Unit 6: Investment Decisions - Practice Quiz

1 What is the main purpose of discounting future cash flows?

2 Which formula calculates the present value of a cash flow received after periods at discount rate ?

3 What does Net Present Value measure?

4 Under the NPV rule, when should an independent project generally be accepted?

5 A project requires an initial investment of $1,000 and has cash inflows with a total present value of $1,200. What is its NPV?

6 What is the Internal Rate of Return of a project?

7 Under the IRR rule, an independent project is generally accepted when:

8 What does the discounted payback period measure?

9 How does the discounted payback period differ from the regular payback period?

10 Which cash flows are relevant when evaluating a capital investment?

11 Why is depreciation added back when estimating operating cash flow using accounting profit?

12 How should a sunk cost generally be treated in a capital budgeting analysis?

13 An increase in net working capital at the beginning of a project is usually treated as:

14 Which statement correctly compares the usual reinvestment assumptions of NPV and IRR?

15 If NPV and IRR rank mutually exclusive projects differently, which method is generally preferred for maximizing firm value?

16 What is the main purpose of risk analysis in capital budgeting?

17 Which project would generally be considered riskier, all else being equal?

18 In sensitivity analysis, what is typically changed at one time?

19 What does sensitivity analysis help a financial manager identify?

20 What does the certainty equivalent approach do to a risky expected cash flow?

21 A project costs and generates at the end of each of the next three years. If the required return is , what is the project's approximate NPV?

22 A project requires an initial investment of and produces at the end of each of the next two years. What is its approximate IRR?

23 A project costs and generates annually for three years. At a discount rate of , what is its approximate discounted payback period?

24 A company paid for a feasibility study before deciding whether to undertake a project. How should this amount be treated when estimating the project's cash flows?

25 A company owns land that can be sold today for . If the land is instead used for a proposed project, what amount should be included in the project's initial cash flow, ignoring taxes?

26 Equipment costing is depreciated straight-line to zero over four years. If the corporate tax rate is , what annual depreciation tax shield should be included in operating cash flow?

27 A project requires an additional of net working capital immediately, all of which will be recovered when the project ends. How should this be recorded?

28 Two mutually exclusive projects have conflicting rankings: Project A has the higher IRR, while Project B has the higher positive NPV at the company's required return. Which project should normally be selected?

29 Project A pays in one year, while Project B pays in two years. Both require the same initial investment. At approximately what discount rate will the projects have equal NPVs?

30 A project has cash flows of , , and in years 0, 1, and 2, respectively. Why can the IRR method be problematic for this project?

31 A project's base-case NPV is . A decrease in sales volume reduces NPV to . What is the sensitivity of NPV to sales volume, measured as percentage change in NPV divided by percentage change in volume?

32 A project's NPV can be expressed as , where is annual unit sales. If base-case sales are units, by what percentage can sales decline before NPV becomes zero?

33 A project's possible NPVs are , , and , with probabilities of , , and , respectively. What is the expected NPV?

34 Project A has an expected NPV of and a standard deviation of . Project B has an expected NPV of and a standard deviation of . Which project has lower relative risk?

35 Under the risk-adjusted discount-rate approach, how should a company normally evaluate a project that is riskier than its average project?

36 A one-year project has an expected cash inflow of and a certainty-equivalent coefficient of . If the risk-free rate is , what is the present value of the risk-adjusted inflow?

37 A project costs and has expected inflows of in year 1 and in year 2. The certainty-equivalent coefficients are and , respectively, and the risk-free rate is . What is the approximate NPV?

38 Project A has an NPV of and a two-year life. Project B has an NPV of and a three-year life. If the projects can be repeated and the discount rate is , which has the higher equivalent annual annuity?

39 A project requires an initial investment of and has discounted future cash inflows totaling . What is its profitability index, and should it be accepted if projects are independent?

40 A project's cash flows are forecast in nominal terms, including expected inflation. Which discount rate should be used to calculate a consistent NPV?

41 A project requires an immediate investment of $500 and generates cash inflows of $180, $220, and $260 at the ends of years 1, 2, and 3. The corresponding annually compounded spot rates are 8%, 9%, and 11%. What is the project's NPV?

