is the:
A) Discounted payback period.
B) Profitability index.
C) Payback period.
D) Net present value.
E) Internal rate of return.
Answer: D

329) 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) Net present value.
B) Internal rate of return.
C) Discounted cash period.
D) Payback period.
E) Profitability index.
Answer: D

71
330) The length of time required for an investment's discounted cash flows to equal its initial cost is the:
A) Discounted payback period.
B) Internal rate of return.
C) Net present value.
D) Payback period.
E) Profitability index.
Answer: A

331) Your firm's CFO presents you with two capital budgeting analyses: one that involves buying a new
delivery truck to replace the existing truck and one that involves the purchase of a three-ton metal
stamping press to replace the existing press on the plant floor. This is an example of a decision
involving ________.
A) Payback projects.
B) Crossover projects.
C) Mutually exclusive projects.
D) Independent projects.
E) Working capital projects.
Answer: D

332) When the funds available for investment are limited and you wish to receive the greatest benefit per
dollar spent, you should use the ________ method of analysis to determine which one of two
projects should be accepted.
A) Average accounting rate of return.
B) Payback.
C) Profitability index.
D) Internal rate of return.
E) Net present value.
Answer: C

333) The New Blues Co. is considering two projects. Project A consists of building a wholesale book
outlet on lot #169 of the Minglewood Retail Center. Project B consists of building a sit-down
restaurant on lot #169 of the Minglewood Retail Center. When trying to decide whether or build the
book outlet or the restaurant, management should rely most heavily on the analysis results from the
________ method of analysis.
A) Payback.
B) Accounting rate of return.
C) Net present value.
D) Internal rate of return.
E) Profitability index.
Answer: C

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334) Your firm needs to buy a metal stamping press. The CFO presents you with two analyses: one for a
press that is automated, requiring little labour to operate, and another that is manual, requiring a
significant amount of labour. This is an example of a decision involving ________.
A) Working capital projects.
B) Crossover projects.
C) Independent projects.
D) Positive NPV projects.
E) Mutually exclusive projects.
Answer: E

335) Which capital investment evaluation technique is described by the following characteristics? (1)
Easy to understand; (2) Biased towards liquidity; (3) Requires an arbitrary cutoff point; (4) Ignores
the time value of money.
A) Payback period
B) NPV
C) Discounted payback
D) IRR
E) Profitability index
Answer: A

336) You need to borrow $2,000 quickly, and the local pawn shop will give it to you if you promise to
repay them $200.92 monthly over the next year.

Suppose the pawn shop has more customers than funds. Which capital budgeting technique would
allow it to rank potential customers in order to maximize current wealth?
A) Payback period
B) NPV
C) Profitability index
D) Discounted payback
E) AAR
Answer: C

337) As the required rate of return increases, the:

A) Payback period decreases.
B) Net present value increases.
C) Discounted payback period decreases.
D) Profitability index decreases.
E) Average accounting return decreases.
Answer: D

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338) The following values have been computed for various independent projects which have a required
payback period of 3 years, a required discount rate of 14.5 percent, and a required accounting return
of 11 percent. Which one of these values indicates an accept decision?
A) Internal rate of return of 13.6 percent.
B) Payback period of 3.2 years.
C) Profitability index of 1.02.
D) Net present value of ($1,200).
E) Accounting rate of return of 10 percent.
Answer: C

339) By definition, the net present value is equal to zero when the discount rate is equal to the:
A) Profitability index rate.
B) Crossover rate.
C) Average account rate of return.
D) Internal rate of return.
E) Rate used in the discounted payback formula.
Answer: D

340) The principle that an investment should be accepted if the difference between the investment's
market value and its cost is positive and rejected if the difference is negative is referred to as the:
A) Discounted payback rule.
B) Internal rate of return rule.
C) Net present value rule.
D) Profitability index rule.
E) Average accounting return rule.
Answer: C

341) Using the profitability index, which of the following projects would you choose if you have limited
funds?

A) Project 1 B) Project 2 C) Project 3 D) Project 4 E) Project 5

Answer: D

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342) Matt is analyzing two mutually exclusive projects of similar size and has prepared the following
data. Both projects have 5 year lives.

