Financial Management
Investment Decision Criteria
1. An Overview of Capital Budgeting
1) Which of the following are typical consequences of good capital budgeting decisions?
Answer: D
2) Errors in capital budgeting decisions
Answer: B
3) Which of the following factors is least important to capital budgeting decisions?
Answer: C
4) Which of the following would be considered a capital budgeting decision?
Answer: D
5) Which of the following is a typical capital budgeting decision?
Answer: C
6) Good capital investment opportunities are most likely to exist when
Answer: D
7) Errors resulting from a capital budgeting decision are not considered major since the consequences of such errors average out over the life of the investment.
Answer: FALSE
8) Competitive market forces make it imperative for a firm to have a systematic strategy for generating capital-budgeting projects.
Answer: TRUE
9) The size of capital investments and the difficulty in reversing them once they are made make capital-budgeting decisions very important to the firm.
Answer: TRUE
10) Capital budgeting is the decision-making process with respect to investment in working capital.
Answer: FALSE
11) Some capital budgeting decisions may be mandated by government regulations.
Answer: TRUE
12) The primary objective of all capital budgeting decisions is to increase the size of the firm.
Answer: FALSE
13) Why are capital budgeting decisions among the most important decisions made by any company? Give a few examples from recent business developments.
Answer: The main objective of financial management is to maximize the value of the firm. The main source of value is the company's cash flows discounted at rates that reflect their risk. Both the firm's cash flows and their level of risk are determined by the projects the company chooses to undertake. Recent examples include Apples string of "I" products (pod, phones, pad), and Amazon's Kindle which have added tremendous value to those companies. Students may cite examples from the text such as Kimberly-Clark's Huggies or Walmart's use of central distribution centers. Examples of less than successful decisions, at least so far, might include the Segue or the Gap's ephemeral redesigned logo. (Students' answers will vary their experience and recent events.)
14) Distinguish between revenue enhancement investments, cost-reduction investments, and mandated investments.
Answer: Revenue enhancements investments may include new product lines such as Amazon's Kindle or GM's Chevy Volt undertaken, obviously, to increase cash flows by increasing sales. Companies such as Walmart may expand internationally or enter new businesses such as groceries for the same reason. Cost reduction investments such as improved distribution, energy saving equipment or loss prevention systems may not increase sales, but increase cash flows by reducing costs. Mandated investments may include such issues as access for the handicapped, pollution abatement, or employee safety. They are unavoidable because required by federal, state, or local laws. In these cases, companies will seek the least expensive way to comply.
15) Why is it so difficult for firms to find good investment ideas?
Answer: All firms are competing to maximize their value, so if an idea is obvious, many companies will pursue it at the same time. The Blackberry, for example, soon faced intense competition from any number of smart phones. Companies often find the best opportunities in areas where they have some protection from competition because they possess proprietary technology (Pfizer, Merck), strong brand loyalty (Coca Cola), or because the business is very expensive to enter (Toyota, Disney).
2. Net Present Value
1) Project Sigma requires an investment of $1 million and has a NPV of $10. Project Delta requires an investment of $500,000 and has a NPV of $150,000. The projects involve unrelated new product lines.
Answer: A
2) ABC Service can purchase a new assembler for $15,052 that will provide an annual net cash flow of $6,000 per year for five years. Calculate the NPV of the assembler if the required rate of return is 12%. (Round your answer to the nearest $1.)
Answer: D
3) Central Mass Ambulance Service can purchase a new ambulance for $200,000 that will provide an annual net cash flow of $50,000 per year for five years. Calculate the NPV of the ambulance if the required rate of return is 9%. (Round your answer to the nearest $1.)
Answer: C
4) Central Mass Ambulance Service can purchase a new ambulance for $200,000 that will provide an annual net cash flow of $50,000 per year for five years. The salvage value of the ambulance will be $25,000. Assume the ambulance is sold at the end of year 5. Calculate the NPV of the ambulance if the required rate of return is 9%. (Round your answer to the nearest $1.)
Answer: B
5) Fitchminster Armored Car can purchase a new vehicle for $200,000 that will provide annual net cash flow over the next five years of $40,000, $45,000, $50,000, $55,000, $60,000. The salvage value of the vehicle will be $25,000. Assume that the vehicle is sold at the end of year 5. Calculate the NPV of the ambulance if the required rate of return is 9%. (Round your answer to the nearest $1.)
