NPV & IRR questions and answers

Answer Options:
have two net present value profiles
have operational ambiguity
create a mutually exclusive investment decision
produce multiple economies of scale
have multiple rates of return

Answer: E — have multiple rates of return

Question: Which one of the following outcomes indicates that an independent project with conventional cash flows should be accepted?

Answer Options:
Profitability index that is less than 1.0
Project’s internal rate of return that is less than the required return
Discounted payback period that is greater than the required return
Average accounting return that is less than the internal rate of return
Modified internal rate of return that exceeds the required return

Answer: E — Modified internal rate of return that exceeds the required return

Question: Which one of the following descriptions is the best example of two mutually exclusive projects?

Answer Options:
Building a music store next to a mattress store in the same shopping mall
Producing both compostable wooden forks and spoons on the same assembly line
Using an empty warehouse to store both raw materials and finished goods
Promoting two products during the same television commercial
Waiting until a machine finishes sewing Product X before being able to sew Product Y

Answer: E — Waiting until a machine finishes sewing Product X before being able to sew Product Y

Question: An analyst has evaluated two mutually exclusive projects that have 3-year lives. Project X has an NPV of $65,000, a payback period of 2.3 years, and an AAR of 10.5 percent. Project Y has an NPV of $72,000, a payback period of 2.6 years, and an AAR of 8.9 percent. The required return for Project X is 12 percent while it is 13 percent for Project Y. Both projects have a required AAR of 8.5 percent. What outcome should the analyst recommend?

Answer Options:
Accept both projects because both NPVs are positive
Accept Project X because it has the shortest payback period
Accept Project Y and reject Project X based on their NPVs
Accept Project X and reject Project Y based on their AARs
Accept Project X because it has the lower required return

Answer: C — Accept Project Y and reject Project X based on their NPVs

Question: Which one of the following methods of analysis provides the best information on the benefits to be received from a project per dollar invested?

Answer Options:
Net present value
Payback
Internal rate of return
Average accounting return
Profitability index

Answer: E — Profitability index

Question: Given independent projects with conventional cash flows, which one of the following statements would generally be considered as accurate?

Answer Options:
The internal rate of return decision may contradict the net present value decision
Business practice dictates that independent projects should have three distinct accept indicators before a project is actually implemented
The payback decision rule could override the net present value decision rule if the availability of cash is limited
The profitability index rule cannot be applied in this situation
The projects cannot be accepted unless the average accounting return decision ruling is positive

Answer: C — The payback decision rule could override the net present value decision rule if the availability of cash is limited

Question: Two mutually exclusive projects have an initial cost of $41,000 each. Project X produces cash inflows of $29,000, $33,000, and $28,000 for Years 1 through 3, respectively. Project Y produces cash inflows of $29,000, $30,500 and $23,000 for Years 1 through 3, respectively. The required rate of return is 10.7 percent for Project X and 9.8 percent for Project Y. Which project(s) should be accepted and why?

Answer Options:
Project X, because it has the higher required rate of return
Project X, because it has the larger NPV
Both projects, because they both have positive NPVs
Project Y, because it has the higher required rate of return
Project Y, because it has the larger NPV

Answer: B — Project X, because it has the larger NPV

Question: An analyst estimates the cost of a new project will be $10,000. The project is expected to produce net cash inflows of $2,700, $5,100, $8,600, and $13,000 over the next four years, respectively. If the firm employs a 3-year payback requirement for these types of projects, what should the analyst recommend?

Answer Options:
Reject; the payback period is 3.77 years
Reject; the payback period is 2.94 years
Accept; the payback period is 1.64 years
Accept; the payback period is 2.51 years
Accept; the payback period is 2.26 years

Answer: E — Accept; the payback period is 2.26 years

Question: A project has an initial cost of $18,400 and expected cash inflows of $7,200, $8,900, and $7,500 over Years 1 to 3, respectively. What is the discounted payback period if the required rate of return is 11.2 percent?

Answer Options:
2.31 years
2.45 years
2.55 years
2.87 years
Never

Answer: D — 2.87 years

Question: A project has a required discount rate of 15.2 percent and an initial cost of $309,000. The cash inflows are $47,000, $198,000, and $226,000 for Years 2 to 4, respectively. Should the project be accepted based on discounted payback if the required payback period is 2.5 years?

Answer Options:
Accept; the discounted payback period is 2.18 years
Accept; the discounted payback period is 2.32 years
Accept; the discounted payback period is 2.98 years
Reject; the discounted payback period is 3.87 years
Reject; the project never pays back on a discounted basis

Answer: E — Reject; the project never pays back on a discounted basis

Question: A project will generate sales of $86,800 per year for the next four years. The project’s initial cost is $97,500, the profit margin is 6 percent, 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.

Answer Options:
rejected; 11.03
accepted; 10.68
rejected; 11.16
accepted; 11.03
rejected; 10.68

Answer: E — rejected; 10.68

Question: A project has an initial cost of $31,300 and a three-year life. The company uses straight-line depreciation to a book value of zero over the life of the project. The projected net income from the project is $1,750, $2,100, and $1,700 per year for the next three years, respectively. What is the average accounting return?

Answer Options:
12.79%
11.82%
10.35%
11.69%
10.14%

Answer: B — 11.82%

Question: Projects X and Y are mutually exclusive and have an initial cost of $78,000 each. Project X has annual cash flows for Years 1 to 3 of $28,300, $31,500, and $22,300, respectively. Project Y has annual cash flows for Year 1 of $36,900 and $40,500 for Year 2. What is the crossover rate?

Answer Options:
17.17%
16.33%
17.32%
16.99%
15.20%

Answer: D — 16.99%

Question: 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.

Answer Options:
11.03; accept
8.03; reject
9.87; reject
10.47; reject
10.93; accept

Answer: E — 10.93; accept