Matt has been asked for his best recommendation given this information. His recommendation should
be to accept:
A) Project B and reject project A based on both the payback period and the average accounting
return.
B) Project A and reject project B based on their net present values.
C) Project B because it has the shortest payback period.
D) Both projects as they both have positive net present values.
E) Project B and reject project A based on their average accounting returns.
Answer: B

343) Corey is considering two projects both of which have an initial cost of $20,000 and total cash
inflows of $25,000. The cash inflows of project A are $3,000, $5,000, $8,000, and $9,000 over the
next four years, respectively. The cash inflows for project B are $9,000, $8,000, $5,000, and $3,000
over the next four years, respectively. Which one of the following statements is correct if Corey
requires a 10 percent rate of return and has a required discounted payback period of 3 years?
A) Both projects should be rejected.
B) Both projects should be accepted.
C) Project A should be accepted and project B should be rejected.
D) Project A should be rejected and project B should be accepted.
E) You should be indifferent to accepting either or both projects.
Answer: A

344) Ilona is considering two projects both of which have an initial cost of $17,000 and total cash inflows
of $21,000. The cash inflows of project A are $6,000, $5,000, $5,000, and $5,000 over the next four
years, respectively. The cash inflows for project B are $9,000, $7,000, $3,000 and $2,000 over the
next four years, respectively. Which one of the following statements is correct if Ilona requires a 12
percent rate of return and has a required discounted payback period of 3.5 years?
A) Project A should be accepted and Project B should be rejected.
B) Neither project ever pays back.
C) Both projects should be rejected even though Project B does pay back.
D) Both projects should be accepted.
E) Project A should be rejected and Project B should be accepted.
Answer: C

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345) Randy's Manufacturing is considering two mutually exclusive projects. The company has a required
rate of return of 13.5% on projects of this nature. Project A costs $100,000 and has an IRR of
14.5%. Project B costs $150,000 and has an IRR of 14%. Which project should be accepted and
why?
A) Project B because it has the lower IRR of the two projects.
B) Project B because it has the largest net present value.
C) Project A because it costs less and has a higher IRR than Project B.
D) Both projects because both project IRRs are greater than the required return.
E) Project A because it has the highest IRR of the two projects and exceeds the required return.
Answer: B

346) You are considering the following two mutually exclusive projects. The required rate of return is
10.75 percent for project A and 12 percent for project B. Which project should you accept and why?

A) Project B; because it is the largest sized project.

B) Project B; because it has the largest total cash inflow.
C) Project A; because its NPV is about $796 more than the NPV of project B.
D) Project A; because it has the lower required rate of return.
E) Project B; because it returns all its cash flows within two years.
Answer: C

347) You are considering the following two mutually exclusive projects. The required rate of return is
11.25 percent for project A and 10.75 percent for project B. Which project should you accept and
why?

A) Project B; because it returns all its cash flows within two years.
B) Project B; because it is the largest sized project.
C) Project A; because it has the higher required rate of return.
D) Project A; because its NPV is about $335 more than the NPV of project B.
E) Project B; because it has the largest total cash inflow.
Answer: D

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348) The discounted payback rule may cause:
A) Projects to be incorrectly accepted due to ignoring the time value of money.
B) Some projects to be accepted which would otherwise be rejected under the payback rule.
C) Some positive net present value projects to be rejected.
D) The most liquid projects to be rejected in favor of less liquid projects.
E) Projects with negative net present values to be accepted.
Answer: C

349) The internal rate of return is defined as the:

A) Rate of return which yields a net present value equal to the initial investment in a project.
B) Average annual rate of return divided by the average book value of a project's fixed assets.
C) Rate of return which causes the net present value of a project to equal zero.
D) Average annual rate of return on a project.
E) Rate of return which a cost-cutting, non-revenue generating project returns in an average year.
Answer: C

350) The average accounting return:

A) Rule, when applied, guarantees that only projects that increase shareholder wealth will be
accepted.
B) Reflects the projected net effect of the cash flows from a project on the overall firm.
C) Is comparable to the return on assets and thus provides a similar measure of performance.
D) Ignores all income produced by a project after an arbitrarily assigned cutoff point.
E) Reflects the anticipated net impact of a project on the shareholders of the firm.
Answer: C

351) A four-year project has an initial outlay of $100,000. The future cash inflows from its project are
$50,000 for years one and two and $40,000 for years three and four. Given a discount rate of 10%,
will the project be accepted?
A) Reject the project as the NPV is $44,150.
B) Accept the project as the NPV is $44,150.
C) Accept the project as the NPV is $18,250.
D) Reject the project as the NPV is $(44,150).
E) Reject the project as the NPV is $18,250.
Answer: B

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352) You are considering the following two mutually exclusive projects with the following cash flows.
Both projects will be depreciated using straight-line depreciation to a zero book value over the life
of the project. Neither project has any salvage value.