Answer: A
6) Project H requires an initial investment of $100,000 and the produces annual cash flows of $50,000, $40,000, and $30,000. Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000, $40,000, and $50,000. If the required rate of return is greater than 0% and the projects are mutually exclusive
Answer: A
7) Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years. Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1, $40,000 in year 2, and $70,000 in year 3. If the discount rate is 10% and the projects are mutually exclusive
Answer: B
8) Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years. Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1, $40,000 in year 2, and $70,000 in year 3. If the discount rate is 10% and the projects are not mutually exclusive
Answer: D
9) Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years. Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1, $40,000 in year 2, and $70,000 in year 3. If the discount rate increases from 10% to 16%
Answer: D
10) A machine costs $1,000, has a three-year life, and has an estimated salvage value of $100. It will generate after-tax annual cash flows (ACF) of $600 a year, starting next year. If your required rate of return for the project is 10%, what is the NPV of this investment? (Round your answer to the nearest $10.)
Answer: B
11) Suppose you determine that the NPV of a project is $1,525,855. What does that mean?
Answer: B
12) Project January has a NPV of $50,000, project December has a NPV of $40,000. Which of the following circumstances could make it possible to choose December over January?
Answer: C
13) The present value of the total costs over a five year period for Project April is $50,000. The net present value of total costs over a 4 year period for Project October is $40,000. The company uses a discount rate of 9%. Which project should it choose and why?
Answer: D
14) Warchester Inc. is considering the purchase of copying equipment that will require an initial investment of $15,000 and $4,000 per year in annual operating costs over the equipment's estimated useful life of 5 years. The company will use a discount rate of 8.5%. What is the equivalent annual cost?
Answer: D
15) Artie's Soccer Ball Company is considering a project with the following cash flows:
Initial outlay = $750,000
Incremental after-tax cash flows from operations Years 1-4 = $250,000 per year
Compute the NPV of this project if the company's discount rate is 12%.
Answer: A
The information below describes a project with an initial cash outlay of $10,000 and a required return of 12%.
After-tax cash inflow
Year 1 $6,000
Year 2 $2,000
Year 3 $2,000
Year 4 $2,000
16) Which of the following statements is correct?
Answer: B
17) You have been asked to analyze a capital investment proposal. The project's cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project's NPV?
Answer: D
18) Which of the following is a correct equation to solve for the NPV of the project that has an initial outlay of $30,000, followed by incremental cash inflows in the next 3 years of $15,000, $20,000, and $30,000? Assume a discount rate of 10%.
Answer: B
19) Project EH! requires an initial investment of $50,000, and has a net present value of $12,000. Project BE requires an initial investment of $100,000, and has a net present value of $13,000. The projects are mutually exclusive. The firm should accept
Answer: B
20) Project Eh! requires an initial investment of $50,000, and has a net present value of $12,000. Project B requires an initial investment of $100,000, and has a net present value of $13,000. The projects are proposals for increasing revenue and are not mutually exclusive. The firm should accept
Answer: C
21) A machine has a cost of $5,375,000. It will produce cash inflows of $1,825,000 (Year 1); $1,775,000 (Year 2); $1,630,000 (Year 3); $1,585,000 (Year 4); and $1,650,000 (Year 5). At a discount rate of 16.25%, what is the NPV?
Answer: D
22) A machine has a cost of $5,575,000. It will produce cash inflows of $1,825,000 (Year 1); $1,775,000 (Year 2); $1,630,000 (Year 3); $1,585,000 (Year 4); and $1,650,000 (Year 5). At a discount rate of 16.25%, the project should be
Answer: B
23) Which of the following is the correct equation to solve for the NPV of the project that has an initial outlay of $30,000, followed by three years of $20,000 in incremental cash inflow? Assume a discount rate of 10%.
Answer: B
24) Project Full Moon has an initial outlay of $30,000, followed by positive cash flows of $10,000 in year 1, $15,000 in year 2, and $15,000 in year 3. The project should be accepted if the required rate of return is
Answer: B
25) Which of the following is a correct EXCEL formula to solve for the net present value of a project.