42 A project will produce a year-3 cash inflow of $500 measured in current purchasing power. Expected annual inflation is 4%, and the real required return is 6%. Assuming the Fisher relation holds exactly, what is the present value of the inflow?

43 A project has cash flows of , , , and at times 0 through 3. Positive cash flows are reinvested at 10%, while negative cash flows are financed at 8%. What is the project's modified internal rate of return?

44 Two mutually exclusive machines provide identical services and can be replaced indefinitely under unchanged conditions. At a 10% discount rate, Machine A has an NPV of $120 and a life of 2 years, while Machine B has an NPV of $160 and a life of 3 years. Which choice is correct using the equivalent annual annuity method?

45 A project has cash flows of at time 0, at time 1, and at time 2. Which statement correctly identifies its internal rates of return?

46 Project A costs $1,000 and pays $600 in each of years 1 and 2. Project B costs $1,600 and pays $900 in year 1 and $1,000 in year 2. What is the incremental IRR of choosing B over A, and which project is preferred at an 8% required return?

47 A project requires $500 immediately and generates $180 at each year-end for five years. Using a 10% discount rate and linear interpolation within the recovery year, what is its discounted payback period?

48 A new machine costs $800, requires $40 of installation costs, and increases net working capital by $60. Existing equipment with a book value of $140 can be sold immediately for $100. If the tax rate is 30%, what is the project's initial net cash outlay?

49 A project adds annual revenue of $500 and cash operating costs of $280 but reduces contribution margin from an existing product by $60. Annual project depreciation is $80, and the corporate tax rate is 25%. What is the annual incremental operating cash flow?

50 At project termination, equipment with a book value of $80 will be sold for $140. Net working capital of $50 will be recovered, and a tax-deductible cleanup payment of $20 will be made. If the tax rate is 30%, what is the total terminal cash flow?

51 Two one-year projects are mutually exclusive. Project A costs $1,000 and returns $1,400, while Project B costs $5,000 and returns $6,500. The required return is 10%, and capital is unconstrained. Which project should be selected?

52 Projects A and B each cost $1,000. A pays $200 in year 1 and $1,100 in year 2; B pays $900 in year 1 and $300 in year 2. Project B has a slightly higher IRR, and their crossover rate is approximately 14.29%. Which project should be selected at a 10% required return?

53 A project costs $600. The present value of its inflows will be $900 in a boom, $700 under normal conditions, or $400 in a recession, with probabilities 0.30, 0.50, and 0.20. What are the expected NPV and standard deviation of NPV?

54 A project costs $500 now and pays $100 at the end of year 1. At that time, demand is observed. With probability 0.60, year-2 cash flow will be $700; with probability 0.40, it will be $100. Instead of continuing, the firm may abandon the project at year 1 for $250. At a 10% discount rate, what is the project's NPV under the optimal abandonment policy?

55 Projects A and B have standard deviations of NPV equal to $100 and $80, respectively. Their NPV correlation is . If both projects are undertaken, what is the standard deviation of their combined NPV?

56 A three-year project costs $600,000, has no salvage value, and uses straight-line depreciation. Annual fixed cash costs are $60,000, unit price is $20, unit variable cost is $12, and the tax rate is 25%. At a 10% discount rate, what annual sales volume makes NPV equal to zero? Express volume in units.

57 Project A pays $1,000 in year 1. Project B pays an amount in year 5 chosen so that both cash flows have the same present value at 10%. If the discount rate rises from 10% to 11%, which statement best describes the change in present value?

58 A tornado chart shows that NPV changes more when selling price is moved through its selected range than when any other input is moved through its own selected range. What conclusion is justified?

59 A project costs $900 and has expected cash inflows of $300, $400, and $500 in years 1 through 3. The corresponding certainty-equivalent coefficients are 0.90, 0.80, and 0.70. If the risk-free rate is 5%, what is the certainty-equivalent NPV?

60 A single expected cash inflow of $1,000 occurs in year 2. It is valued using a 14% risk-adjusted discount rate. If the risk-free rate is 6%, what year-2 certainty-equivalent coefficient produces the same present value?