You should ________ Project A and ________ Project B based on the payback period of each
project.
A) reject; reject
B) accept; reject
C) reject; accept
D) accept; accept
E) The payback method should not be used to determine which of these projects should be
accepted.
Answer: A

353) Larry's Lanterns is considering a project which will produce sales of $240,000 a year for the next
five years. The profit margin is estimated at 6 percent. The project will cost $290,000 and be
depreciated straight-line to a book value of zero over the life of the project. Larry's has a required
accounting return of 8 percent. This project should be ________ because the AAR is ________.
A) Rejected; 4.14 percent.
B) Accepted; 8.28 percent.
C) Rejected; 8.28 percent.
D) Rejected; 6 percent.
E) Accepted; 9.93 percent.
Answer: E

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354) The Blue Moon is considering a project which will produce sales of $120,000 a year for the next
five years. The profit margin is estimated at 5.5 percent. The project will cost $140,000 and will be
depreciated straight-line to a book value of zero over the life of the project. The firm has a required
accounting return of 9.5 percent. This project should be ________ because the AAR is ________
percent.
A) Accepted; 9.67
B) Accepted; 9.43
C) Rejected; 8.57
D) Rejected; 9.43
E) Rejected; 4.71
Answer: C

355) The average accounting rate of return is most similar to which one of the following ratios?
A) Plowback ratio.
B) Return on equity.
C) Payout ratio.
D) Profit margin.
E) Return on assets.
Answer: E

356) You are considering the following two mutually exclusive projects. Both projects will be depreciated
using straight-line depreciation to a zero book value over the life of the project.

Neither project has any salvage value.

Based upon the average accounting return (AAR) and the information provided in the problem, you:
A) Should accept both project A and project B.
B) Should accept project A because the AAR is less than the required rate.
C) Should accept project A because the AAR exceeds the required rate.
D) Should accept whichever project you prefer as they are equivalent from an AAR perspective.
E) Cannot compute the AAR of either project.
Answer: E

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357) The primary idea behind the net present value rule is that an investment:
A) Should break even from an accounting point of view.
B) Should earn a rate of return that is less than the discount rate.
C) Is worthwhile if it creates value for the owners.
D) Must have total cash flows that equal zero.
E) Should be accepted if it enhances management's position.
Answer: C

358) Jack is considering adding work jeans and T-shirts to the items he stocks in his general store
provided that his payback period is less than 2.5 years. He estimates that the initial cost of inventory
will be $6,750. The remodeling expenses required for this addition are $18,200. Jean and T-shirt
sales are expected to produce net cash inflows of $10,200, $14,500, and $16,600 over the next three
years, respectively. Jack ________ add the jeans and T-shirts to his offerings as the payback period
is ________ years.
A) should not; 2.02
B) should; 3.67
C) should; 2.02
D) should; 1.67
E) should not; 3.67
Answer: C

359) The discounted payback period is best defined as the length of time until the:
A) Sum of the discounted net income is equal to the cost of the project.
B) Sum of the discounted cash flows is equal to the initial investment.
C) Sum of the cash inflows is equal to the sum of the cash outflows.
D) Sum of the discounted cash flows is equal to the average book value.
E) Sum of the discounted cash flows from project A equals the sum of the discounted cash flows
from project B.
Answer: B

360) You are comparing two mutually exclusive projects. Given a required discount rate of 9 percent,
you have selected Project A. If you delay starting the project until such time as the discount rate
increases to 10.5 percent, you should:
A) Discontinue all plans to implement any new projects.
B) Re-analyze the two projects before proceeding with either.
C) Continue with your plans to implement Project A.
D) Switch your plans and accept Project B instead.
E) Proceed by accepting and implementing both projects.
Answer: B

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361) If a project with conventional cash flows has a profitability index less than one, then:
A) The AAR is greater than the required return.
B) The NPV is positive.
C) The discounted payback period is greater than the project's life.
D) The IRR is greater than the required return.
E) The payback period is less than the maximum acceptable period.
Answer: C

362) Which one of the following statements is correct concerning the average accounting return (AAR)?
A) The AAR is a true financial rate of return, which is relatively easy to compute.
B) The average book value used in the AAR formula will always equal one-half of the initial
investment as long as straight-line depreciation over the life of the project is used.
C) The average net income is the same as the total cash flows from the project minus the initial
cash outflow to start the project.
D) Under the AAR rule, a project should be accepted if the targeted AAR is greater than the
project's AAR.
E) The AAR is similar to the profitability index in that both are based on accounting values rather
than financial cash flows.
Answer: B

363) An independent project has conventional cash flows and a positive net present value. It can be stated
with certainty that the project is acceptable according to the capital budgeting technique known as:
A) The accounting rate of return.
B) Payback.
C) Discounted payback.
D) The internal rate of return.
E) The crossover method.
Answer: D

364) The profitability index is closely related to:

A) Payback.
B) Net present value.
C) Discounted payback.
D) Mutually exclusive projects.
E) The average accounting return.
Answer: B

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

A) It produces better decisions than those made using either NPV or IRR.
B) The cost of the analysis is less than the potential loss from a faulty decision.
C) It is the most desirable of all the available analytical methods from a financial perspective.
D) It considers the time value of money.
E) All relevant cash flows are included in the analysis.
Answer: B

