Question 1

According to Graham and Harvey's 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are ________.

Accepted Answer

A)  NPV, IRR, MIRR 
B)  MIRR, IRR, Payback period 
C)  IRR, NPV, Payback period 
D)  Profitability index, NPV, IRR 
A)  NPV, IRR, MIRR 
B)  MIRR, IRR, Payback period 
C)  IRR, NPV, Payback period 
D)  Profitability index, NPV, IRR

Question 2

Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favors liquidity?

Accepted Answer

A)  profitability index 
B)  MIRR 
C)  equivalent annual annuity 
D)  payback period 
A)  profitability index 
B)  MIRR 
C)  equivalent annual annuity 
D)  payback period

Question 3

Use the table for the question(s) below.
Consider the following list of projects:
  
-Assuming that your capital is constrained, which project should you invest in last?

Accepted Answer

A)  Project A 
B)  Project I 
C)  Project D 
D)  Project C 
A)  Project A 
B)  Project I 
C)  Project D 
D)  Project C

Question 4

A janitorial services firm is considering two brands of industrial vacuum cleaners to equip their staff. Option A will cost $1,500, require servicing of $200 per year, and it will last five years. Option B will cost $1,000, require servicing of $100 per year, and it will last three years. If the cost of capital is 8%, which is the better option, given that the firm has an ongoing requirement for vacuum cleaners?

Accepted Answer

A)  Option A, since it has a lower equivalent annual annuity. 
B)  Option B, since it has a lower equivalent annual annuity. 
C)  Option A, since it has a greater equivalent annual annuity. 
D)  Option B, since it has a greater equivalent annual annuity. 
A)  Option A, since it has a lower equivalent annual annuity. 
B)  Option B, since it has a lower equivalent annual annuity. 
C)  Option A, since it has a greater equivalent annual annuity. 
D)  Option B, since it has a greater equivalent annual annuity.

Question 5

A small department store in a mall has the opportunity to rent an additional 20,000 square feet of space for five years. It can divide up this space between the above new departments. Each department will require a different amount of space, and each department is expected to make a yearly profit as shown, for each of the next five years. The discount rate is 10%. Based on this information, what departments should be added?

Accepted Answer

A)  Pet, Fabrics, Hardware, and Shoe Repair 
B)  Fabrics, Luggage, Hardware, Watches, and Shoe Repair 
C)  Pets, Fabrics, Books, and Luggage 
D)  Pet, Fabrics, Luggage, Hardware, and Shoe Repair 
A)  Pet, Fabrics, Hardware, and Shoe Repair 
B)  Fabrics, Luggage, Hardware, Watches, and Shoe Repair 
C)  Pets, Fabrics, Books, and Luggage 
D)  Pet, Fabrics, Luggage, Hardware, and Shoe Repair

Question 6

Use the information for the question(s) below.
  
-A florist is buying a number of motorcycles to expand its delivery service. These will cost $78,000 but are expected to increase profits by $3000 per month over the next four years. What is the payback period in this case?

Accepted Answer

A)  10.40 months 
B)  15.60 months 
C)  19.50 months 
D)  26.00 months 
A)  10.40 months 
B)  15.60 months 
C)  19.50 months 
D)  26.00 months

Question 7

Consider the following two projects:   The profitability index for project B is closest to ________.

Accepted Answer

A)  22.49 
B)  14.99 
C)  0.15 
D)  0.09 
A)  22.49 
B)  14.99 
C)  0.15 
D)  0.09

Question 8

Use the information for the question(s) below.
  
-If WiseGuy Inc. uses payback period rule to choose projects, which of the projects (Project A or Project B) will WiseGuy Inc. prefer?

Accepted Answer

A)  Project A 
B)  Project B 
C)  Project A and Project B have the same ranking. 
D)  Cannot calculate a payback period without a discount rate. 
A)  Project A 
B)  Project B 
C)  Project A and Project B have the same ranking. 
D)  Cannot calculate a payback period without a discount rate.

Question 9

Which of the following is true regarding the profitability index?

Accepted Answer

A)  It does not use the net present value (NPV) to assess benefits. 
B)  It is very simple to compute. 
C)  Attention must be taken when using it to make sure that all of the constrained resource is utilized. 
D)  It is unreliable when used for choosing between different projects. 
A)  It does not use the net present value (NPV) to assess benefits. 
B)  It is very simple to compute. 
C)  Attention must be taken when using it to make sure that all of the constrained resource is utilized. 
D)  It is unreliable when used for choosing between different projects.

Question 10

Use the table for the question(s) below.
Consider the following list of projects:
  
-Assuming that your capital is constrained, which project should you invest in first?

Accepted Answer

A)  Project C 
B)  Project G 
C)  Project B 
D)  Project F 
A)  Project C 
B)  Project G 
C)  Project B 
D)  Project F

Question 11

Consider a project with the following cash flows:   Assume the appropriate discount rate for this project is 14%. The profitability index for this project is closest to ________.

Accepted Answer

A)  0.17 
B)  0.25 
C)  0.66 
D)  0.18 
A)  0.17 
B)  0.25 
C)  0.66 
D)  0.18

Question 12

Use the information for the question(s) below.
  
-If WiseGuy Inc. uses IRR rule to choose projects, which of the projects (Project A or Project B) will rank highest?

Accepted Answer

A)  Project A 
B)  Project B 
C)  Project A and Project B have the same ranking. 
D)  Cannot calculate a payback period without a discount rate. 
A)  Project A 
B)  Project B 
C)  Project A and Project B have the same ranking. 
D)  Cannot calculate a payback period without a discount rate.

