35.

Which of the following is a legitimate reason the valuation of common stock is generally harder
than the valuation of bonds?
I. Future cash flows on stocks are not known in advance.
II. Common stocks don't have a maturity date.
III. Common stock valuation is sensitive to estimates of the dividend growth rate.
A) I only
B) I and II only
C) I and III only
D) II and III only
E) I, II, and III

Ans: E Level: Basic Subject: Stock & Bond Valuation Type: Concepts

36. Which of the following is true about the differences between debt and common stock?
A) Debt is ownership in a firm but equity is not.
B) Creditors have voting power while stockholders do not.
C) Periodic payments made to either class of security are tax deductible for the issuer.
D) Interest payments are promised while dividend payments are not.
E) Bondholders can also own equity, but not vice versa.

Ans: D Level: Basic Subject: Debt vs. Equity Type: Concepts

37. You are considering investing in a firm and wish to place a value on the common stock. The
dividend on the firm's stock has not changed in the last five years. Absent any information
suggesting future changes in the dividend rate, the most appropriate stock valuation model would
be the ___________ model.
A) zero growth
B) supernormal growth
C) nonconstant growth
D) growing perpetuity
E) bond pricing

Ans: A Level: Basic Subject: Common Stock Valuation Type: Concepts

38. Over the past four years, a company has paid dividends of $1.00, $1.10, $1.20, and $1.30,
respectively. This pattern is expected to continue into the future. This is an example of a
company paying a:
A) Dividend that grows by 10% each year.
B) Dividend that grows at a constant rate.
C) Dividend that grows by a decreasing amount.
D) Dividend that grows at a decreasing rate.
E) Preferred stock dividend.

Ans: D Level: Basic Subject: Dividend Growth Type: Concepts

39. Dividends on the common stock of Stable Inc. are expected to grow at a constant rate forever. If
you are told Stable's most recent dividend paid, its dividend growth rate, and a discount rate, you
can calculate ____________.
I. the price today
II. the price five years from now
III. the dividend that is expected to be paid 10 years from now
A) I only
B) I and II only
C) I and III only
D) II and III only
E) I, II, and III

Ans: E Level: Basic Subject: Dividend Growth Model Type: Concepts

40. Which of the following is (are) true?
I. The dividend growth model only holds if, at some point in time, the dividend growth rate
exceeds the stock's required return.
II. A decrease in the dividend growth rate will increase a stock's market value, all else the
same.
III. An increase in the required return on a stock will decrease its market value, all else the
same.
A) I only
B) III only
C) II and III only
D) I and III only
E) I, II, and III

Ans: B Level: Basic Subject: Stock Valuation Type: Concepts

41. You are attempting to value a stock in an industry where firms are generating exceptional dividend
growth, but this growth is expected to slow to an equilibrium growth rate in about five years. Of
the stock valuation models studied, the most appropriate is the _______________.
A) perpetuity model
B) constant growth model
C) supernormal growth model
D) perpetual growth model
E) preferred stock model

Ans: C Level: Basic Subject: Stock Valuation Type: Concepts

42. As illustrated using the dividend growth model, the total return on a share of common stock is
comprised of a ________________.
A) capital gains yield and a dividend growth rate
B) capital gains growth rate and a dividend growth rate
C) dividend payout ratio and a required rate of return
D) dividend yield and the present dividend
E) dividend yield and a capital gains yield

Ans: E Level: Basic Subject: Dividend Growth Model Type: Concepts

43. Which of the following is (are) true?
I. The dividend yield on a stock is the annual dividend divided by the par value.
II. When the constant dividend growth model holds, g = capital gains yield.
III. The total return on a share of stock = dividend yield + capital gains yield.
A) I only
B) II only
C) I and II only
D) II and III only
E) I, II, and III

Ans: D Level: Basic Subject: Stock Yields Type: Concepts

60. Which of the following is NOT a right of an owner of a share of common stock?
A) The right to share proportionately in dividends paid.
B) The right to share proportionately in remaining assets from a liquidation.
C) The right to vote for directors.
D) Preference over preferred shareholders in the payment of dividends.
E) The right to vote on stockholder matters of great importance.

Ans: D Level: Basic Subject: Common Stock vs. Preferred Type: Concepts

61. Which of the following would be considered a violation of the rights of one or more classes of a
firm's stakeholders?
A) Common dividends are paid even though preferred dividends are in arrears.
B) Preferred stockholders are paid before common shareholders in a liquidation.
C) Common stockholders are able to place members on the board of directors to represent their
interests in opposition to the board candidates backed by preferred shareholders.
D) Common shareholders are able to vote by proxy even when they are unable to attend a
shareholders' meeting in person.
E) Debt is repaid before preferred shareholders are paid anything in a liquidation.

Ans: A Level: Basic Subject: Priority Of Payments Type: Concepts

80. The capital gain yield:

A) When subtracted from the dividend yield is equal to the required rate of return.
B) Is the rate at which the price of the stock grows.
C) Must always be a positive value.
D) Is equal to the dividend amount divided by the current market price of the stock.
E) Is the same as the current yield for shares of common stock.

Ans: B Level: Intermediate Subject: Capital Gain Yield Type: Concepts

81. Given constant earnings per share, an increase in dividends will generally:
A) Increase the dividend yield as well as the capital gains yield.
B) Decrease the growth rate of the corporation and increase the current yield.
C) Increase the dividend yield and decrease the current yield.
D) Have no effect on either the capital gains yield or the total return.
E) Have no effect on either the total return or the current yield.

