Multiple-Choice Quiz

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Chapter 13:   Capital Budgeting Techniques

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1. A profitability index of .85 for a project means that:

the present value of benefits is 85% greater than the project's costs.

the project's NPV is greater than zero.

the project returns 85 cents in present value for each current dollar invested.

the payback period is less than one year.

2. BackInSoon, Inc., has estimated that a proposed project's 10-year annual net cash benefit, received each year end, will be $2,500 with an additional terminal benefit of $5,000 at the end of the tenth year. Assuming that these cash inflows satisfy exactly BackInSoon's required rate of return of 8 percent, calculate the initial cash outlay. (Hint: With a desired IRR of 8%, use the IRR formula: ICO = discounted cash flows.)





3. Woatich Windmill Company is considering a project that calls for an initial cash outlay of $50,000. The expected net cash inflows from the project are $7,791 for each of 10 years. What is the IRR of the project? [(Hint: The cash f lows from the project are an annuity so you can solve for i in the equation PVA = R(PVIFAi,10).]

6 percent

7 percent

8 percent

9 percent

4. Which of the following statements is correct?

If the NPV of a project is greater than 0, its PI will equal 0.

If the IRR of a project is 0%, its NPV, using a discount rate, k, greater than 0, will be 0.

If the PI of a project is less than 1, its NPV should be less than 0.

If the IRR of a project is greater than the discount rate, k, its PI will be less than 1 and
     its NPV will be greater than 0.

5. Assume that a firm has accurately calculated the net cash flows relating to an investment proposal. If the net present value of this proposal is greater than zero and the firm is not under the constraint of capital rationing, then the firm should:

calculate the IRR of this investment to be certain that the IRR is greater than the cost of

compare the profitability index of the investment to those of other possible investments.

calculate the payback period to make certain that the initial cash outlay can be recovered
     within an appropriate period of time.

accept the proposal, since the acceptance of value-creating investments should increase
     shareholder wealth.

6. A project's profitability index is equal to the ratio of the          of a project's future cash flows to the project's         .

present value; initial cash outlay

net present value; initial cash outlay

present value; depreciable basis

net present value; depreciable basis

7. The discount rate at which two projects have identical          is referred to as Fisher's rate of intersection.

present values

net present values


profitability indexes

8. Two mutually exclusive investment proposals have "scale differences" (i.e., the cost of the projects differ). Ranking these projects on the basis of IRR, NPV, and PI methods          give contradictory results.

will never

will always


will generally

9. If capital is to be rationed for only the current period, a firm should probably first consider selecting projects by descending order of         .

net present value

payback period

internal rate of return

profitability index

10. The          method provides correct rankings of mutually exclusive projects, when the firm is not subject to capital rationing.

net present value

internal rate of return

payback period

profitability index

11. In an NPV sensitivity graph, a steep sensitivity line for a particular input variable means that a          in that variable results in a          in NPV.

small percentage change; large change

large percentage change; small change

12. One potential problem with sensitivity analysis is that it generally looks at sensitivity "one variable at a time." However, one way to judge the sensitivity of results to simultaneous changes in two variables, at least, is to construct an          .

NPV profile

NPV sensitivity matrix

NPV sensitivity graph

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