Question 13

The internal rate of return (IRR) is the interest rate that sets the net present value (NPV) of the cash flows equal to zero.

Accepted Answer

A) True 
 B)False

Question 14

An investor is considering the two investments shown above. Her cost of capital is 8%. Which of the following statements about these investments is true?

Accepted Answer

A)  The investor should take investment A since it has a greater net present value (NPV). 
B)  The investor should take investment A since it has a greater internal rate of return (IRR). 
C)  The investor should take investment B since it has a greater net present value (NPV). 
D)  The investor should take investment B since it has a greater internal rate of return (IRR). 
A)  The investor should take investment A since it has a greater net present value (NPV). 
B)  The investor should take investment A since it has a greater internal rate of return (IRR). 
C)  The investor should take investment B since it has a greater net present value (NPV). 
D)  The investor should take investment B since it has a greater internal rate of return (IRR).

Question 15

Which of the following decision rules is best defined as the amount of time it takes to pay back the initial investment?

Accepted Answer

A)  internal rate of return (IRR) 
B)  profitability index 
C)  net present value (NPV) 
D)  payback period 
A)  internal rate of return (IRR) 
B)  profitability index 
C)  net present value (NPV) 
D)  payback period

Question 16

A local government awards a landscaping company a contract worth $1.5 million per year for five years for maintaining public parks. The landscaping company will need to buy some new machinery before they can take on the contract. If the cost of capital is 6%, what is the most that this equipment could cost if the contract is to be worthwhile for the landscaping company?

Accepted Answer

A)  $5.69 million 
B)  $6.00 million 
C)  $6.32 million 
D)  $6.63 million 
A)  $5.69 million 
B)  $6.00 million 
C)  $6.32 million 
D)  $6.63 million

Question 17

How do you apply the Net Present Value rule when multiple projects are available and you have the added constraint of accepting only one project?

Accepted Answer

When making an investment deci

Question 18

A consultancy calculates that it can supply crude oil assaying services to a small oil producer for $115,000 per year for five years. There are some upfront costs the consultancy will require the oil producer to absorb. What is the maximum that these upfront costs could be, if the equivalent annual annuity to the oil company is to be under $160,000, given that the cost of capital is 9%?

Accepted Answer

A)  $45,000 
B)  $175,034 
C)  $201,289 
D)  $160,000 
A)  $45,000 
B)  $175,034 
C)  $201,289 
D)  $160,000

Question 19

Consider the following two projects:   Assume that projects Alpha and Beta are mutually exclusive. The correct investment decision and the best rationale for that decision is to ________.

Accepted Answer

A)  invest in project Beta, since NPVBeta > 0 
B)  invest in project Alpha, since NPVBeta Alpha 
C)  invest in project Beta, since IRRB > IRRA 
D)  invest in project Beta, since NPVBeta > NPVAlpha > 0 
A)  invest in project Beta, since NPVBeta > 0 
B)  invest in project Alpha, since NPVBeta Alpha 
C)  invest in project Beta, since IRRB > IRRA 
D)  invest in project Beta, since NPVBeta > NPVAlpha > 0

Question 20

When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule.

Accepted Answer

A) True 
 B)False

Exam 8: Investment Decision Rules

According to Graham and Harvey's 2001 survey (Figure 8.2 in the text), the most popular decision rules for capital budgeting used by CFOs are ________.

Which of the following decision rules might best be used as a supplement to net present value (NPV) by a firm that favors liquidity?

Use the table for the question(s) below. Consider the following list of projects: -Assuming that your capital is constrained, which project should you invest in last?

Use the information for the question(s) below. -A florist is buying a number of motorcycles to expand its delivery service. These will cost $78,000 but are expected to increase profits by $3000 per month over the next four years. What is the payback period in this case?

Consider the following two projects: The profitability index for project B is closest to ________.

Use the information for the question(s) below. -If WiseGuy Inc. uses payback period rule to choose projects, which of the projects (Project A or Project B) will WiseGuy Inc. prefer?

Which of the following is true regarding the profitability index?

Use the table for the question(s) below. Consider the following list of projects: -Assuming that your capital is constrained, which project should you invest in first?

Consider a project with the following cash flows: Assume the appropriate discount rate for this project is 14%. The profitability index for this project is closest to ________.

Use the information for the question(s) below. -If WiseGuy Inc. uses IRR rule to choose projects, which of the projects (Project A or Project B) will rank highest?

The internal rate of return (IRR) is the interest rate that sets the net present value (NPV) of the cash flows equal to zero.

An investor is considering the two investments shown above. Her cost of capital is 8%. Which of the following statements about these investments is true?

Which of the following decision rules is best defined as the amount of time it takes to pay back the initial investment?

How do you apply the Net Present Value rule when multiple projects are available and you have the added constraint of accepting only one project?

Consider the following two projects: Assume that projects Alpha and Beta are mutually exclusive. The correct investment decision and the best rationale for that decision is to ________.

When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule.

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

Time Value of Money: an Introduction

Time Value of Money: Valuing Cash Flow Streams

Interest Rates

Bonds

Stock Valuation

Fundamentals of Capital Budgeting

Stock Valuation: a Second Look

Risk and Return in Capital Markets

Systematic Risk and the Equity Risk Premium

The Cost of Capital

Raising Equity Capital

Debt Financing

Capital Structure

Payout Policy

Financial Modeling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Option Applications and Corporate Finance

Mergers and Acquisitions

International Corporate Finance

Leasing

Insurance and Risk Management

Corporate Governance

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