Answer: A
26) WSU Inc. has various options for replacing a piece of manufacturing equipment. The present value of costs for option Ell is $84,000. Option Ell has a useful life of 5 years; annual operating costs were discounted at 9%. What is the equivalent annual cost?
Answer: B
27) The equivalent annual cost (EAC) method is appropriate for evaluating accessibility projects mandated by the Americans With Disabilities Act.
Answer: TRUE
28) The required rate of return represents the cost of capital for a project.
Answer: TRUE
29) The higher the discount rate, the greater the importance of the early cash flows.
Answer: TRUE
30) The equivalent annual cost (EAC) method is helpful for mutually exclusive projects with unequal economic lives.
Answer: TRUE
31) What is the NPV of a $45,000 project that is expected to have an after-tax cash flow of $14,000 for the first two years, $10,000 for the next two years, and $8,000 for the fifth year? Use a 10% discount rate. Would you accept the project?
Answer:
>Year | >After-tax Cash Flow | >PVIF at 10% | Present Value |
>1 | >$14,000 | >.909 | $12,726 |
>2 | >$14,000 | >.826 | $11,564 |
>3 | >$10,000 | >.751 | $7,510 |
>4 | >$10,000 | >.683 | $6,830 |
5 | $8,000 | .621 | $4,968 |
Present value cash flow | $43,598 | ||
Initial outlay | 45,000 | ||
Net present value | $-1,402 |
32) Dieyard Battery Recyclers is considering a project with the following cash flows:
Initial outlay = $13,000
Cash flows: Year 1 = $5,000
Cash flows: Year 2 = $3,000
Cash flows: Year 3 = $9,000
If the appropriate discount rate is 15%, compute the NPV of this project.
Answer: NPV=13,000 + 5,000/(1.15) + 3,000/(1.15)2 + 9,000/(1.15)3
33) Two projects are under consideration by the same company at the same time. Project Alpha has a NPV of $20 million and an estimated useful life of 10 years. Project Beta has a NPV of $12 million and also an estimated useful life of 10 years. What should the company's decision be
Answer: If the projects involve unrelated expansion decisions, they should both be accepted because they both add significant value to the firm. If they are mutually exclusive, they cannot both be accepted so the company should accept project Alpha because it has the higher NPV and reject project Beta.
34) Dudster Manufacturing has 2 options for installing legally required safety equipment. Option Ex has an initial cost of $25,000 and annual operating costs over 3 years of $5,000, $5,250, $5,600. Option WYE has an initial cost of $40,000 and annual operating costs of $4,000, $4,200, $4,450, $4,750, $5,100. Whether Dudster chooses Ex or Wye, the equipment is always needed and must be replaced at the end of its useful life. Which choice is least expensive over the long run? Use a discount rate of 9%.
Answer:
NPV Project X = -$25,000 - $5,000/(1.09)1 - $5,250/(1.09)2 - $5,600/(1.09)3 =-$38,330.20
NPV = -$40,000 - $4,000/(1.09)1 - $4,200/(1.09)2 - $4,450/(1.09)3 - $4,750/(1.09)4 - $5,100/(1.09)5 = -$57,320.67. Using a financial calculator, the EAC for project Ex is N = 3, i = 9,PV = -38,330.20, PMT = 15,138.57, FV = 0. For Project Wye N = 5, i = 9,PV = -57,320.67, PMT = 14,736.71, FV = 0. Project Wye has the lower EAC (PMT) and should be selected.
35) What is the NPV of a $45,000 project that is expected to have an after-tax cash flow of $14,000 for the first two years, $10,000 for the next two years, and $8,000 for the fifth year? Use a discount rate of 8%. Would you accept or reject the investment?
Answer:
Year | After-tax Cash Flow | PVIF at 8% | Present Value |
1 | $14,000 | .926 | $12,964 |
2 | $14,000 | .857 | $11,998 |
3 | $10,000 | .794 | $7,940 |
4 | $10,000 | .735 | $7,350 |
5 | $8,000 | .681 | $5,448 |
Present value of cash flows | $45,700 | ||
Initial outlay | $45,000 | ||
Net present value | $ 700 |
3. Other Investment Criteria
1) Webley Corp. is considering two expansion options, but does not have enough capital to undertake both, Project W requires an investment of $100,000 and has an NPV of $10,000. Project D requires an investment of $80,000 and has an NPV of $8,200. If Webley uses the profitability index to decide, it would
Answer: A
2) If a project has a profitability index greater than 1
Answer: D
3) A project has an initial outlay of $4,000. It has a single payoff at the end of Year 4 of $6,996.46. What is the IRR for the project (round to the nearest percent)?
