1．A firm is unable to raise the necessary funding for all projects that have positive expected net present values. Therefore, this firm must:

A)   declare bankruptcy.

B)   engage in capital rationing.

C)   hire an investment banker.

D)   cut overhead and other costs.

2．A given firm cannot invest in all projects that have a higher return than the associated cost of capital. Therefore, the firm must engage in:

A)   sensitivity analysis.

B)   capital rationing.

C)   a pure play.

D)   Monte Carlo simulations.

capital rationing and allocate available funds to the best projects.

3．In the absence of capital rationing, a firm should take on the most profitable investments first and keep expanding their investments to the point where the marginal:

A)   return of the last investment equals the marginal cost of capital.

B)   return of the last investment equals the risk free rate.

C)   returns of all investments are equal.

D)   cost of debt equals the marginal cost of equity.

4．Which of the following statements about mutually exclusive projects with unequal lives is FALSE?

A)   The replacement chain approach assumes continuous replacements can and will be made each time the asset's life ends.

B)   For comparing mutually exclusive projects with unequal lives, replacement chain analysis leads to the same decision as obtained by calculating the equivalent annual annuity.

C)   Mutually exclusive projects sometimes have long and different lives, which makes applying the replacement chain method difficult because the lowest common denominator is very large. The equivalent annual annuity is a substitute method that uses the annuity concept to value a project's cash flows.

D)   In comparing mutually exclusive projects with unequal lives, you should always choose the project which has the highest NPV.

5．Which of the following statements about the equivalent annual annuity approach for capital budgeting is FALSE?

A)   A 5-year project has a NPV of $2,000, if the firm's cost of capital is 10% the equivalent annual annuity is $725.

B)   The replacement chain approach assumes that it is possible to make continuous replacements each time the asset's life ends.

C)   When comparing mutually exclusive projects with unequal lives, replacement chain analysis yields the same decision as the equivalent annual annuity method.

D)   Mutually exclusive projects sometimes have very long lives making the replacement chain method difficult to apply. The equivalent annual annuity (EAA) is a substitute method that uses annuity concepts to value a project's cash flows.

6.Jayco, Inc. is evaluating two mutually exclusive investment projects. Assume both projects can be repeated indefinitely. Printer A has a net present value (NPV) of $20,000 over a three-year life and Printer B has a NPV of $25,000 over a five-year life. The project types are equally risky and the firm's cost of capital is 12 percent. What is the equivalent annual annuity (EAA) of project A and B?

A)           $8,327                                $6,935

B)           $8,327                                   $5,326

C)           $7,592                                   $6,935

D)           $7,592                                   $5,326

1．A firm is unable to raise the necessary funding for all projects that have positive expected net present values. Therefore, this firm must:

A)   declare bankruptcy.

B)   engage in capital rationing.

C)   hire an investment banker.

D)   cut overhead and other costs.

The correct answer was B)

When a firm is unable to fund all projects that have positive expected net present values, the firm must engage in capital rationing.

2．A given firm cannot invest in all projects that have a higher return than the associated cost of capital. Therefore, the firm must engage in:

A)   sensitivity analysis.

B)   capital rationing.

C)   a pure play.

D)   Monte Carlo simulations.

The correct answer was B)

If a firm cannot invest in all the profitable projects available, the managers must engage in capital rationing and allocate available funds to the best projects.

3．In the absence of capital rationing, a firm should take on the most profitable investments first and keep expanding their investments to the point where the marginal:

A)   return of the last investment equals the marginal cost of capital.

B)   return of the last investment equals the risk free rate.

C)   returns of all investments are equal.

D)   cost of debt equals the marginal cost of equity.

The correct answer was A)

The firm will generally invest in the most profitable projects first. Subsequent projects will have lower expected returns. As the amount of capital increases, the marginal cost of capital tends to rise. The firm should invest in new projects until the expected return is equal to the marginal cost of capital.

4．Which of the following statements about mutually exclusive projects with unequal lives is FALSE?

A)   The replacement chain approach assumes continuous replacements can and will be made each time the asset's life ends.

B)   For comparing mutually exclusive projects with unequal lives, replacement chain analysis leads to the same decision as obtained by calculating the equivalent annual annuity.

C)   Mutually exclusive projects sometimes have long and different lives, which makes applying the replacement chain method difficult because the lowest common denominator is very large. The equivalent annual annuity is a substitute method that uses the annuity concept to value a project's cash flows.

D)   In comparing mutually exclusive projects with unequal lives, you should always choose the project which has the highest NPV.

The correct answer was D)

In comparing mutually exclusive projects replacement chain or equivalent annual annuity analysis should be used if the projects have unequal lives and can be replicated. Therefore, you will not always choose the project that has the highest NPV, if a project with a lower NPV can be replicated and results in a higher NPV over the same period of time as the project that has a longer time period.

5．Which of the following statements about the equivalent annual annuity approach for capital budgeting is FALSE?

A)   A 5-year project has a NPV of $2,000, if the firm's cost of capital is 10% the equivalent annual annuity is $725.

B)   The replacement chain approach assumes that it is possible to make continuous replacements each time the asset's life ends.

C)   When comparing mutually exclusive projects with unequal lives, replacement chain analysis yields the same decision as the equivalent annual annuity method.

D)   Mutually exclusive projects sometimes have very long lives making the replacement chain method difficult to apply. The equivalent annual annuity (EAA) is a substitute method that uses annuity concepts to value a project's cash flows.

The correct answer was A)

EAA = PMT = 528, i = 10, n = 5, PV = –2,000, PMT = 528.

6.Jayco, Inc. is evaluating two mutually exclusive investment projects. Assume both projects can be repeated indefinitely. Printer A has a net present value (NPV) of $20,000 over a three-year life and Printer B has a NPV of $25,000 over a five-year life. The project types are equally risky and the firm's cost of capital is 12 percent. What is the equivalent annual annuity (EAA) of project A and B?

A)           $8,327                                $6,935

B)           $8,327                                   $5,326

C)           $7,592                                   $6,935

D)           $7,592                                   $5,326

The correct answer was A)

Printer A: PV = 20,000, N = 3, I = 12, FV = 0, Compute PMT = 8,327: Printer B: PV = 25,000, N = 5, I = 12, FV = 0, Compute PMT = 6,935, Note take the highest EAA, Printer A in this example.