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366) 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 crossover point by determining:
A) The discount rate that makes the net present value of each project equal to 1.
B) The discount rate that equates the discounted payback periods for each project.
C) The internal rate of return for the cash flows of each project.
D) The net present value of each project using the internal rate of return as the discount rate.
E) The internal rate of return for the differences in the cash flows of the two projects.
Answer: E

367) In comparing two projects using an NPV profile, at the point where the net present value of the
projects involved are equal, ________.
A) The AAR exceeds the cost of capital.
B) The IRR of each is equal to the cost of capital.
C) The projects both have NPVs equal to zero.
D) The discount rate that equates them is called the crossover rate.
E) The IRR of each is equal to zero.
Answer: D

368) You are considering a project with the following data:

Which one of the following is correct given this information?

A) This project should be accepted based on the profitability ratio.
B) The discount rate used to compute the profitability ratio was equal to the internal rate of return.
C) This project should be rejected based on the internal rate of return.
D) The discount rate used in computing the net present value must have been less than 8.7 percent.
E) The discounted payback period will have to be less than 2.44 years.
Answer: C

369) Which of the following is NOT correct?

A) The financial manager acts in the shareholders' best interests by identifying and taking positive
NPV projects.
B) Investment criteria other than NPV provide additional information about whether or not a
project truly has a positive NPV.
C) NPV is one of the two or three most important concepts in finance.
D) NPVs can normally be directly observed in the market.
E) NPV is always just the difference between the market value of an asset or project and its cost.
Answer: D

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370) All else constant, the net present value of a project increases when:
A) Each cash inflow is delayed by one year.
B) The discount rate increases.
C) All cash inflows occur during the last year of a project's life instead of periodically throughout
the life of the project.
D) The rate of return decreases.
E) The initial cost of a project increases.
Answer: D

371) ________ quantifies, in dollar terms, how stockholder wealth will be affected by undertaking a
project.
A) Net present value.
B) Discounted payback analysis.
C) The average accounting return.
D) The internal rate of return.
E) The profitability index.
Answer: A

372) Fora project with conventional cash flows, if NPV is greater than zero, then:
A) The IRR is equal to the firm's required rate of return.
B) The payback period is faster than the firm's required cutoff point.
C) The project does not pay back on a discounted payback basis.
D) The AAR exceeds the IRR.
E) The profitability index is greater than 1.
Answer: E

373) Which of the following is NOT a true statement?

A) The discounted payback rule requires a cutoff hurdle be set.
B) The AAR is based on accounting data.
C) The payback rule ignores the time value of money.
D) There may be multiple IRRs for an independent project.
E) The profitability index is closely related to the payback period.
Answer: E

374) If a project is assigned a required rate of return equal to zero, then:

A) Whether the project is accepted or rejected will depend on the timing of the cash flows.
B) The timing of the project's cash flows has no bearing on the value of the project.
C) The project will always be accepted.
D) The project can never add value for the shareholders.
E) The project will always be rejected.
Answer: B

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375) Without using formulas, provide a definition of "net present value profile."
A) A project analysis tool that measures the acceptability of a project through the difference
between a project's initial investment and whether the present value of its cash flow will repay
the investment.
B) A graphical representation of the relationship between varying rates of return and the
corresponding NPV value.
C) The rate of return provided by a project. The value is compared with a company's rate of return
to determine viability of a project.
D) A project analysis tool that measures the acceptability of a project by determining the amount
of profit that can be expected based on an investment made.
E) A situation whereby a choice has to be made between two or more projects, and choosing
multiple projects is not an option.
Answer: B

376) Without using formulas, provide a definition of "mutually exclusive investment decisions."
A) The rate of return provided by a project. The value is compared with a company's rate of return
to determine viability of a project.
B) A project analysis tool that measures the acceptability of a project through the difference
between a project's initial investment and whether the present value of its cash flow will repay
the investment.
C) A situation whereby a choice has to be made between two or more projects, and choosing
multiple projects is not an option.
D) A project analysis tool that measures the acceptability of a project by determining the amount
of profit that can be expected based on an investment made.
E) A graphical representation of the relationship between varying rates of return and the
corresponding NPV value.
Answer: C

377) A conventional cash flow is defined as a series of cash flows where:

A) The total of the cash flows is positive.
B) The sum of the cash flows is equal to zero.
C) Only the initial cash flow is negative.
D) The present value of the cash flows is equal to zero.
E) All of the cash flows are positive.
Answer: C

378) The primary reason that company projects with positive net present values are considered acceptable
is that:
A) The required cash inflows exceed the actual cash inflows.
B) The investment's cost exceeds the present value of the cash inflows.
C) They return the initial cash outlay within three years or less.
D) The project's rate of return exceeds the rate of inflation.
E) They create value for the owners of the firm.
Answer: E