Answer: D
4) Given the following annual net cash flows, determine the IRR to the nearest whole percent of a project with an initial outlay of $1,800.
Year | Net Cash Flow |
1 | $1,000 |
2 | $750 |
3 | $500 |
Answer: A
5) Initial Outlay Cash Flow in Period
1 2 3 4
-$4,000 $1,546.17 $1,546.17 $1,546.17 $1,546.17
The IRR (to the nearest whole percent) is
Answer: C
6) Your company is considering a project with the following cash flows:
Initial outlay = $1,748.80
Cash flows Years 1-6 = $500
Compute the IRR on the project.
Answer: C
7) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). If the company 's required rate of return is 12%, the project should be
Answer: B
8) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000).
Answer: D
9) Compute the payback period for a project with the following cash flows, if the company's discount rate is 12%.
Initial outlay = $450
Cash flows: Year 1 = $325
Cash flows: Year 2 = $65
Cash flows: Year 3 = $100
Answer: D
10) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000).
Answer: C
11) Project Black Swan requires an initial investment of $115,000. It has positive cash flows of $140,000 for each of the next two years. Because of major demolition and environmental clean-up costs, cash flow for the third and final year of the project is $(170,000). The company accepts all projects with a payback period of 2 years or less.
Answer: D
12) Consider a project with the following cash flows:
Year | After-Tax Accounting Profits | After-Tax Cash Flow from Operations |
1 | $799 | $750 |
2 | $150 | $1,000 |
3 | $200 | $1,200 |
Initial outlay = $1,500
Terminal cash flow = 0
Compute the profitability index if the company's discount rate is 10%.
Answer: B
13) Manheim Candles is considering a project with the following incremental cash flows. Assume a discount rate of 10%.
Year | Cash Flow |
0 | ($20,000) |
1 | 0 |
2 | $30,000 |
3 | $30,000 |
Calculate the project's MIRR. (Round to the nearest whole percentage.)
Answer: B
14) Project H requires an initial investment of $100,000 and produces annual cash flows of $50,000, $40,000, and $30,000. Project T requires an initial investment of $100,000 and the produces annual cash flows of $30,000, $40,000, and $50,000. The projects are mutually exclusive. The company accepts projects with payback periods of 3 years or less.
Answer: A
15) A new forklift under consideration by Home Warehouse requires an initial investment of $100,000 and produces annual cash flows of $50,000, $40,000, and $30,000. Which of the following will not change if the required rate of return is increased from 10% to 12%.
Answer: B
16) Project Ell requires an initial investment of $50,000 and the produces annual cash flows of $30,000, $25,000, and $15,000. Project Ess requires an initial investment of $60,000 and then produces annual cash flows of $25,000 per year for the next ten years. The company ranks projects by their payback periods.
Answer: D
17) Which of the following series of cash flows could have more than one IRR? (Negative cash flows are in parentheses.)
Answer: B
Below are the expected after-tax cash flows for Projects Y and Z. Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.
Project Y | Project Z | |
Year 1 | $12,000 | $10,000 |
Year 2 | $8,000 | $10,000 |
Year 3 | $6,000 | 0 |
Year 4 | $2,000 | 0 |
Year 5 | $2,000 | 0 |
18) Payback for Project Y is
Answer: A
19) What is payback for Project Z?
Answer: A
20) MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000. The project will generate after-tax cash flows of $33,100 in Year 1, $31,500 in Year 2, and $31,200 in Year 3. Assume that the firm's proper rate of discount is 10% and that the firm's tax rate is 40%. What is the project's payback?
Answer: C
21) MacHinery Manufacturing Company is considering a three-year project that has a cost of $75,000. The project will generate after-tax cash flows of $33,100 in Year 1, $31,500 in Year 2, and $31,200 in Year 3. Assume that the appropriate discount rate is 10% and that the firm's tax rate is 40%. What is the project's discounted payback period?