Ans: B Level: Challenge Subject: Dividends And Growth Type: Concepts

 84. The dividend on Simple Motors common stock will be $2 in one year, $3.50 in two years, and
$5.00 in three years. You can sell the stock for $75 in three years. If you require a 10% return on
your investment, how much would you be willing to pay for a share of this stock today?
A) $59.69
B) $64.65
C) $64.82
D) $65.66
E) $71.30

Ans: C Level: Basic Subject: Stock Price Type: Problems

85. A stock that pays a constant dividend of $2.50 forever currently sells for $20. What is the required
rate of return?
A) 11.0%
B) 11.5%
C) 12.0%
D) 12.5%
E) 13.0%

Ans: D Level: Basic Subject: Zero Growth Stock Return Type: Problems

86. Suppose NoGro, Inc. has just issued a dividend of $2.90 per share. Subsequent dividends will
remain at $2.90 indefinitely. Returns on the stock of firms like NoGro are currently running 15%.
What is the value of one share of stock?
A) $2.90
B) $13.65
C) $19.33
D) $31.25
E) $39.70

Ans: C Level: Basic Subject: Stock Price Type: Problems

87. ABC Company's preferred stock is selling for $25 a share. If the required return is 12%, what will
the dividend be two years from now?
A) $2.39
B) $2.50
C) $3.00
D) $3.30
E) $3.76

Ans: C Level: Basic Subject: Preferred Stock Dividend Type: Problems

132. Alhandro, Inc. just paid an annual dividend of $1.03. They have been increasing their dividends by
4% annually and are expected to continue doing so. How much can they expect to receive for each
new share of stock offered if investors require an 11% rate of return?
A) $9.36
B) $9.74
C) $14.71
D) $15.30
E) $15.91

Ans: D Level: Intermediate Subject: Stock Value Type: Problems

133. The KLS Co. is expected to pay the following annual dividends for the next three years: $1.00,
$1.50, and $1.60, respectively. After that time, they are expected to increase their dividends by 3%
annually. Stocks similar to KLS are yielding 9.5%. What is one share of KLS worth today?
A) $22.69
B) $23.87
C) $27.05
D) $27.30
E) $29.20

Ans: A Level: Intermediate Subject: Value Of Non-Constant Dividend Type: Problems

134. The Brown Company just announced that they will be increasing their annual dividend to $1.68
next year and that future dividends will be increased by 2.5% annually. How much would you be
willing to pay for one share of the Brown Company stock if you require a 12% rate of return?
A) $14.35
B) $14.63
C) $17.68
D) $18.13
E) $19.81

Ans: C Level: Intermediate Subject: Stock Value Type: Problems

135. The MIKO Corp. paid $0.84 in dividends last year. They have just announced that they expect to
increase their dividends by 2% each year for the foreseeable future. Currently, MIKO stock is
priced at $21.32 per share. What is the rate of return on MIKO stock?
A) 4.01%
B) 4.96%
C) 5.86%
D) 5.94%
E) 6.02%

Ans: E Level: Intermediate Subject: Required Return Type: Problems

136. Swanson Brothers expects to pay a $2.20 dividend next year which is an increase of 3.25% over
the prior year. After next year, dividends are projected to grow at a steady rate of 2.5%. Shares of
Swanson stock are currently selling at $15.80 per share. What is the rate of return on Swanson
stock?
A) 14.27%
B) 16.42%
C) 16.77%
D) 17.17%
E) 23.66%

Ans: B Level: Intermediate Subject: Required Return Type: Problems

139. Noshima Industries issued dividends totaling $0.60 last year. For the next two years, they expect
dividends to increase by 50% annually and then remain constant thereafter. How much is one
share of Noshima Industries stock worth today if you require a 9% rate of return?
A) $13.45
B) $13.77
C) $14.59
D) $15.00
E) $15.14

Ans: C Level: Intermediate Subject: Nonconstant Dividend Type: Problems

140. MDK, Inc. is a high growth firm that has never paid a dividend. The company just issued a press
release stating that next year they plan on paying an annual dividend of $0.34. They also stated
that dividends are expected to increase by 40% a year for each of the following four years and
then increase by 4% annually thereafter. The required rate of return on this stock is 15%. What is
the expected price per share of MDK stock six years from now?
A) $9.12
B) $9.42
C) $12.35
D) $12.84
E) $14.14

Ans: D Level: Challenge Subject: Nonconstant Dividend Type: Problems

141. Mahenterin Inc. is expecting to pay $1.23, $0.99, and $1.13 in annual dividends for the next three
years respectively. After that, they project that dividends will increase by 1.5% annually. Andy is
in the 25% marginal tax bracket and wants to earn 6% after-tax on his investments. How much is
Andy willing to pay today for one share of Mahenterin Inc. stock?
A) $16.90
B) $17.04
C) $17.31
D) $17.36
E) $17.81

Ans: A Level: Challenge Subject: Nonconstant Dividend Type: Problems

142. Michael's Inc. 9% preferred stock is currently priced at $124.30. If Michaels wishes to sell some
new preferred stock at par, what rate should they assign to the new shares?
A) 6.76%
B) 7.24%
C) 8.05%
D) 9.00%
E) 11.19%

Ans: B Level: Intermediate Subject: Preferred Stock Value Type: Problems

143. Jamie just paid $8,239 for 100 shares of 6% preferred stock. What rate of return will she earn?
A) 4.94%
B) 7.28%
C) 8.24%
D) 10.94%
E) 713.73%

Ans: B Level: Intermediate Subject: Preferred Stock Rate Of Return Type: Problems

35. Net present value _____________.

A) is equal to the initial investment in a project
B) compares project cost to the present value of the project benefits
C) is equal to zero when the discount rate used is less than the IRR
D) is simplified by the fact that future cash flows are easy to estimate
E) requires the firm set an arbitrary cutoff point for determining whether an investment is
acceptable

Ans: B Level: Basic Subject: Net Present Value Type: Concepts

36. An NPV of zero implies that an investment's ____________.

A) cost exceeds the present value of its cash inflows
B) cost is equal to the present value of its cash inflows
C) IRR is greater than the firm's required rate of return
D) present value of cash inflows are positive
E) present value of cash inflows exceed the investment's cost

Ans: B Level: Basic Subject: Net Present Value Type: Concepts

37. The __________ decision rule is considered the "best" in principle.

A) internal rate of return
B) payback period
C) average accounting return
D) net present value
E) profitability index

Ans: D Level: Basic Subject: Net Present Value Type: Concepts

38. _________ quantifies, in dollar terms, how stockholder wealth will be affected by undertaking a
project.
A) Discounted payback analysis
B) The average accounting return
C) The internal rate of return
D) Net present value
E) The profitability index

Ans: D Level: Basic Subject: Net Present Value Type: Concepts

39. If the required return is zero, then:
A) The payback period exceeds the discounted payback period.
B) The NPV equals the difference between the undiscounted future cash flows and the initial
cost.
C) If the NPV is negative, the IRR will be greater than zero.
D) The PI will be less than one.
E) The project will be acceptable according to the AAR criteria.