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379) The discounted payback period of a project will decrease whenever the:
A) Discount rate applied to the project is increased.
B) Time period of the project is increased.
C) Amount of each project cash flow is increased.
D) Initial cash outlay of the project is increased.
E) Costs of the fixed assets utilized in the project increase.
Answer: C

380) Which one of the following is a reason why managers may utilize more than one method when
analyzing a project?
A) Because there are multiple methods of analysis with basically no associated disadvantages.
B) To better understand the conditions under which the project can be successful.
C) Because each of the five primary analytical methods is based on completely different data
related to a proposed project.
D) To ensure that the projected cash flows are accurate.
E) To determine a guaranteed rate of return on a projected project.
Answer: B

381) The final decision on which one of two mutually exclusive projects to accept ultimately depends
upon the:
A) Initial cost of each project.
B) Assigned payback period of each project.
C) Required discount rate.
D) Total cash inflows of each project.
E) Length of each project's life.
Answer: C

382) Which one of the following is the best example of two mutually exclusive projects?
A) Using an empty warehouse for storage or renting it entirely out to another firm.
B) Using the company sales force to promote sales of both shoes and socks.
C) Planning to build a warehouse and a retail outlet side by side.
D) Buying sufficient equipment to manufacture both desks and chairs simultaneously.
E) Buying both inventory and fixed assets using funds from the same bond issue.
Answer: A

383) Which of the following is true about using discounted payback analysis for projects which have only
positive cash flows after the initial outlay and for which the discount rate is positive?
A) Discounted payback is better than simple payback because in simple payback analysis the
cutoff payback period is arbitrarily set by management
B) Discounted payback is much simpler to calculate than regular payback
C) The discounted payback period will be longer than the regular payback period
D) Any project that fails to pay back at all on a discounted basis must have a positive NPV
E) When comparing two projects, the one with shorter payback period on a discounted basis will
have a larger NPV
Answer: C

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384) The crossover point is useful when trying to determine:
A) Which one of two mutually exclusive projects should be accepted.
B) Whether you should accept or reject an independent project.
C) The rate of return which should be applied to an independent project.
D) Whether two independent projects are acceptable.
E) The rate of return which should be applied to a mutually exclusive project.
Answer: A

385) According to the capital budgeting surveys cited in the text, in general, most financial managers of
large Canadian firms:
A) Prefer to use NPV or IRR to analyze their investment projects.
B) Use the AAR as their primary method of evaluating capital budgeting projects.
C) Make use of payback analysis more heavily than discounted cash flow methods.
D) Who use payback analysis use it only in conjunction with some other type of analysis.
E) Prefer to rely exclusively on payback analysis to evaluate projects.
Answer: D

386) The internal rate of return:

A) Is the best analytical method to use when comparing mutually exclusive projects.
B) Is relatively difficult to interpret and explain.
C) Method of analysis can result in multiple rates under certain conditions.
D) Will increase as the initial investment in a project is increased.
E) Determines the discount rate which should be used to evaluate a project given current market
conditions.
Answer: C

387) Use the following mutually exclusive investment cash flows for the question(s) below:

Based on the payback criterion, which of the following is NOT true?

A) With a payback cutoff of three years, both projects are acceptable.
B) With a payback cutoff of 1.5 years, neither project is acceptable.
C) With a payback cutoff of 1.75 years, only Project A is acceptable.
D) With a payback cutoff of 2.5 years, both projects are acceptable.
E) If you choose the project that pays back the fastest, Project A is preferred.
Answer: C

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388)

Based on the payback rule, which of the following is false?

A) You would be indifferent between the two projects.
B) With a payback cutoff of 1.5 years, both projects are unacceptable.
C) With a payback cutoff of three years, both projects are acceptable.
D) Since both projects pay back, the NPV of both must be positive.
E) With a payback cutoff of one year, neither project is acceptable.
Answer: D

389) You are considering an investment with the following cash flows. Your required return is 10%, you
require a payback of three years and a discounted payback of four years. If your objective is to
maximize your wealth, should you take this investment?

Year 0 1 2 3 4 5
Cash Flow -$100,000 $40,000 $40,000 $40,000 $40,000 --$50,000

A) Yes, because the payback is 2.5 years.

B) Yes, because the discounted payback is four years.
C) Yes, because both the payback and the discounted payback are less than two years.
D) No, because the project has a large negative cash flow at the end of its life.
E) No, because the NPV is negative.
Answer: E

390) Your required return is 15%. Should you accept a project with the following cash flows?

A) Yes, because the IRR is 17.2%.

