## Fundamentals of Corporate Finance 9th Canadian Edition By Ross – Test Bank

Exam Name___________________________________ MULTIPLE CHOICE.

Choose the one alternative that best completes the statement or answers the question.

1) A 50- year project has a cost of $500,000 and has annual cash flows of $100,000 in years 1-25, and $200,000 in years 26-50. The company’s required rate is 8%. Given this information, calculate the profitability index of the project. 1) A) 2.16 B) 2.76 C) 1.76 D) 2.46 E) 2.06 Answer: B Explanation: A) B) C) D) E) 2) Project A has a five-year life and an initial cost of $2,000 and annual cash flows of $700 per year. Project B also has a five-year life and an initial cost of $3,000 with annual cash flows of $950 per year. Given this information, calculate the NPV that the IRR cross-over rate provides. 2) A) ($216.48) B) $328.87 C) $800.00 D) ($594.16) E) $1,041.50 Answer: C Explanation: A) B) C) D) E) 1 3) You are analyzing a project and have prepared the following data: Based on the profitability index of ________ for this project, you should ________ the project. 3) A) .97; reject B) 0.97; accept C) 1.18; accept D) 1.05; accept E) 1.05; reject Answer: D Explanation: A) B) C) D) E) 4) You are considering a project with an initial cost of $27,900. What is the payback period for this project if the cash inflows are $14,650, $16,190, $12,480, and $9,500 a year over the next four years, respectively? 4) A) 1.90 years B) 1.82 years C) 0.82 year D) 0.90 year E) 1.11 years Answer: B Explanation: A) B) C) D) E) 2 5) Sun, Inc. is analyzing two projects. Project A requires an initial investment of $2,200 and produces cash inflows of $500, $550, $700, and $900 respectively over four years. Project B requires an initial investment of $2,400 and produces cash inflows of $550, $650, $700, and $1,100 respectively over four years. What is the crossover point? 5) A) 16.88% B) 14.14% C) 19.76% D) 18.32% E) 21.65% Answer: E Explanation: A) B) C) D) E) 6) Which one of the following is a reason why managers may utilize more than one method when analyzing a project? 6) A) To better understand the conditions under which the project can be successful. B) To determine a guaranteed rate of return on a projected project. C) Because each of the five primary analytical methods is based on completely different data related to a proposed project. D) To ensure that the projected cash flows are accurate. E) Because there are multiple methods of analysis with basically no associated disadvantages. Answer: A Explanation: A) B) C) D) E) 7) A project produces annual net income of $14,600, $18,700, and $23,500 over three years, respectively. The initial cost of the project is $310,800. This cost is depreciated straight-line to a zero book value over three years. What is the average accounting rate of return if the required discount rate is 9 percent? 7) A) 18.28 percent B) 15.63 percent C) 12.18 percent D) 17.67 percent E) 14.29 percent Answer: C Explanation: A) B) C) D) E) 3 8) When two projects both require the total use of the same limited economic resource, the projects are generally considered to be: 8) A) Internally profitable. B) Marginally profitable. C) Acceptable. D) Mutually exclusive. E) Independent. Answer: D Explanation: A) B) C) D) E) 9) What is the internal rate of return on an investment with the following cash flows? 9) A) 6.75 percent B) 6.87 percent C) 7.50 percent D) 6.33 percent E) 7.67 percent Answer: C Explanation: A) B) C) D) E) 4 10) Based on the payback rule, which of the following is false? 10) A) With a payback cutoff of 1.5 years, both projects are unacceptable. B) With a payback cutoff of three years, both projects are acceptable. C) With a payback cutoff of one year, neither project is acceptable. D) You would be indifferent between the two projects. E) Since both projects pay back, the NPV of both must be positive. Answer: E Explanation: A) B) C) D) E) 11) Suppose a project costs $300 and produces cash flows of $100 over each of the following six years. What is the IRR of the project? 11) A) 38.1% B) 24.3% C) There is not enough information; a discount rate is required D) 10.0% E) 34.9% Answer: B Explanation: A) B) C) D) E) 12) Freeley Co. is considering an expansion project costing $390,000 up front. The expansion is expected to produce cash flows of $120,000 a year for two years. In Year 3, the project is expected to produce a cash flow of $225,000. The expected return on this expansion project is: 12) A) 8.33% B) 8.47% C) 8.16% D) 8.51% E) 7.12% Answer: A Explanation: A) B) C) D) E) 5 13) Ginny is considering two independent projects. Each project costs $10,000. Project A produces cash inflows of $3,000 a year for four years. Project B produces no cash flows for the first two years and $6,000 a year for the following two years. Ginny wants to recoup her money within 3 years. Should Ginny accept these projects? 