Ans: B Level: Basic Subject: NPV Investment Criteria Type: Concepts

40. A project whose NPV equals zero ______________.

A) should be rejected
B) has a profitability index that is greater than one
C) is expected to earn a return equal to the firm's required return
D) has a discounted payback period that is shorter than the life of the project
E) should be accepted even if the firm has alternative investments with positive NPVs

Ans: C Level: Basic Subject: Net Present Value Type: Concepts

41. 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
A) estimation of the reduction in wages you will have from the decrease in work force
B) estimation of the reduction in taxes you will get from the increase in depreciation
C) estimation of the cost of purchasing the new equipment
D) estimation of the cost of installing the new equipment
E) estimation of the total change in sales that will result from the change

Ans: E Level: Basic Subject: Cash Flow Estimation Type: Concepts

42. A financial manager who consistently underestimates the ___________ will tend to incorrectly
reject projects that would actually create wealth for the stockholders.
A) marginal income tax rate
B) initial cost of projects
C) future cash outlays associated with projects
D) required return on projects
E) future cash inflows associated with projects

Ans: E Level: Basic Subject: Project Analysis Type: Concepts

43. Which of the following decision rules is best for evaluating projects for which cash flows beyond
a specified point in time, and the time value of money, can both be ignored?
A) Payback
B) Net present value
C) Average accounting return
D) Profitability index
E) Internal rate of return

Ans: A Level: Basic Subject: Payback Type: Concepts

 44. A firm seeks to accept projects with a high degree of liquidity, avoid the higher forecasting error
associated with cash flows occurring in the distant future, and avoid projects that require a large
amount of research and development expenses. This firm may be justified in using the
____________ to evaluate its projects.
A) IRR rule
B) NPV rule
C) AAR rule
D) payback rule
E) PI rule

Ans: D Level: Basic Subject: Payback Period Type: Concepts

46.Which of the following uses an arbitrary cutoff number in its decision rule?
I. Payback period
II. AAR
III. IRR
A) I only
B) II only
C) III only
D) I and II only
E) II and III only

Ans: D Level: Basic Subject: Payback Period Type: Concepts

47. Which capital investment evaluation technique is described by the following characteristics? (1)
Easy to understand; (2) Biased towards liquidity; (3) Requires an arbitrary cutoff point; (4) Ignores
the time value of money.
A) NPV
B) IRR
C) Profitability index
D) Payback period
E) Discounted payback

Ans: D Level: Basic Subject: Payback Period Type: Concepts

48. For which capital investment evaluation technique is the following a complete list of its
disadvantages when compared to NPV analysis? (1) Ignores cash flows beyond the cutoff date; (2)
Requires an arbitrary cutoff point; (3) Biased against long-term projects; (4) May reject positive
NPV projects.
A) NPV
B) IRR
C) AAR
D) Payback period
E) Discounted payback

Ans: E Level: Basic Subject: Discounted Payback Period Type: Concepts

51. Which of the following decision rules has the advantage that the information needed for the
calculation is readily available?
A) Net present value
B) Internal rate of return
C) Average accounting return
D) Payback period
E) Discounted payback

Ans: C Level: Basic Subject: Average Accounting Return Type: Concepts

52. Which of the following is considered to be a redeeming feature of average accounting return
analysis?
A) It incorporates time value of money.
B) Estimation of the appropriate cutoff rate is straightforward and easy.
C) Calculation relies on net income and not cash flows or asset values.
D) Calculation relies on book values and not market values or cash flows.
E) It is relatively easy to calculate.

Ans: E Level: Basic Subject: Average Accounting Return Type: Concepts

53. Which of the following does NOT incorporate discounted cash flow (DCF) valuation in its
calculation?
A) Discounted payback
B) Profitability index
C) Net present value
D) Internal rate of return
E) Average accounting return

Ans: E Level: Basic Subject: AAR Type: Concepts

54. Which of the following is calculated using ONLY accounting numbers?

A) Payback period
B) Profitability index
C) Net present value
D) Internal rate of return
E) Average accounting return

Ans: E Level: Basic Subject: Average Accounting Return Type: Concepts

55. Which capital investment evaluation technique offers the following advantages? (1) Easy to
calculate; (2) Needed information will usually be available.
A) NPV
B) IRR
C) AAR
D) Payback period
E) Discounted payback

Ans: C Level: Basic Subject: Average Accounting Return Type: Concepts

80. Which of the following will NOT lead to ambiguous decision-making when considering mutually
exclusive projects?
I. AAR
II. PI
III. IRR
IV. NPV
A) I only
B) II and III only
C) II and IV only
D) I and IV only
E) IV only

Ans: D Level: Basic Subject: Mutually Exclusive Decisions Type: Concepts

81. According to the capital budgeting surveys cited in the text, in general, most financial managers of
large Canadian firms:
A) Prefer to rely exclusively on payback analysis to evaluate projects.
B) Use the AAR as their primary method of evaluating capital budgeting projects.
C) Who use payback analysis use it only in conjunction with some other type of analysis.
D) Prefer to use NPV or IRR to analyze their investment projects.
E) Make use of payback analysis more heavily than discounted cash flow methods.

