Exam 8: Investment Decision Rules

You are opening up a brand new retail strip mall. You presently have more potential retail outlets wanting to locate in your mall than you have space available. What is the most appropriate tool to use if you are trying to determine the optimal allocation of your retail space?

A print shop has contracted to print a number of jobs within 24 hours. Any jobs not completely printed within this time will result in a penalty, as shown in the table above. However too many jobs have been accepted, and not all can be printed. Which jobs should be printed in the next 24 hours?

Net present value (NPV) is usefully supplemented by internal rate of return (IRR), since IRR gives a good indication of the sensitivity of any decision made to changes in the discount rate.

The timeline of an investment is shown above. If the cost of capital is 8%, what is the profitability index of this investment?

An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million. The sponsorship would last for three years and is expected to increase cash flows by $570,000 per year. If the discount rate is 6.9%, what will be the change in the value of the company if it chooses to go ahead with the sponsorship?

When an alternative decision rule disagrees with the net present value (NPV), the NPV should be followed.

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 ________.

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.

The owner of a number of gas stations is considering installing coffee machines in his gas stations. It will cost $260,000 to install the coffee machines, and they are expected to boost cash flows by $111,428 per year for their five-year working life. What must the cost of capital be if this investment has a profitability index of 1?

You are trying to decide between three mutually exclusive investment opportunities. The most appropriate tool for identifying the correct decision is ________.

Which of the following statements is FALSE?

A lottery winner can take $6 million now or be paid $600,000 at the end of each of the next 16 years. The winner calculates the internal rate of return (IRR) of taking the money at the end of each year and, estimating that the discount rate across this period will be 4%, decides to take the money at the end of each year. Was her decision correct?

An investor has a budget of $30 million. He can invest in the projects shown above. If the cost of capital is 5%, what investment or investments should he make?

You are offered an investment opportunity that costs you $28,000, has a net present value (NPV) of $2278, lasts for three years, has interest rate of 10%, and produces the following cash flows: The missing cash flow from year 2 is closest to ________.

Under what situation can the net present value (NPV) profile be upward sloping?

Which of the following is true regarding the profitability index?

A firm has an opportunity to invest $95,000 today that will yield $109,250 in one year. If interest rates are 4%, what is the net present value (NPV) of this investment?

What are some potential problems in using internal rate of return (IRR) for mutually exclusive projects?

Internal rate of return (IRR) can reliably be used to choose between mutually exclusive projects.

Is there a unique way for calculating the MIRR to resolve the multiple IRR situation?