hinsafdar

Landen, Inc. uses several methods to evaluate capital projects. An appropriate decision rule for Landen would be to invest in a project if it has a positive:

A) profitability index (PI).

B) internal rate of return (IRR).

C) net present value (NPV).

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The decision rules for net present value, profitability index, and internal rate of return are to invest in a project if NPV > 0, IRR > required rate of return, or PI > 1.

hinsafdar

An analyst has gathered the following data about a company with a 12% cost of capital:

	Project A	Project B
Cost	$15,000	$25,000
Life	5 years	5 years
Cash inflows	$5,000/year	$7,500/year

Projects A and B are mutually exclusive. What should the company do?

A) Reject A, Accept B.

B) Reject A, Reject B.

C) Accept A, Reject B.

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For mutually exclusive projects accept the project with the highest NPV. In this example the NPV for Project A (3,024) is higher than the NPV of Project B (2,036). Therefore accept Project A and reject Project B.

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If the projects are independent, what should the company do?

A) Accept A, Accept B.

B) Reject A, Reject B.

C) Accept A, Reject B.

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Project A: N = 5; PMT = 5,000; FV = 0; I/Y = 12; CPT → PV = 18,024; NPV for Project A = 18,024 − 15,000 = 3,024.
Project B: N = 5; PMT = 7,500; FV = 0; I/Y = 12; CPT → PV = 27,036; NPV for Project B = 27,036 − 25,000 = 2,036.
For independent projects the NPV decision rule is to accept all projects with a positive NPV. Therefore, accept both projects.

hinsafdar

Which of the following statements about the discounted payback period is least accurate? The discounted payback:

A) frequently ignores terminal values.

B) method can give conflicting results with the NPV.

C) period is generally shorter than the regular payback.

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The discounted payback period calculates the present value of the future cash flows. Because these present values will be less than the actual cash flows it will take a longer time period to recover the original investment amount.

hinsafdar

Lincoln Coal is planning a new coal mine, which will cost $430,000 to build, with the expenditure occurring next year. The mine will bring cash inflows of $200,000 annually over the subsequent seven years. It will then cost $170,000 to close down the mine over the following year. Assume all cash flows occur at the end of the year. Alternatively, Lincoln Coal may choose to sell the site today. What minimum price should Lincoln set on the property, given a 16% required rate of return?

A) $325,859.

B) $376,872.

C) $280,913.

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The key to this problem is identifying this as a NPV problem even though the first cash flow will not occur until the following year. Next, the year of each cash flow must be property identified; specifically: CF0 = $0; CF1 = -430,000; CF2-8 = +$200,000; CF9 = -$170,000. One simply has to discount all of the cash flows to today at a 16% rate. NPV = $280,913.

hinsafdar

The process of evaluating and selecting profitable long-term investments consistent with the firm’s goal of shareholder wealth maximization is known as:

A) financial restructuring.

B) capital budgeting.

C) monitoring.

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In the process of capital budgeting, a manager is making decisions about a firm’s earning assets, which provide the basis for the firm’s profit and value. Capital budgeting refers to investments expected to produce benefits for a period of time greater than one year. Financial restructuring is done as a result of bankruptcy and monitoring is a critical assessment aspect of capital budgeting.

hinsafdar

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 $150,000 today, and the firm's cost of capital is 10%. The payback period for this investment is closest to:

A) 4.86 years.

B) 5.23 years.

C) 6.12 years.

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Years	0	1	2	3	4	5
Cash Flows	-$150,000	$30,000	$30,000	$30,000	$30,000	$35,000

$150,000
120,000	(4 years)(30,000/year)
$30,000

With $30,000 unrecovered cost in year 5, and $35,000 cash flow in year 5; $30,000 / $35,000 = 0.86 years
4 + 0.86 = 4.86 years

hinsafdar

Project sequencing is best described as:

A) an investment in a project today that creates the opportunity to invest in other projects in the future.

B) arranging projects in an order such that cash flows from the first project fund subsequent projects.

C) prioritizing funds to achieve the maximum value for shareholders, given capital limitations.

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Projects are often sequenced through time so that investing in a project today may create the opportunity to invest in other projects in the future. Note that funding from the first project is not a requirement for project sequencing.

Gypsy

The Chief Financial Officer of Large Closeouts Inc. (LCI) determines that the firm must engage in capital rationing for its capital budgeting projects. Which of the following describes the most likely reason for LCI to use capital rationing? LCI:

A) has a limited amount of funds to invest.

B) must choose between projects that compete with one another.

C) would like to arrange projects so that investing in a project today provides the option to accept or reject certain future projects.

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Capital rationing exists when a company has a fixed (maximum) amount of funds to invest. If profitable project opportunities exceed the amount of funds available, the firm must ration, or prioritize its funds to achieve the maximum value for shareholders given its capital limitations.

Gypsy

Rosalie Woischke is an executive with ColaCo, a nationally known beverage company. Woischke is trying to determine the firm’s optimal capital budget. First, Woischke is analyzing projects Sparkle and Fizz. She has determined that both Sparkle and Fizz are profitable and is planning on having ColaCo accept both projects. Woischke is particularly excited about Sparkle because if Sparkle is profitable over the next year, ColaCo will have the opportunity to decide whether or not to invest in a third project, Bubble. Which of the following terms best describes the type of projects represented by Sparkle and Fizz as well as the opportunity to invest in Bubble?

Sparkle and Fizz

Opportunity to invest in Bubble

A) Independent projects Add-on project

B) Independent projects Project sequencing

C) Mutually exclusive projects Project sequencing

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Independent projects are projects for which the cash flows are independent from one another and can be evaluated based on each project’s individual profitability. Since Woischke is accepting both projects, the projects must be independent. If the projects were mutually exclusive, only one of the two projects could be accepted. The opportunity to invest in Bubble is a result of project sequencing, which means that investing in a project today creates the opportunity to decide to invest in a related project in the future.

Gypsy

If two projects are mutually exclusive, a company:

A) must accept both projects or reject both projects.

B) can accept one of the projects, both projects, or neither project.

C) can accept either project, but not both projects.

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Mutually exclusive means that out of the set of possible projects, only one project can be selected. Given two mutually exclusive projects, the company can accept one of the projects or reject both projects, but cannot accept both projects.