Ans: C Level: Basic Subject: Capital Budgeting In Practice Type: Concepts

82. The internal rate of return on a project is 11.24%. Which of the following (is) are true if the project
is assigned a 9.5% discount rate?
I The project will have a negative net present value.
II The profitability index will be greater than 1.0.
III The initial investment is less than the market value of the project.
IV The project will have a positive effect on shareholders if it is accepted.
A) I only
B) II and IV only
C) I and III only
D) II and III only
E) II, III, and IV only

Ans: E Level: Challenge Subject: Net Present Value And Internal Rate Of Return
Type: Concepts

83. The primary idea behind the net present value rule is that an investment:
A) Is worthwhile if it creates value for the owners.
B) Must have total cash flows that equal zero.
C) Should be accepted if it enhances management's position.
D) Should break-even from an accounting point of view.
E) Should earn a rate of return that is less than the discount rate.

Ans: A Level: Intermediate Subject: Net Present Value Type: Concepts

107. Would you accept a project which is expected to pay $10,000 a year for seven years if the initial
investment is $40,000 and your required return is 15%?
A) Yes; the NPV is $1,604
B) Yes; the NPV is $1,446
C) Yes; the NPV is $4,238
D) No; the NPV is -$1,369
E) No; the NPV is -$2,783

Ans: A Level: Basic Subject: Net Present Value Type: Problems

105. A project has an initial investment of $10,000, with $3,500 annual inflows for each of the
subsequent four years. If the required return is 15%, what is the NPV?
A) -$435.26
B) -$32.48
C) -$7.58
D) $4.63
E) $5.49

Ans: C Level: Basic Subject: Net Present Value Type: Problems

109. You are going to choose between two investments. Both cost $80,000, but investment A pays
$35,000 a year for four years while investment B pays $30,000 a year for five years. If your
required return is 13%, which should you choose?
A) A because it pays back sooner.
B) A because its IRR exceeds 13%.
C) A because it has a higher IRR.
D) B because its IRR exceeds 13%.
E) B because it has a higher NPV.

Ans: E Level: Basic Subject: Net Present Value Rule Type: Problems

111. For a project with an initial investment of $40,000 and cash inflows of $11,000 a year for five
years, calculate NPV given a required return of 11.65%.
A) -$1,205
B) -$1,103
C) -$1.23
D) $567
E) $1,218

Ans: C Level: Basic Subject: Net Present Value Type: Problems

114. A project costs $475 and has cash flows of $100 for the first three years and $75 in each of the
project's last five years. What is the payback period of the project?
A) The project never pays back
B) 4.75 years
C) 5.00 years
D) 5.33 years
E) 6.00 years

Ans: D Level: Basic Subject: Payback Type: Problems

117. A project costs $475 and has cash flows of $100 for the first three years and $75 in each of the
project's last five years. If the discount rate is 10%, what is the discounted payback period?
A) The project never pays back on a discounted basis
B) 5 years
C) 6 years
D) 7 years
E) 8 years

Ans: A Level: Basic Subject: Discounted Payback Type: Problems

119. Suppose a firm invests $600 in a project. The initial cost is depreciated straight-line to zero over 3
years. Net income from the project is $100, $125, and $140 in each of the three years of the
project's life. What is the average accounting return?
A) 18.25%
B) 20.28%
C) 35.49%
D) 40.56%
E) 60.83%

Ans: D Level: Basic Subject: Average Accounting Return Type: Problems

121. 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?
A) There is not enough information; a discount rate is required
B) 10.0%
C) 24.3%
D) 34.9%
E) 38.1%

Ans: C Level: Basic Subject: Internal Rate Of Return Type: Problems

123. What is the IRR of an investment that costs $77,500 and pays $27,500 a year for four years?
A) 16%
B) 18%
C) 20%
D) 22%
E) 24%

Ans: A Level: Basic Subject: Internal Rate Of Return Type: Problems

124. You are evaluating two mutually exclusive projects, A and B. Project A costs $350 and has cash
flows of $250 in each of the next two years. Project B costs $300 and generates cash flows of
$300 and $100 for the next two years, respectively. What is the crossover rate for these projects?
A) 26.38%
B) 27.47%
C) 30.28%
D) 61.80%
E) 83.48%

Ans: C Level: Basic Subject: Crossover Rate Type: Problems

 Use the following to answer questions 134-138:

Bill plans to open a do-it-yourself dog bathing centre 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.

134. Assume the required return is 10%. What is the project's NPV?
A) $14,111
B) $27,322
C) $32,556
D) $34,737
E) $45,001

Ans: D Level: Basic Subject: Net Present Value Type: Problems

135. What is the project's payback period?

A) 1.5 years
B) 2.0 years
C) 3.3 years
D) 4.0 years
E) 4.3 years

Ans: D Level: Basic Subject: Payback Type: Problems

136. Assume the required return is 10%. What is the project's discounted payback period?
A) three years
B) four years
C) five years
D) six years
E) seven years

Ans: D Level: Basic Subject: Discounted Payback Type: Problems

137. Assume the required return is 17%. What is the project's IRR? Should it be accepted?
A) 12.2%; yes
B) 12.2%; no
C) 16.3%; yes
D) 16.3%; no
E) 17.0%; indifferent

Ans: D Level: Basic Subject: Internal Rate Of Return Type: Problems

138. Assume the required return is 15%. What is the project's PI? Should it be accepted?
A) 0.88; yes
B) 0.88; no
C) 1.00; indifferent
D) 1.04; yes
E) 1.04; no

Ans: D Level: Basic Subject: Profitability Index Type: Problems

 Use the following to answer questions 139-142:

You need to borrow $2,000 quickly, and the local pawn shop will give it to you if you promise to repay
them $200.92 monthly over the next year.