13) A) Ginny should accept Project A and reject Project B. B) Ginny should reject Project A and accept Project B. C) Ginny should reject both projects. D) Ginny should accept both projects. E) Ginny cannot make that decision based on the information provided. Answer: C Explanation: A) B) C) D) E) 14) Bill plans to open a do-it-yourself dog bathing center in a storefront. The bathing equipment will cost $160,000. Bill expects the after-tax cash inflows to be $40,000 annually for seven years, after which he plans to scrap the equipment and retire to the beaches of Jamaica. Assume the required return is 17%. What is the project’s IRR? Should it be accepted? 14) A) 12.2%; yes B) 16.3%; yes C) 12.2%; no D) 17.0%; indifferent E) 16.3%; no Answer: E Explanation: A) B) C) D) E) 6 15) You run a small bagel shop and are considering replacing your four employees with automated machines that allow customers to buy their bagels without any human interaction. Of the following, the most difficult task you face in computing the NPV of this change is the: 15) A) Estimation of the reduction in wages you will have from the decrease in work force. B) Estimation of the cost of installing the new equipment. C) Estimation of the cost of purchasing the new equipment. D) Estimation of the reduction in taxes you will get from the increase in depreciation. E) Estimation of the total change in sales that will result from the change. Answer: E Explanation: A) B) C) D) E) 16) The internal rate of return is defined as the: 16) A) Rate of return which a cost-cutting, non-revenue generating project returns in an average year. B) Rate of return which yields a net present value equal to the initial investment in a project. C) Average annual rate of return on a project. D) Rate of return which causes the net present value of a project to equal zero. E) Average annual rate of return divided by the average book value of a project’s fixed assets. Answer: D Explanation: A) B) C) D) E) 7 17) Yuliis analyzing the following two mutually exclusive projects and has developed the following cash flow information. What is the crossover rate? 17) A) 8.70 percent B) 10.66 percent C) 9.69 percent D) 8.39 percent E) 10.02 percent Answer: B Explanation: A) B) C) D) E) 18) Which of the following ranks decision rules from worst to best in terms of their overall usefulness in capital budgeting analysis. 18) A) Payback, NPV, IRR. B) NPV, IRR, Payback. C) IRR, Payback, NPV. D) Payback, IRR, NPV. E) IRR, NPV, Payback. Answer: D Explanation: A) B) C) D) E) 8 19) You are considering the following two mutually exclusive projects with the following cash flows. Both projects will be depreciated using straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage value. You should accept Project ________ because it has the ________ profitability index of the two projects. 19) A) A; higher B) A; lower C) B; higher D) B; lower E) The profitability index should not be used to determine which of these projects should be accepted. Answer: E Explanation: A) B) C) D) E) 9 20) Which of the following is true about using discounted payback analysis for projects which have only positive cash flows after the initial outlay and for which the discount rate is positive? 20) A) Discounted payback is much simpler to calculate than regular payback B) The discounted payback period will be longer than the regular payback period C) When comparing two projects, the one with shorter payback period on a discounted basis will have a larger NPV D) Any project that fails to pay back at all on a discounted basis must have a positive NPV E) Discounted payback is better than simple payback because in simple payback analysis the cutoff payback period is arbitrarily set by management Answer: B Explanation: A) B) C) D) E) 21) The following values have been computed for various independent projects which have a required payback period of 3 years, a required discount rate of 14.5 percent, and a required accounting return of 11 percent. Which one of these values indicates an accept decision? 