Finance Chapter 9 Homework

The Average Accounting Return (AAR) Rule states that a company will accept a project that has an average account return that:

exceeds a pre-determined target average accounting return.

is less than a pre-determined target average accounting return.

exceeds the net present value for the company.

is less than the net present value for the company.

is equal to the increase of the net income over the past year.

exceeds a pre-determined target average accounting return.

*Based upon the following data: calculate the Average Accounting Return

Net Income:

Year 1:$1,500,000

Year 2:$1,200,000

Year 3:$1,050,000

Year 4:-$1,400,000

Year 5:$1,350,000

The starting book value is $11,840,000, which will end with $0, at the end of five years.

6.25%

10%

12.5%

20%

25%

12.5%

According to the video, which of the following are disadvantages of the Average Accounting Return (AAR)?

Time value of money is ignored.

An arbitrary benchmark cutoff rate is established.

Market values are not considered.

All of the above.

A & C only.

All of the above.

The Discounted Payback Period Rule states that a company will accept a project if:

The calculated payback is less than three years for all projects.

The calculated payback is less than a pre-specified number of years.

We can recover the costs in a reasonable amount of time.

The project stays within budget.

The project increases shareholder value.

The calculated payback is less than a pre-specified number of years.

*Based upon the following data: calculate the Discounted Payback Period with a discount rate of 10%.

Project A

Initial Cost-$50,000

Year 1$20,000

Year 2$25,000

Year 3$20,000

1.74 years

2.0 years

2.25 years

2.54 years

2.74 years

2.74 years

All of the following are disadvantages of the discounted payback period, except:

The method ignores the time value of money.

All projects are considered based upon cash flows alone.

Cash flows that extend beyond the cutoff date are not considered.

The company must select a specified number of years to compare projects.

The method incorporates the time value of money.

The method incorporates the time value of money.

The Internal Rate of Return (IRR) represents which of the following:

The discount rate that must be lower than the required rate of return.

The discount rate that makes the net present value equal to zero.

The discount rate that makes the net present value positive.

The discount rate that makes the net present value negative.

The discount rate that is affected by the cash flows external to the project.

The discount rate that makes the net present value equal to zero.

What are non-conventional cash flows?

A combination of cash outflows and inflows.

Low cash flows followed by much higher cash flows.

High cash flows followed by much lower cash flows.

Small initial investments and much larger returns.

A zero return on an investment.

A combination of cash outflows and inflows.

*All of the following are commonly cited reasons for using the Internal Rate of Return, except:

Rates of return are commonly used when considered positive projects being considered.

Internal rate of return is an easy way to provide information about a proposal.

The IRR does need a discount rate to complete the calculation.

A high IRR can be assumed to be a positive project to consider.

Multiple IRR's allow the company to choose the best one when evaluating projects.

Multiple IRR's allow the company to choose the best one when evaluating projects.

What does the Modified Internal Rate of Return (MIRR) assume?

The MIRR assumes only conventional cash flow models are used.

The MIRR assumes that all cash inflows are paid out as dividends.

The MIRR assumes that cash flows will be reinvested at the cost of capital.

The MIRR assumes that cash flows will be reinvested at the MIRR.

The MIRR assumes that cash flows will be reinvested at the IRR.

The MIRR assumes that cash flows will be reinvested at the cost of capital.

*Using the discounting approach, calculate the MIRR of the following cash flows: Assume that the required return on this project is 15%

Project A

Initial Cost-$50

Year 1$175

Year 2-$115

13.87%

27.74%

29.74%

32.43%

37.74%

27.74%

The combination approach for calculating the Modified Internal Rate of Return (MIRR) differs because:

It does not use the required return in the calculation.

It is the most controversial method for calculating the Modified Internal Rate of Return.

It requires fewer steps than the discounting or reinvestment approach.

Negative cash flows are discounted back and positive cash flows are compounded forward.

Negative cash flows are compounded forward and positive cash flows are discounted back.

Negative cash flows are discounted back and positive cash flows are compounded forward.

What does mutually exclusive mean?

Independent projects are also mutually exclusive.

We must choose all the high NPV projects that are exclusive for our company.

Each project must be mutually beneficial for other projects in the company.

The highest IRR is always the best option, which is mutually exclusive.

Taking one project means that we cannot take the other.

Taking one project means that we cannot take the other.

When choosing between mutually exclusive projects, what is the best method to use?

The highest IRR is always the best option.

The lowest IRR is always the best option.

The highest NPV is always the best option.

The lowest NPV is always the best option.

The lowest initial investment is always the best option.

The highest NPV is always the best option.

Based upon the following data, which of the following mutually exclusive projects should you choose if your required return is 10%?

Year Investment A Investment B

0 −$150 −$150

1 80 40

2 40 50

3 40 60

4 30 55

Investment A with an NPV of $6.33

Investment B with an NPV of $6.33

Investment A with an NPV of $10.33

Investment B with an NPV of $10.33

Both projects since they have positive NPV's.

Investment B with an NPV of $10.33

What is the first step in the Net Present Value (NPV) process?

Identify the appropriate discount rate to use.

Compare the cost of the investment to the future cash flows.

Estimate the future cash flows.

Use a financial calculator to calculate the NPV.

Find the present value of the cash flows.

Estimate the future cash flows.

Using the method of your choice, calculate the Net Present Value of the following cash flows. Assume that the required return on this project is 15%

Project A

Initial Cost-$150

Year 1$175

Year 2$100

$15

$35

$55

$70

$78

$78

According the video, one of the biggest challenges for the Net Present Value method is:

Identifying the appropriate discount rate to use.