139. Suppose that the pawn shop's cost of funds is 12%, compounded monthly. From their viewpoint,
what is the NPV of this deal?
A) $44.11
B) $111.01
C) $226.17
D) $261.37
E) $292.01

Ans: D Level: Basic Subject: Net Present Value Type: Problems

140. From the pawn shop's viewpoint, what is the IRR of this transaction?
A) 1.0% per month
B) 1.7% per month
C) 2.0% per month
D) 2.5% per month
E) 3.0% per month

Ans: E Level: Basic Subject: Internal Rate Of Return Type: Problems

141. From your viewpoint, what is the percentage cost of this transaction?
A) 1.0% per month
B) 1.7% per month
C) 2.0% per month
D) 2.5% per month
E) 3.0% per month

Ans: E Level: Basic Subject: Internal Rate Of Return Type: Problems

142. Suppose the pawn shop has more customers than funds. Which capital budgeting technique would
allow them to rank their potential customers in order to maximize current wealth?
A) AAR
B) Payback period
C) Profitability index
D) NPV
E) Discounted payback

Ans: C Level: Basic Subject: Capital Budgeting Techniques Type: Problems

Use the following to answer questions 143-147:

Floyd Clymer is the CFO of Bonavista Mustang, a manufacturer of parts for classic automobiles. Floyd is
considering the purchase of a two-ton press which will allow the firm to stamp out auto fenders. The
equipment costs $250,000. The project is expected to produce after-tax cash flows of $60,000 the first
year, and increase by $10,000 annually; the after-tax cash flow in year 5 will reach $100,000. Liquidation
of the equipment will net the firm $10,000 in cash at the end of five years, making the total cash flow in
year five $110,000.
143. What is the payback period for the proposed investment?
A) 2.0 years
B) 2.4 years
C) 3.0 years
D) 3.4 years
E) The investment doesn't pay back

Ans: D Level: Intermediate Subject: Payback Period Type: Problems

144. Assume that sale of the equipment at the end of five years would net the firm $200,000, rather
than $10,000. Now what is the payback period for the proposed investment?
A) 2.0 years
B) 2.4 years
C) 3.0 years
D) 3.4 years
E) The investment doesn't pay back

Ans: D Level: Intermediate Subject: Payback Period Type: Problems

145. Assume the required return is 15%. What is the project's discounted payback period?
A) two years
B) three years
C) four years
D) five years
E) Longer than the project's life.

Ans: D Level: Intermediate Subject: Discounted Payback Type: Problems

146. Assume the required return is 15%. What is the project's net present value?
A) The NPV is negative
B) $12,001
C) $12,623
D) $13,853
E) $15,226

Ans: D Level: Intermediate Subject: Net Present Value Type: Problems

147. Assuming a required return is 15%, what is the project's profitability index?
A) 0.98
B) 1.01
C) 1.06
D) 1.12
E) 1.28

Ans: C Level: Intermediate Subject: Profitability Index Type: Problems

148. A project has an initial cash outlay of $16,500. Cash inflows are $5,200 in year 1, $6,800 in year
2, and $8,100 in year 3. What is the net present value if an 8.30% discount rate is applied to this
project?
A) $333.33
B) $466.04
C) $475.88
D) $574.76
E) $601.13

Ans: C Level: Intermediate Subject: Net Present Value Type: Problems

153. Sal is considering a project that costs $15,000. The project produces cash inflows of $3,000,
$5,000, $7,000, and $3,000 respectively for the next four years. Sal wants to recoup his money
within 3 years after applying a 6% discount rate. Sal should:
A) Accept the project because it produces $15,534 on a discounted payback basis.
B) Accept this project because the discounted payback period is 2.78 years.
C) Accept this project because the payback period is exactly 3 years.
D) Reject this project because the payback period is 2.78 years.
E) Reject this project because the discounted payback period is 3.78 years.

Ans: E Level: Intermediate Subject: Discounted Payback Type: Problems

154. Atlantic, Inc. is considering a project that is expected to produce the following cash flows over the
next five years: $22,500, $27,900, $41,800, $33,000, and $15,000 respectively. Atlantic has
$98,000 available, which is the amount needed to initiate the project. Should Atlantic accept this
project if the required rate of return is 12%? Why or why not?
A) No; Atlantic would lose $2,407 in today's dollars if they accept the project.
B) No; The IRR is 13.47%, which is greater than the required return.
C) No; The PI is 1.04, which is considered a reject signal.
D) Yes; Atlantic will make $3,567 in today's dollars if they accept the project.
E) Yes; The PI is .96, which is considered an acceptance signal.

Ans: D Level: Intermediate Subject: Net Present Value Type: Problems

155. Stuart is reviewing a project that costs $13,500 to start. The project is expected to produce cash
inflows of $3,000, $5,000, $6,000, and $4,000 over the next four years, respectively. If Stuart
invests in this project, he wants to earn at least 9% and recoup his money on a discounted basis
within 3 years. Should Stuart invest in this project? Why or why not?
A) Yes; The project has a net present value of $927.50 and pays back within 3 years.
B) Yes; The project has a net present value of $1,906.21 and pays back within 3 years.
C) No; The project has a net present value of $927.50 but does not pay back within 3 years.
D) No; The project meets the payback requirement but has a net present value of -$1,906.21.
E) No; The project does not meet either requirement.

Ans: C Level: Intermediate Subject: Discounted Payback Type: Problems

156. Kim Lee is analyzing two projects. The first requires a $1,200 initial investment and returns $600
a year for four years. The second project requires a $1,500 initial investment and returns $700 a
year for four years. What is the crossover point for these two projects?
A) 4.25%
B) 6.37%
C) 8.14%
D) 12.59%
E) The crossover point cannot be computed based on the information provided.