B) No, because the IRR is 13.9%.
C) Yes, because the IRR is 16.2%.
D) No, because the IRR is 14.7%.
E) Yes, because the IRR is 19.2%.
Answer: A

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391) You are considering an investment which has the following cash flows. If you require a four year
payback period, should you take the investment?

Year 0 1 2 3 4 5 6
Cash Flow -$70,000 $10,000 $20,000 $25,000 $40,000 -$40,000 $20,000

A) No, the payback is 4.125 years.

B) Yes, the payback is 3.375 years.
C) Yes, the payback is 1.000 years.
D) No, the payback is 5.500 years.
E) Yes, the payback is 2.675 years.
Answer: B

392) An investment has the following cash flows. Should the project be accepted if it has been assigned a
required return of 14.5 percent? Why or why not?

A) Yes; because the IRR is 14.8 percent.

B) Yes; because the IRR is 13.9 percent.
C) No; because the IRR is 13.9 percent.
D) No; because the IRR is 14.3 percent.
E) Yes; because the IRR is 14.3 percent.
Answer: C

393) An investment has the following cash flows. Should the project be accepted if it has been assigned a
required return of 9.5 percent? Why or why not?

A) No; because the IRR is 9.89 percent.

B) No; because the IRR exceeds the required return by about 3.9 percent.
C) Yes; because the IRR exceeds the required return by about 0.39 percent.
D) Yes; because the IRR is less than the required return by about 3.9 percent.
E) Yes; because the IRR is positive.
Answer: C

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394) Jack is considering adding toys to his general store. He estimates that the cost of inventory will be
$4,200. The remodeling expenses and shelving costs are estimated at $1,500. Toy sales are expected
to produce net cash inflows of $1,200, $1,500, $1,600, and $1,750 over the next four years,
respectively. Should Jack add toys to his store if he assigns a three-year payback period to this
project?
A) yes; because the payback period is 2.02 years
B) no; because the payback period is 3.80 years
C) no; because the payback period is 2.02 years
D) yes; because the payback period is 2.94 years
E) yes; because the payback period is 3.80 years
Answer: B

395) Based on the profitability index (PI) rule, should a project with the following cash flows be accepted
if the discount rate is 8 percent? Why or why not?

A) Yes; because the PI is .999

B) No; because the PI is .992
C) No; because the PI is 1.008
D) Yes; because the PI is 1.008
E) Yes; because the PI is .992
Answer: B

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396) You are considering two mutually exclusive projects with the following cash flows. Will your
choice between the two projects differ if the required rate of return is 8 percent rather than 11
percent? If so, what should you do?

A) No; Regardless of the required rate, project B always has the higher NPV.
B) No; Regardless of the required rate, project A always has the higher NPV.
C) Yes; Select A at 8 percent and select neither at 11 percent.
D) Yes; Select B at 8 percent and A at 11 percent.
E) Yes; Select A at 8 percent and B at 11 percent.
Answer: E

397) An investment has the following cash flows. Should the project be accepted if it has been assigned a
required return of 14 percent? Why or why not?

A) Yes; The IRR is less than the required return by about 1.08 percent.
B) Yes; The IRR exceeds the required return by about 1.08 percent.
C) No; The IRR exceeds the required return by about 1.08 percent.
D) Yes; The IRR is less than the required return by about 0.97 percent
E) No; The IRR is less than the required return by about 0.97 percent.
Answer: B

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398) Bridgewater Fountains is considering expanding its current line of business and has developed the
following expected cash flows for the project. Should this project be accepted based on the
discounting approach to the modified internal rate of return if the discount rate is 9.6 percent? Why
or why not?

A) No; The IRR is 11.99 percent.

B) Yes; The IRR is 11.87 percent.
C) Yes; The IRR is 11.99 percent.
D) No; The IRR is 11.87 percent.
E) Yes; The IRR is 9.11 percent.
Answer: B

399) Would you accept a project which is expected to pay $10,000 a year for seven years if the initial
investment is $40,000 and your required return is 15%?
A) Yes; the NPV is $4,238
B) No; the NPV is -$2,783
C) No; the NPV is -$1,369
D) Yes; the NPV is $1,446
E) Yes; the NPV is $1,604
Answer: E

400) Roger is considering adding toys to his general store. He estimates that the cost of inventory will be
$6,400. The remodeling expenses and shelving costs are estimated at $2,100. Toy sales are expected
to produce net cash inflows of $1,400, $2,300, $3,100, and $2,000 over the next four years,
respectively. Should Roger add toys to his store if he assigns a three-year payback period to this
project? Why or why not?
A) No; The payback period is 3.85 years.
B) No; The payback period is 3.55 years.
C) Yes; The payback period is 2.55 years.
D) Yes; The payback period is 3.13 years.
E) Yes; The payback period is 2.87 years.
Answer: A