Answer: A
22) Analysis of a machine indicates that it has a cost of $5,375,000. The machine is expected to produce cash inflows of $1,825,000 in Year 1; $1,775,000 in Year 2; $1,630,000 in Year 3; $1,585,000 in Year 4; and $1,650,000 in Year 5. What is the machine's IRR?
Answer: B
Below are the expected after-tax cash flows for Projects Y and Z. Both projects have an initial cash outlay of $20,000 and a required rate of return of 17%.
Project Y | Project Z | |
Year 1 | $12,000 | $10,000 |
Year 2 | $8,000 | $10,000 |
Year 3 | $6,000 | 0 |
Year 4 | $2,000 | 0 |
Year 5 | $2,000 | 0 |
23) Discounted payback periods for projects Y and Z are
Answer: B
24) You are considering investing in a project with the following year-end after-tax cash flows:
Year 1: $5,000
Year 2: $3,200
Year 3: $7,800
If the initial outlay for the project is $12,113, compute the project's IRR.
Answer: A
25) WKW, Inc. is analyzing a project that requires an initial investment of $10,000, followed by cash inflows of $1,000 in Year 1, $4,000 in Year 2, and $15,000 in Year 3. The cost of capital is 10%. What is the profitability index of the project?
Answer: B
26) Frazier Fudge has a project with an initial outlay of $40,000, followed by three years of annual incremental cash flows of $35,000. At the end of the third year, equipment will be sold producing additional cash flow of $10,000. Assuming a cost of capital of 10%, calculate the MIRR of the project.
Answer: A
27) Frazier Fudge has a project with an initial outlay of $40,000, followed by three years of annual incremental cash flows of $35,000. At the end of the third year, equipment will be sold producing additional cash flow of $10,000. Assuming a discount rate of 10%, which of the following is the correct equation to solve for the IRR of the project?
Answer: D
28) The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $100,000 today, and the firm's cost of capital is 10%. Assume cash flows occur evenly during the year.
Answer: B
29) The director of capital budgeting of South Park Development Corporation is evaluating a project that will cost $200,000; it is expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year. If the firm's cost of capital is 14% and its tax rate is 40%, what is the project's IRR?
Answer: C
30) The owner of a small construction business has asked you to evaluate the purchase of a new front end loader. You have determined that this investment has a large, positive, NPV, but are afraid that your client will not understand the method. A good alternative method in this circumstance might be
Answer: A
31) Whenever the IRR on a project equals that project's required rate of return
Answer: A
32) Aroma Candles, Inc. is evaluating a project with the following cash flows. Calculate the IRR of the project. (Round to the nearest whole percentage.)
Year | Cash Flows |
0 | ($120,000) |
1 | $30,000 |
2 | $70,000 |
3 | $90,000 |
Answer: B
33) Aroma Candles, Inc. is evaluating a project with the following cash flows. The project involves a new product that will not affect the sales of any other project. Which two methods would always lead to the same accept/reject decision for this project, regardless of the discount rate.
Year | Cash Flows |
0 | ($120,000) |
1 | $30,000 |
2 | $70,000 |
3 | $90,000 |
Answer: C
34) Which of the following is considered to be a deficiency of the IRR?
Answer: B
35) You have been asked to analyze a capital investment proposal. The project's cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project's MIRR?
Answer: D
36) Dizzyland Enterprises has been presented with an investment opportunity which will yield end-of-year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10%. What is the profitability index for this investment?
Answer: A
37) We compute the profitability index of a capital-budgeting proposal by
Answer: C
38) What is the payback period for a $20,000 project that is expected to return $6,000 for the first two years and $3,000 for Years 3 through 5?
Answer: C
39) The payback method focuses primarily on the length of time required to recover the cost of the investment rather than estimating the total value the project will add to the firm.
Answer: TRUE
40) One advantage of the payback method is that it can be readily understood by people with no special training in finance.
Answer: TRUE
41) When several sign reversals in the cash flow stream occur, the IRR equation can have more than one positive IRR.
Answer: TRUE
42) If the project's internal rate of return is greater than or equal to zero, the project should always be accepted.
Answer: FALSE
43) The profitability index provides the same accept/reject decision result as the net present value (NPV) method but would not necessarily rank mutually exclusive projects the same way.