Ans: D Level: Intermediate Subject: Crossover Point Type: Problems

26. When we employ ________________ we are evaluating a project on the basis of its incremental
cash flows, thereby ignoring the other cash flows of the firm.
A) the stand-alone principle
B) the equivalence theorem
C) the law of one price
D) Bell's theorem
E) the equivalent annual cost procedure

Ans: A Level: Basic Subject: Stand-Alone Principle Type: Concepts

27. Which of the following is true regarding project evaluation?

A) Financing costs must be included in the statement of cash flows because they are not
accounted for elsewhere.
B) The stand-alone principle calls for evaluation of a project based on its incremental cash
flows.
C) Changes in NWC are not considered incremental cash flows.
D) When fixed assets are sold at the project end, there are usually no tax consequences of the
sale.
E) Whether straight-line depreciation or CCA is used will have no impact on project NPV.

Ans: B Level: Basic Subject: Project Evaluation Type: Concepts

28. Your company currently sells oversized golf clubs. The Board of Directors wants you to look at
replacing them with a line of supersized clubs. Which of the following is NOT relevant?
A) A reduction in revenues of $300,000 from terminating the oversized line of clubs.
B) Land you own with a market value of $750,000 that may be used for the project.
C) $200,000 spent on research and development last year on oversized clubs.
D) $350,000 you will pay to Fred Singles to promote your new clubs.
E) $125,000 you will receive by selling the existing production equipment which must be
upgraded if you produce the new supersized clubs.

Ans: C Level: Basic Subject: Project Costs Type: Concepts

29. Which of the following is NOT considered a relevant, incremental cash flow in capital budgeting
analysis?
A) Opportunity costs
B) Erosion costs
C) Additions to net working capital
D) Sunk costs
E) Fixed asset salvage values

Ans: D Level: Basic Subject: Relevant Project Cash Flows Type: Concepts

30. Which of the following describe(s) relevant cash flows for the purpose of performing capital
budgeting analysis?
I. Cash flows must be incremental
II. Cash flows must be after-tax
III. NI + D
IV. Additions to net working capital
A) I and III only
B) I, II, and III only
C) I and IV only
D) II, III, and IV only
E) I, II, III, and IV

Ans: E Level: Basic Subject: Relevant Cash Flows Type: Concepts

31. The government has been trying to decide whether or not to purchase any of the new, advanced
missiles it has developed. One of the arguments in favour of purchasing the missiles is that since
so much money has been spent on their development it would be a waste of money not to buy
them now. What is the major problem with this argument?
A) It includes erosion costs in the decision-making process.
B) It includes sunk costs in the decision-making process.
C) It includes opportunity costs in the decision-making process.
D) It includes net working capital changes in the decision-making process.
E) It includes financing costs in the decision-making process.

Ans: B Level: Basic Subject: Sunk Costs Type: Concepts

32. You discover the engine-oil additive your scientists developed three years ago makes a great men's
after-shave once diluted properly using certain chemicals. How should you treat the original
$125,000 of R&D expenditures that went into developing the engine-oil additive for your present
decision regarding whether or not to begin production of the after-shave?
A) Treat it as a cash outflow three years ago for the current project; that is, find the future value
today of the $125,000 spent three years ago.
B) The full $125,000 should be treated as an initial investment today.
C) As a cash inflow since the formula has obviously increased in value over the years.
D) As an opportunity cost if the formula cannot presently be sold to another manufacturer.
E) As a sunk cost since the R&D expenditure has no bearing on today's decision.

Ans: E Level: Basic Subject: Sunk Costs Type: Concepts

33. You are advising a friend who is attempting to decide whether or not to drop one of the courses
they are currently enrolled in. If they drop, they will forfeit the money spent on tuition. Which of
the following regarding the drop decision is consistent with capital budgeting principles?
I. Remaining in the class means you must give up your part-time job.
II. The tuition cost for the class was outrageous, $1,000 per credit hour.
III. If you drop the class, you can sell the textbook now for $30 at the bookstore.
A) I only
B) I and II only
C) I and III only
D) II and III only
E) I, II, and III

Ans: C Level: Basic Subject: Sunk Costs Type: Concepts

43. Which of the following projects would increase net working capital the most?
A) Financing a land purchase for a new manufacturing plant via a sale of new stock.
B) Decreasing the amount of sales your firm makes on credit.
C) Decreasing the number of product lines your firm carries.
D) Changing your production schedule so that you produce goods only after a customer order.
E) Using long-term bank credit to reduce payables.

Ans: E Level: Basic Subject: Net Working Capital Type: Concepts

44. Which of the following is true about net working capital?

A) Projects in which a firm expands its operations and sales will generally not lead to changes
in net working capital.
B) Changes in net working capital account for differences between accounting sales and costs
and actual cash receipts and payments.
C) Net working capital is typically an expense at the beginning of a project and an equal
revenue source at the end of a project; thus, there is no impact on project NPV.
D) Dollar changes in the cash account are generally equal to changes in net working capital.
E) Net working capital is not considered an investment of the firm.

Ans: B Level: Basic Subject: Net Working Capital Type: Concepts

45. _________________ would usually represent a net cash inflow at the beginning of a project and
an equal net cash outflow upon completion of the project.
A) An increase in payables
B) An increase in inventory
C) An increase in receivables
D) An increase in fixed assets
E) An increase in receivables, coupled with an identical increase in payables

Ans: A Level: Basic Subject: Payables Type: Concepts

46. If a company making only cash sales is considering allowing customer credit, then __________.
A) sales will likely decrease
B) the change will result in a source of funds
C) receivables will likely increase
D) net working capital will decrease if funding needs are met with long-term liabilities
E) expenses will fall due to monthly billings and collection efforts

Ans: C Level: Basic Subject: Receivables Type: Concepts

47. Which of the following would be considered a use of funds?

I. An increase in receivables
II. An increase in payables
III. An increase in inventory
IV. An increase in sales
A) I and III only
B) I and IV only
C) II and III only
D) II and IV only
E) I, III, and IV only

Ans: A Level: Basic Subject: Use Of Funds Type: Concepts

48. If a firm moves into a higher tax bracket, one would expect its depreciation tax shield to be which
of the following, all else the same?
A) More valuable.
B) Less valuable.
C) Unchanged, since depreciation doesn't change.
D) Unchanged, because changes in tax rates don't matter once a project is in place.
E) It is impossible to tell how it will change, if at all, without more information.