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401) Given that the net present value (NPV) is generally considered to be the best method of analysis,
why should you still use the other methods?
A) The average accounting return must always indicate acceptance since this is the best method
from a financial perspective.
B) The other methods help validate whether or not the results from the net present value analysis
are reliable.
C) The discounted payback method must always be computed to determine if a project returns a
positive cash flow since NPV does not measure this aspect of a project.
D) You need to use the other methods since conventional practice dictates that you only accept
projects after you have generated three accept indicators.
E) You need to use other methods because the net present value method is unreliable when a
project has unconventional cash flows.
Answer: B

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

A) Neither project
is acceptable.
B) You should accept both projects since both of their PIs are positive.
C) You should only accept project B since it has the largest PI and the PI exceeds 1.
D) You should accept both projects since both of their PIs are greater than 1.
E) You should accept project A since it has the higher PI.
Answer: D

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403) You are considering two independent projects both of which have been assigned a discount rate of 9
percent. Based on the profitability index, what is your recommendation concerning these projects?

A) You should accept project B and reject project A.

B) You should reject both projects.
C) You should accept project A and reject project B.
D) You should accept both projects.
E) You should accept project A and be indifferent to project B.
Answer: A

404) You are considering two independent projects with the following cash flows. The required return for
both projects is 10 percent. Given this information, which one of the following statements is
correct?

A) You should accept project A because it has the higher NPV and you cannot accept both
projects.
B) You should accept both projects if the funds are available to do so.
C) You should accept project A because it has the lower NPV and reject project B.
D) You should accept project B since it has the higher IRR and reject project A because you
cannot accept both projects.
E) You should accept project B because it has the higher IRR and reject project A.
Answer: B

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 405) You are considering two independent projects with the following cash flows. The required return for
both projects is 12 percent. Given this information, which one of the following statements is
correct?

A) You should accept project A since it has the higher IRR and reject project B because you
cannot accept both projects.
B) You should accept both projects based on both the NPV and IRR rules.
C) You should accept project A because it has the higher NPV and reject project B.
D) You should accept project B because it has the higher IRR and reject project A.
E) You should accept project B because it has the higher NPV and reject project A.
Answer: B

406) What is the net present value of a project that has an initial cash outflow of $12,670 and the
following cash inflows? The required return is 11.5 percent.

A) $370.16 B) $218.68 C) $1,249.65 D) $768.20 E) $1,371.02

Answer: B

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.

407) Without using formulas, provide a definition of "discounted cash flow (DCF) valuation."
Answer: The process of valuing an investment by discounting its future cash flows.

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408) Given our goals of firm value and shareholder wealth maximization, we have stressed the
importance of NPV. And yet, many of the financial decision-makers at some of the most prominent
firms in the world continue to use less desirable measures such as the payback period and AAR, in
addition to the NPV and IRR. Why do you think this is the case?
Answer: This is an open-ended question which allows the creative student to speculate on the value
(dubious or otherwise) of non-DCF evaluation measures. We use it as a springboard to stress
that even rational financial managers sometimes find it expedient to use a group of measures.
For example, one CFO explained that his firm relied heavily on a combination of the IRR and
AAR techniques - the former because it was easier to explain to board members than NPV,
and the latter because, for large projects, AAR provides shareholders some insights as to the
project's impact on net income and EPS.

409) How does the net present value method of analysis help managers adhere to the primary objective of
creating shareholder wealth?
Answer: The net present value rule states that projects with positive net present values should be
accepted and projects with negative net present values should be rejected. This directly
corresponds to shareholder wealth considerations as positive net present value projects
increase shareholder wealth whereas negative net present value projects reduce shareholder
wealth.

410) According to the text, the NPV rule states that "An investment should be accepted if the NPV is
positive and rejected if it is negative." What does an NPV of zero mean? If you were a
decision-maker faced with a project with a zero NPV (or very close to zero) what would you do?
Why?
Answer: Although the possibility of a zero NPV is remote, it makes for an interesting question and
tests the student's understanding of the underlying theory. In strict economic terms, one should
be indifferent to the project; however, many projects require further considerations. A key
point in the student's answer should be that they stress the project provides a return just equal
to the firm's required return. This question provides a good lead-in to the two capital
budgeting chapters that follow.

411) Without using formulas, provide a definition of "net present value (NPV)."
Answer: A project analysis tool that measures the acceptability of a project through the difference
between a project's initial investment and whether the present value of its cash flow will repay
the investment.

412) Without using formulas, provide a definition of "payback period."

Answer: A project analysis tool that determines the amount of time required for an investment to
generate cash flows to recover its initial cost.