Answer: TRUE
44) The internal rate of return (IRR) will increase as the required rate of return of a project is increased.
Answer: FALSE
45) The IRR assumes that cash flows are reinvested at the cost of capital.
Answer: FALSE
46) If the NPV of a project is zero, then the profitability index should equal one.
Answer: TRUE
47) Unlike the basic IRR method, the MIRR method allows the analyst to specify a reinvestment rate for positive cash flows.
Answer: TRUE
48) According to the modified internal rate of return (MIRR) technique, when a project's MIRR is greater than its cost of capital, the project should be accepted.
Answer: TRUE
49) The IRR is the discount rate that equates the present value of the project's future net cash flows with the project's initial outlay.
Answer: TRUE
50) Determine the IRR on the following projects:
Answer:
Using a financial calculator
51) Discuss the merits and shortcomings of using the payback period for capital budgeting decisions.
Answer: The payback period is intuitive and easily understood even by those with no training in finance. It also provides a quick assessment of a project's risk because cash flow forecasts are likely to be more accurate for the near-term.
On the other hand, there is no clear-cut decision rule associated with this method; it does not specifically take the time value of money into account, and it ignores cash flows that occur after the payback period.
52) Project November requires an initial investment of $500,000. The present value of operating cash flows is $550,000. Project December requires an initial investment of $750,000. The present value of operating cash flows is $810,000.
Answer:
53) Black Friday Inc. has estimated the following cash flows for a project it is considering:
Period |
Cash Flow |
0 |
($150,000) |
1 |
$70,000 |
2 |
$80,000 |
3 |
($100,0000) |
Answer: The payback period is exactly 2 years (70,000+80,000) = 150,000. However, the project obviously has a negative NPV at any discount rate. One major problem with the payback method is that it ignores cash flows occurring after the payback period.
54) Tinker Tools, Inc. is considering a project with the following cash flows. Calculate the MIRR of the project assuming a reinvestment rate of 8%.
Year | Cash Flows |
0 | ($70,000) |
1 | ($55,000) |
2 | $40,000 |
3 | $60,000 |
4 | $100,000 |
Answer:
PV Cash Outflows
Year 0 = -$70,000
Year 1: Calculator Steps' → N=1, i=8, FV=-55,000, solve for PV = -$50,926
PV Outflows = -$70,000 - $50,926 = -$120,926
FV of Cash Inflows
N=2, i=8, PV=40000, PMT =0, solve for FV = $46,656
N=1, i=8, PV=60000, PMT =0, solve for FV = $64,800
FV of Inflows = $46,656 +$64,800 + $100,000 = $211,456
MIRR: N=4, PV=-$120,926,FV= $211,456 solve for i=15%
11. A Glance at Actual Capital-Budgeting Practices
1) Recent surveys of the CFOs of large U.S. companies rank the popularity of major capital budgeting methods in which order?
Answer: A
2) Which of the following best explains the continuing popularity of the payback method?
Answer: A
3) With respect to the capital budgeting practices of large U. S. corporations
Answer: B
4) Which of the following techniques will always produce a single rate of return estimate?
Answer: B
5) Which of the following techniques might be useful in situations where the economic life of a project is highly uncertain?
Answer: D
6) Which of the following techniques might be useful in situations where mutually exclusive projects have unequal lives?
Answer: B
7) When various capital budgeting techniques rank mutually exclusive projects differently, which of the following is theoretically most reliable?
Answer: C
8) Many firms today continue to use the payback method but employ the NPV or IRR methods as secondary decision methods of control for risk.
Answer: FALSE
9) Currently, most firms use NPV and IRR as their primary capital-budgeting technique.
Answer: TRUE
10) Most firms use the payback period as a secondary capital-budgeting technique, which in a sense allows them to control for risk.
Answer: TRUE
11) Although discounted cash flow decision techniques have become widely accepted, their use depends to some degree on the size of the project and where within the firm the decision is being made.
Answer: TRUE
12) Briefly describe the actual capital budgeting methods of large U.S. corporations.
Answer: According to recent surveys of CFOs, the most common methods are IRR and NPV used by more than 70% of large corporations. The payback method remains popular and is used as a primary or secondary method by almost 60% of those surveyed, perhaps because of its simplicity and for a quick calculation of risk.
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