Ans: A Level: Basic Subject: Depreciation Tax Shield Type: Concepts

54. Which of the following describes the "tax shield" approach to defining operating cash flow?
A) EBIT + D - Taxes
B) NI + D
C) (S - C) (1 - TC) + DTc
D) S - C - Taxes
E) EBIT + DTc

Ans: C Level: Basic Subject: Operating Cash Flow Type: Concepts

55. You are to calculate operating cash flow using the following information: sales, net income,
depreciation, and net initial investment. If interest expenses are zero, then it would likely be
easiest for you to use the _______________________ approach.
A) conventional
B) tax shield
C) bottom-up
D) top-down
E) depreciation first

Ans: C Level: Basic Subject: Operating Cash Flow Type: Concepts

56. The __________________ approach for calculating project operating cash flow explicitly
measures the depreciation-related tax benefit associated with the investment.
A) stand-alone
B) bottom-up
C) top-down
D) tax shield
E) traditional

Ans: D Level: Basic Subject: Operating Cash Flow Type: Concepts

57. If the only project income statement items known to you are net income and depreciation, which
of the following methods for calculating project OCF would you use?
I. Bottom-up approach
II. Top-down approach
III. Tax-shield approach
A) I only
B) II only
C) III only
D) I and II only
E) I and III only

Ans: A Level: Basic Subject: Operating Cash Flow Type: Concepts

58. Which of the following methods for calculating project operating cash flow do (does) NOT require
you to add back noncash deductions such as depreciation?
I. Bottom-up approach
II. Top-down approach
III. Tax-shield approach
A) I only
B) II only
C) III only
D) II and III only
E) I, II, and III

Ans: B Level: Basic Subject: Operating Cash Flow Type: Concepts

87. You purchase a machine for $22,000 which belongs in a 30% CCA class. What is the present
value of the CCA tax shield on the machine if it is sold at the end of the third year for $6,000, your
tax rate is 34%, and the appropriate discount rate is 15%?
A) $1,014
B) $3,510
C) $5,011
D) $5,623
E) $6,994

Ans: D Level: Basic Subject: PVCCATS Type: Problems

88. The equipment required for a four year project costs $60,000 and belongs in a 20% CCA class.
The project generates after-tax operating income of $13,750 and the fixed assets will be sold for
$7,000 at the termination of the project. If the firm has a tax rate of 34% and a required return of
10%, what is the NPV?
A) $265
B) $1,133
C) $1,839
D) $2,261
E) $2,842

Ans: A Level: Basic Subject: Net Present Value Type: Problems

89. The machinery required for a three year project costs $20,000, belongs in a 15% CCA class, and
will require a net working capital investment of $5,000 up-front. The project generates after-tax
operating income of $11,500. The fixed assets will be sold for $2,000 at the end of the project. If
the firm has a tax rate of 34% and a required return of 10%, what is the project NPV?
A) $10,724
B) $11,033
C) $12,446
D) $13,426
E) $15,942

Ans: C Level: Basic Subject: Net Present Value Type: Problems

90. A firm purchases Class 8 equipment for $1,000,000 (CCA Rate 20%) for a 10 year project. What
will be the CCA tax shield in year 3? The tax rate is 35%.
A) $144,000
B) $50,400
C) $201,600
D) $63,000
E) $35,000

Ans: B Level: Basic Subject: CCA Tax Shield Type: Problems

91. Consider a $12,000 machine that will reduce after-tax operating costs by $2,500 per year over a
five-year period. Assume no changes in net working capital and a salvage value of zero. Further
assume that the machine belongs in a 20% CCA class, a marginal tax rate of 34%, and a required
return of 10%. The project NPV is:
A) $73
B) $449
C) $689
D) $827
E) $1,235

Ans: A Level: Basic Subject: Cost Cutting Proposal Type: Problems

92. Given the following information and assuming a CCA rate of 20%, what is the NPV of this
project? Initial investment = $400,000; life = five years; before-tax cost savings = $150,000 per
year; salvage value = $30,000 in year 5; tax rate = 34%; discount rate = 14%.
A) -$149,841
B) -$33,117
C) $0
D) $19,800
E) $27,428

Ans: E Level: Basic Subject: Net Present Value Type: Problems

93. Given the following information and assuming straight-line depreciation to zero, what is the IRR
of this project? Initial investment = $400,000; life = four years; cost savings = $125,000 per year;
salvage value = $20,000 in year 5; tax rate = 34%; discount rate = 12%.
A) 6.25%
B) 7.51%
C) 8.15%
D) 9.43%
E) 10.24%

Ans: B Level: Basic Subject: Internal Rate Of Return Type: Problems

94. Given the following project information and assuming straight-line depreciation to zero, what is
the discounted payback period? Initial investment = $500,000; life = five years; cost savings =
$160,000 per year; salvage value = $30,000 in year 5; tax rate = 34%; discount rate = 13%.
A) two years
B) three years
C) four years
D) five years
E) The discounted payback period is greater than the project's life.

Ans: D Level: Basic Subject: Discounted Payback Type: Problems

95. Given the following information and assuming straight-line depreciation to zero, what is the
payback period for this project? Initial investment = $500,000; life = five years; cost savings =
$160,000 per year; salvage value = $30,000 in year 5; tax rate = 34%; discount rate = 13%.
A) 2.5 years
B) 3.6 years
C) 3.9 years
D) 4.4 years
E) The payback period is greater than the project's life.