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413) Compare and contrast the advantages and disadvantages of both the payback and the discounted
payback methods of analysis.
Answer: Payback is popular because it is simple to compute and easy to explain. Its disadvantages
include the lack of considering either risk or the time value of money and also the bias towards
liquidity based on an arbitrary cutoff point of time.
Discounted payback is a better method than payback because it includes time value of money
considerations but yet by doing so loses the primary advantage of payback, which is simplicity.
Discounted payback also uses an arbitrary cutoff point of time and thus is also biased towards
liquidity.

414) Without using formulas, provide a definition of "discounted payback period."

Answer: A project analysis tool that measures the acceptability of a project by determining the length
of time required for an investment's discounted cash flows to equal its initial cost.

415) What is the reasoning or logic behind using the average accounting return since it does not provide
pure financial analysis?
Answer: Almost every manager is familiar with net income and most should be familiar with return on
assets. The average accounting return (AAR) provides information on a project in similar
terms. The information is also readily available. While the AAR may not be the primary tool
used in capital budgeting analysis is does provide another dimension of information that can
be reviewed prior to starting a project.

416) Without using formulas, provide a definition of "average accounting return" (AAR).
Answer: A project analysis tool that measures the acceptability of a project by determining the amount
of profit that can be expected based on an investment made.

417) A project has multiple IRRs. Which should you use in determining whether or not to accept the
project, the highest, the lowest, or the intermediate IRR?
Answer: This is basically a trick question, the IRR rule should not be used in this case.

418) You are to present a proposed capital investment project to your board of directors. The project has
a NPV of $12,000 and an IRR of 12%. The firm's required return is 10%. You are to convey your
proposal to the board in a single paragraph. Write that paragraph here. Remember, your job is to
convince the board to either accept or reject the project, whichever you feel is appropriate given this
information.
Answer: This is another open-ended question which asks the student to put into words concepts that
have been learned via definitions.

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419) Explain why the internal rate of return (IRR) is so useful to decision makers when analyzing an
independent project.
Answer: The IRR is the discount rate which makes the net present value of a project equal to zero. This
rate is the maximum discount rate which can be applied to the project and still cause the
project to be acceptable. By knowing the IRR, decision makers know that the project will
remain acceptable as long as the discount rate does not increase to a level above that of the
IRR. The IRR is the turning point between decisions to accept or reject an opportunity.

420) List and briefly discuss the advantages and disadvantages of the IRR rule.
Answer: The advantages of the rule are its close relationship with NPV and the ease with which it is
understood and communicated. The two disadvantages are that there may be multiple
solutions and the rule may lead to a ranking conflict in evaluating mutually exclusive
investments. The student should add a brief explanation demonstrating their understanding of
each.

421) Both net present value and the internal rate of return incorporate the same data and utilize the same
time value of money theory in their computations. Given this, why is net present value considered to
be a superior measure when making capital budgeting decisions?
Answer: For independent projects that are similar in size, both NPV and IRR should lead to the same
decision. However, IRR can lead to faulty decisions if projects are of different sizes or are
mutually exclusive. Also, if the cash flows are nonconventional, a definite IRR cannot be
calculated. Thus, NPV is the preferred method of analysis.

422) Without using formulas, provide a definition of "net present value profile."
Answer: A graphical representation of the relationship between varying rates of return and the
corresponding NPV value.

423) Without using formulas, provide a definition of "mutually exclusive investment decisions."
Answer: A situation whereby a choice has to be made between two or more projects, and choosing
multiple projects is not an option.

424) Without using formulas, provide a definition of "internal rate of return" (IRR).
Answer: The rate of return provided by a project. The value is compared with a company's rate of
return to determine viability of a project.

425) Without using formulas, provide a definition of "profitability index" (PI).

Answer: A ranking method used to assess projects. PI greater than 1 signify positive NPV projects,
while PI less than 1 signify negative NPV projects.

426) Draw a graph that illustrates two mutually exclusive investments, A and B, with a crossover rate of
return equal to 10%, and with A having the higher NPV at a discount rate of zero percent. Explain
the graph, including under which conditions project A or project B would be chosen using NPV and
then using IRR.
Answer: The student should replicate Figure 9.7.

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427) List and identify the discounted cash flow (DCF) and the non-discounted cash flow capital
budgeting techniques. If you were asked to evaluate a project using one of each, which techniques
would you use? Why?
Answer: The purpose here is to test the student's knowledge of the attributes of the various techniques.
DCF techniques include NPV, IRR, Discounted Payback, and PI. Non-DCF included Payback
and AAR. The latter part of the question is designed to allow for a bit of creativity on the part
of the respondent.

428) Explain the differences and similarities between NPV and PI.
Answer: The NPV and PI are the same calculation, and both rules lead to the same accept/reject
decision. The main difference between the two is that the PI may be useful in determining
which projects to accept if funds are limited; however, the PI may lead to incorrect decisions
in considering mutually exclusive investments.

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