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Exam 5: Net Present Value and Other Investment Criteria

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Question 31

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Discuss some of the advantages of using the payback method.

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It tells you how quickly you c...

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Question 32

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You are given a job to make a decision on project X, which is composed of three independent projects A, B, and C that have NPVs of + $70, -$40 and + $100, respectively. How would you go about making the decision about whether to accept or reject the project?

A) Accept project X as it has a positive NPV.
B) Reject project X.
C) Break up the project into its components: Accept A and C, but reject B.
D) Break up the project into its components: Accept C.

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Question 33

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The IRR is defined as

If the NPV of project A is + $120, that of project B is -$40, and that of project C is + $40, what is the NPV of the combined project?

The profitability index of a positive NPV project is always positive.

In the case of a loan project (borrowing), one should accept the project if the IRR is more than the cost of capital.

If the cash flows for project A are C₀ = −1,000; C₁ = +600; C₂ = +400; and C₃ = +1,500, calculate the payback period.

Present values have the value additivity property.

The cost of a new machine is $250,000. The machine has a five-year life and no salvage value. If the cash flow each year is equal to 25 percent of the cost of the machine, calculate the payback period for the project.

One can use the profitability index most usefully for which situation?

The following table gives the available projects (in $millions) for a firm. The firm has only $20 million to invest. What is the maximum NPV that the company can obtain?

There can never be more than one value of the IRR for any sequence of cash flows.

Dry-Sand Company is considering investing in a new project. The project will need an initial investment of $1,200,000 and will generate $600,000 (after-tax) cash flows for three years. However, at the end of the fourth year, the project will generate -$500,000 of after-tax cash flow due to dismantling costs. Calculate the MIRR (modified internal rate of return) for the project if the cost of capital is 15 percent. The reinvestment rate is 12 percent.

The net present value of a project depends upon the

The internal rate of return is the discount rate that makes the NPV of a project's cash flows equal to zero.

Discuss some of the disadvantages of the payback rule.

The following are measures used by firms when making capital budgeting decisions except

If the cash flows for Project M are C₀ = -1,000; C₁ = +200; C₂ = +700; and C₃ = +698, calculate the IRR for the project.

Accounting earnings from a firm's income statement, prepared according to generally accepted accounting principles (GAAP), are typically the best data source for calculating a project's NPV.

The benefit-cost ratio is equal to the profitability index plus one.