Ans: B Level: Basic Subject: Payback Period Type: Problems

 96. Given the following information and assuming a CCA rate of 20%, what is the profitability index
of this project? Initial investment = $400,000; life = five years; before-tax cost savings = $150,000
per year; salvage value = $30,000 in year 5; tax rate = 34%; discount rate = 14%.
A) 0.45
B) 0.74
C) 1.07
D) 1.65
E) 1.98

Ans: C Level: Basic Subject: Profitability Index Type: Problems

97. Given the following information and assuming a CCA rate of 30% (Class 10), what is the NPV for
this project? Initial investment in fixed assets = $800,000; initial investment in net working
capital = $200,000; life = four years; pre-tax cost savings = $400,000 per year; salvage = $10,000
in year 4; tax rate = 35%; discount rate = 12%.
A) $50,000
B) $0
C) -$37,059
D) $110,866.55
E) $400,000

Ans: D Level: Basic Subject: Net Present Value Type: Problems

98. Given the following information and assuming a 20% CCA class, what is the NPV for this
project? Initial investment in fixed assets = $800,000; initial investment in net working capital =
$200,000; life = four years; after-tax cost savings = $250,000 per year; salvage value = $30,000;
tax rate = 35%; discount rate = 16%.
A) $95,101
B) $105,967
C) $147,261
D) $187,098
E) $418,198

Ans: C Level: Basic Subject: Net Present Value Type: Problems

Use the following to answer questions 111-115:

You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy
backhand. You estimate the sales price of The Ultimate to be $400 and sales volume to be 1,000 units in
year 1, 1,250 units in year 2, and 1,325 units in year 3. The project has a three year life. Variable costs
amount to $225 per unit and fixed costs are $100,000 per year. The project requires an initial investment of
$165,000 which is depreciated straight-line to zero over the three year project life. The actual market value
of the initial investment at the end of year 3 is $35,000. Initial net working capital investment is $75,000
and NWC will maintain a level equal to 20% of sales each year thereafter. The tax rate is 34% and the
required return on the project is 10%.
 111. What is EBIT for the project in the first year?
A) $13,200
B) $15,000
C) $20,000
D) $44,000
E) $52,000

Ans: C Level: Intermediate Subject: Earnings Before Interest & Taxes Type: Problems

112. Given the $75,000 initial investment in NWC, what change occurs for NWC during year 1?
A) There is no change in NWC.
B) There is a $5,000 increase in NWC.
C) There is a $5,000 decrease in NWC.
D) There is an $80,000 increase in NWC.
E) There is an $80,000 decrease in NWC.

Ans: B Level: Basic Subject: Additions To Net Working Capital Type: Problems

113. What is the operating cash flow for the project in year 2?
A) $26,400
B) $68,200
C) $97,075
D) $101,210
E) $105,738

Ans: C Level: Basic Subject: Operating Cash Flow Type: Problems

114. What is the effect of the $35,000 salvage value on year 2 cash flows?
A) There is no effect; the salvage value is a noncash event.
B) Cash flows are increased $11,900.
C) Cash flows are increased $23,100.
D) Cash flows are increased $35,000.
E) Salvage value does not affect incremental cash flow until year 3.

Ans: E Level: Intermediate Subject: Salvage Value Type: Problems

115. What is the total cash flow for the project in year 3?
A) $126,461
B) $178,156
C) $194,945
D) $234,838
E) $239,100

Ans: D Level: Intermediate Subject: Cash Flow From Assets Type: Problems

Use the following to answer questions 116-119:

You are considering investing in a piece of equipment to implement a cost-cutting proposal. The pre-tax
cost reduction is expected to equal $41.67 for each of the three years of the project's life. The equipment
has an initial cost of $125 and belongs in a 20% CCA class. Assume a 34% tax bracket, a discount rate of
15%, and a salvage value of zero.
116. What is the value of the annual depreciation tax shield for year 2 of the project?
A) $6.80
B) $7.65
C) $14.17
D) $27.50
E) $41.67

Ans: C Level: Basic Subject: Depreciation Tax Shield Type: Problems

117. What is the annual after-tax cost reduction for the project?
A) $14.17
B) $27.50
C) $41.67
D) $63.14
E) $69.17

Ans: B Level: Basic Subject: Operating Cash Flow Type: Problems

118. If the equipment is sold to another company at the end of year 3 for $20, what is the NPV?
A) $-33.56
B) $-28.91
C) $0
D) $28.91
E) $33.56

Ans: B Level: Intermediate Subject: Net Present Value Type: Problems

119. If the equipment is sold to another company at the end of year 3 for $20, what is the PI?
A) 0.31
B) 0.46
C) 0.77
D) 1.09
E) 1.31

Ans: C Level: Intermediate Subject: Profitability Index Type: Problems

136. The Frank Ernst Co. wants to add an additional production line. To do this, the company must
spend $100,000 to expand its current building and purchase $1.2 million in new equipment. The
building expansion has a salvage value of $80,000 and the equipment has a salvage value of
$390,000. This new line is expected to produce 200,000 units with a projected sales price of $4.65
per unit and a variable cost of $2.90 a unit. Gross profit from existing products is expected to
decline by $29,000 a year as a result of this addition. Fixed costs are $42,000 annually. The net
working capital requirement is $36,000. The company uses straight-line depreciation over the life
of the product and requires a 15% rate of return. Taxes are incurred at a rate of 34%. The life of
the project is five years. What is the total cash flow in year 5?
A) $553,080
B) $582,080
C) $589,080
D) $618,740
E) $748,880

Ans: D Level: Challenge Subject: Projected Cash Flows Type: Problems

137. The Whilst Co. is analyzing a project that has projected sales of $189,400 and costs of $102,300.
The project requires an investment in inventory of $15,000 plus another $28,000 in accounts
receivable. Fixed assets of $80,000 are needed and belong in a 30% CCA class. Accounts payable
will increase by $36,000. An interest expense of $11,000 will be incurred annually. The project has
a life of 3 years. At the end of the three years, the equipment has an estimated market value of
$26,000. The company requires a 14% rate of return and is in the 34% marginal tax bracket. What
is the net present value of this project?
A) $65,887
B) $68,023
C) $81,921
D) $91,425
E) $93,608

Ans: D Level: Challenge Subject: Net Present Value Type: Problems