21) A) Profitability index of 1.02. B) Payback period of 3.2 years. C) Net present value of ($1,200). D) Accounting rate of return of 10 percent. E) Internal rate of return of 13.6 percent. Answer: A Explanation: A) B) C) D) E) 22) The discounted payback period of a project will decrease whenever the: 22) A) Costs of the fixed assets utilized in the project increase. B) Amount of each project cash flow is increased. C) Discount rate applied to the project is increased. D) Initial cash outlay of the project is increased. E) Time period of the project is increased. Answer: B Explanation: A) B) C) D) E) 10 23) ABC Corporation purchased an asset costing $450,000. The asset has an 8 year life, a $50,000 salvage value, and is depreciated on a straight line method. During the past four years, ABC posted net income of $98,000, $112,000, $134,000 and $122,000. Given the following information, calculate the company’s average accounting return over the past four years. 23) A) 35.85% B) 30.15% C) 20.15% D) 25.85% E) 15.85% Answer: A Explanation: A) B) C) D) E) 24) Your firm needs to buy a metal stamping press. The CFO presents you with two analyses: one for a press that is automated, requiring little labour to operate, and another that is manual, requiring a significant amount of labour. This is an example of a decision involving ________. 24) A) Crossover projects. B) Mutually exclusive projects. C) Working capital projects. D) Independent projects. E) Positive NPV projects. Answer: B Explanation: A) B) C) D) E) 11 25) You are considering two mutually exclusive projects with the following cash flows. If the discount rate is 7.5 percent, you prefer Project ________ and if the discount rate is 12 percent, you prefer Project ________. 25) A) A; A B) A; B C) B; A D) B; B E) B; A or B as you are indifferent. Answer: B Explanation: A) B) C) D) E) 26) The internal rate of return: 26) A) Determines the discount rate which should be used to evaluate a project given current market conditions. B) Will increase as the initial investment in a project is increased. C) Is the best analytical method to use when comparing mutually exclusive projects. D) Method of analysis can result in multiple rates under certain conditions. E) Is relatively difficult to interpret and explain. Answer: D Explanation: A) B) C) D) E) 12 27) Without using formulas, provide a definition of “internal rate of return” (IRR). 27) A) A graphical representation of the relationship between varying rates of return and the corresponding NPV value. B) A project analysis tool that measures the acceptability of a project by determining the amount of profit that can be expected based on an investment made. C) A situation whereby a choice has to be made between two or more projects, and choosing multiple projects is not an option. D) A project analysis tool that measures the acceptability of a project through the difference between a project’s initial investment and whether the present value of its cash flow will repay the investment. E) The rate of return provided by a project. The value is compared with a company’s rate of return to determine viability of a project. Answer: E Explanation: A) B) C) D) E) 28) You are considering two mutually exclusive projects with the following cash flows. Will your choice between the two projects differ if the required rate of return is 8 percent rather than 11 percent? If so, what should you do? 28) A) No; Regardless of the required rate, project A always has the higher NPV. B) Yes; Select A at 8 percent and B at 11 percent. C) Yes; Select A at 8 percent and select neither at 11 percent. D) Yes; Select B at 8 percent and A at 11 percent. E) No; Regardless of the required rate, project B always has the higher NPV. Answer: B Explanation: A) B) C) D) E) 13 29) A 25- year project has a cost of $1,500,000 and has annual cash flows of $400,000 in years 1-15, and $200,000 in years 16-25. The company’s required rate is 14%. Given this information, calculate the discounted payback of the project. 29) A) 5.70 years B) 5.5 years C) 6.10 years D) 5.90 years E) 6.30 years Answer: A Explanation: A) B) C) D) E) 30) A project with an NPV of zero ________. 30) A) Should be accepted even if the firm has alternative investments with a positive NPV. B) Has a profitability index that is greater than one. C) Should be rejected. D) Has a discounted payback period that is shorter than the life of the project. E) Is expected to earn a return equal to the firm’s required return. Answer: E Explanation: A) B) C) D) E) 31) If a firm uses the ________ as an investment criterion, one of the risks it takes is that it may ignore some future cash flows. 31) A) IRR B) AAR C) NPV D) Profitability. index E) Payback rule Answer: E Explanation: A) B) C) D) E

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