Choosing good quality projects to invest in.

Comparing the cost of the investment to the future cash flows.

Choosing a method to calculate the Net Present Value.

Not taking on too many new projects at one time.

Identifying the appropriate discount rate to use.

The Payback Period Rule states that a company will accept a project if:

The calculated payback is less than three years for all projects.

The calculated payback is less than a pre-specified number of years.

We can recover the costs in a reasonable amount of time.

The project stays within budget.

The project increases shareholder value.

The calculated payback is less than a pre-specified number of years.

*Based upon the following data: calculate the Payback Period.

Project A

Initial Cost-$50,000

Year 1$20,000

Year 2$15,000

Year 3$20,000

1.5 years

2.0 years

2.25 years

2.5 years

2.75 years

2.75 years

All of the following are disadvantages of the Payback Period, except:

The method ignores the time value of money.

All projects are considered based upon cash flows alone.

Cash flows that extend beyond the cutoff date are not considered.

The company must select a specified number of years to compare projects.

The method incorporates the time value of money.

The method incorporates the time value of money.

A project has a net present value of zero. Given this information:

the project has a zero percent rate of return.

the project requires no initial cash investment.

the project has no cash flows.

the summation of all of the project's cash flows is zero.

the project's cash inflows equal its cash outflows in current dollar terms.

the project's cash inflows equal its cash outflows in current dollar terms.

Which one of the following methods predicts the amount by which the value of a firm will change if a project is accepted?

Net present value

Discounted payback

Internal rate of return

Profitability index

Payback

Net present value

Net present value:

is the best method of analyzing mutually exclusive projects.

is less useful than the internal rate of return when comparing different-sized projects.

is the easiest method of evaluation for nonfinancial managers.

cannot be applied when comparing mutually exclusive projects.

is very similar in its methodology to the average accounting return.

is the best method of analyzing mutually exclusive projects.

The length of time a firm must wait to recoup the money it has invested in a project is called the:

internal return period.

payback period.

profitability period.

discounted cash period.

valuation period.

payback period.

The length of time a firm must wait to recoup, in present value terms, the money it has invested in a project is referred to as the:

net present value period.

internal return period.

payback period.

discounted profitability period.

discounted payback period.

discounted payback period.

A project's average net income divided by its average book value is referred to as the project's average:

net present value.

internal rate of return.

accounting return.

profitability index.

payback period.

accounting return.

Which one of the following statements related to the internal rate of return (IRR) is correct?

The IRR yields the same accept and reject decisions as the net present value method given mutually exclusive projects.

A project with an IRR equal to the required return would reduce the value of a firm if accepted.

The IRR is equal to the required return when the net present value is equal to zero.

Financing type projects should be accepted if the IRR exceeds the required return.

The average accounting return is a better method of analysis than the IRR from a financial point of view.

The IRR is equal to the required return when the net present value is equal to zero.

The internal rate of return is defined as the:

maximum rate of return a firm expects to earn on a project.

rate of return a project will generate if the project is financed solely with internal funds.

discount rate that equates the net cash inflows of a project to zero.

discount rate which causes the net present value of a project to equal zero.

discount rate that causes the profitability index for a project to equal zero.

discount rate which causes the net present value of a project to equal zero.

If a firm accepts Project X it will not be feasible to also accept Project Z because both projects would require the simultaneous and exclusive use of the same piece of machinery. These projects are considered to be:

independent.

interdependent.

mutually exclusive.

economically scaled.

operationally distinct.

mutually exclusive.

A project has an initial cash outflow of $42,600 and produces cash inflows of $17,680, $19,920, and $15,670 for Years 1 through 3, respectively. What is the NPV at a discount rate of 12 percent?

$186.95

−$108.19

$219.41

$229.09

$311.16

$219.41

**A project has a required return of 12.6 percent, an initial cash outflow of $42,100, and cash inflows of $16,500 in Year 1, $11,700 in Year 2, and $10,400 in Year 4. What is the net present value?

−$11,748.69

−$10,933.52

−$11,208.62

−$10,457.09

−$12,006.13

−$11,748.69

**

A project has an initial cost of $7,900 and cash inflows of $2,100, $3,140, $3,800, and $4,500 per year over the next four years, respectively. What is the payback period?

2.70 years

3.28 years

3.36 years

3.70 years

2.28 years

2.70 years

**The Green Fiddle is considering a project with sales of $86,800 a year for the next four years. The profit margin is 6 percent, the project cost is $97,500, and depreciation is straight-line to a zero book value over the life of the project. The required accounting return is 10.8 percent. This project should be _____ because the AAR is _____ percent.

rejected; 11.03

accepted; 10.68

rejected; 11.16

accepted; 11.03

rejected; 10.68

rejected; 10.68

A project has cash flows of -$343,200, $56,700, $138,500, and $245,100 for Years 0 to 3, respectively. The required rate of return is 10.5 percent. Based on the internal rate of return of _____ percent for this project, you should _____ the project.

11.03; accept

8.03; reject

9.87; reject

10.47; reject

10.93; accept

10.93; accept

The Whey Station is considering a project with an initial cost of $146,500 and cash inflows for Years 1 to 3 of $56,700, $68,500, and $71,200, respectively. What is the IRR?

14.37%

15.56%

16.17%

12.88%

13.23%

15.56%