Principles of Managerial Finance, 13e, Global Edition (Gitman)
Chapter 10 Capital Budgeting Te
Techniques
chniques
10.1 Understand the key elements of the capital budgeting process.
1) In capital budgeting, the preferred
p referred approaches in assessing whether a project is acceptable are
those that integrate time value procedures, risk and return considerations, and valuation concepts.
nswer! "#U$
"opic!
"o
pic! %apital &udgeting "echni'ues
"echni'ues
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
+) In capital budgeting, the preferred
p referred approaches in assessing whether a project is acceptable
integrate time value procedures, risk and return considerations, valuation concepts, and the
re'uired payback period.
nswer! -$
"opic!
"o
pic! %apital &udgeting "echni'ues
"echni'ues
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
) %apital budgeting techni'ues are used to evaluate the firm/s fied asset investments which
provide the basis for the firm/s earning power and value.
nswer! "#U$
"opic!
"o
pic! %oncept of %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
) "he purchase of additional physical facilities, such as additional property o r a new factory, is
an eample of a capital ependiture.
nswer! "#U$
"opic!
"o
pic! %apital &udgeting "erminology
"erminology
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
2) %apital budgeting is the process of evaluating and selecting short3term investments consistent
with the firm/s goal of owner wealth maimi4ation.
nswer! -$
"opic!
"o
pic! %oncept of %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
5)  650,000 outlay for a new
n ew machine with a usable life of 12 years is an operating ependiture
that would appear as a current asset on the firm/s balance sheet.
nswer! -$
"opic!
"o
pic! %apital &udgeting "erminology
"erminology
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
1
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9)  capital ependiture is an outlay of funds invested only in fied assets that is epected to
produce benefits over a period of time less than one year.
nswer! -$
"opic!
"o
pic! %apital &udgeting "erminology
"erminology
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
:) n outlay for advertising and management consulting is considered to be a fied asset
ependiture.
nswer! -$
"opic!
"o
pic! %apital &udgeting "erminology
"erminology
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
;) %apital ependiture proposals are reviewed to assess their appropriateness in light of the firm/s
overall objectives and plans, and to evaluate their economic validity.
nswer! "#U$
"opic!
"o
pic! %oncept of %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
10) "he basic motives for capital ependitures are to epand, replace, or renew fied assets or to
obtain some other, less tangible benefit over a long period.
nswer! "#U$
"opic!
"o
pic! <otives for %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
11) "he primary motive for capital ependitures
epe nditures is to refurbish fied assets.
nswer! -$
"opic!
"o
pic! <otives for %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
1+) #esearch and development is considered to be a motive for making capital ependitures.
nswer! "#U$
"opic!
"o
pic! <otives for %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
1) "he capital budgeting process consists of five distinct but interrelated steps! proposal
generation, review and analysis, decision making, implementation, and follow3up.
nswer! "#U$
"opic!
"o
pic! teps in %apital
%apital &udgeting 8rocess
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
+
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9)  capital ependiture is an outlay of funds invested only in fied assets that is epected to
produce benefits over a period of time less than one year.
nswer! -$
"opic!
"o
pic! %apital &udgeting "erminology
"erminology
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
:) n outlay for advertising and management consulting is considered to be a fied asset
ependiture.
nswer! -$
"opic!
"o
pic! %apital &udgeting "erminology
"erminology
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
;) %apital ependiture proposals are reviewed to assess their appropriateness in light of the firm/s
overall objectives and plans, and to evaluate their economic validity.
nswer! "#U$
"opic!
"o
pic! %oncept of %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
10) "he basic motives for capital ependitures are to epand, replace, or renew fied assets or to
obtain some other, less tangible benefit over a long period.
nswer! "#U$
"opic!
"o
pic! <otives for %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
11) "he primary motive for capital ependitures
epe nditures is to refurbish fied assets.
nswer! -$
"opic!
"o
pic! <otives for %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
1+) #esearch and development is considered to be a motive for making capital ependitures.
nswer! "#U$
"opic!
"o
pic! <otives for %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
1) "he capital budgeting process consists of five distinct but interrelated steps! proposal
generation, review and analysis, decision making, implementation, and follow3up.
nswer! "#U$
"opic!
"o
pic! teps in %apital
%apital &udgeting 8rocess
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
+
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1) "he capital budgeting process consists of four distinct but interrelated steps! proposal
generation, review and analysis, decision making, and termination.
nswer! -$
"opic!
"o
pic! teps in %apital
%apital &udgeting 8rocess
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
12) Independent projects are projects that compete with one another for the firm/s resources, so
that the acceptance of one
o ne eliminates the others from further consideration.
nswer! -$
"opic!
"o
pic! Independent 8rojects
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
15)  non3conventional cash flow pattern associated with capital investment projects consists of
an initial outflow followed by a series of inflows.
nswer! -$
"opic!
"o
pic! %onventional versus =onconventional %ash lows
lows
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
19) If a firm has unlimited funds to invest in
in capital assets, all independent projects that meet its
minimum investment criteria should be implemented.
nswer! "#U$
"opic!
"o
pic! %oncept of %apital &udgeting
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
1:) "he following three projects would seem to compete with one another form the firm/s
resources and therefore would be eamples of
o f mutually eclusive projects.
>1) installin
installing
g air conditioning
conditioning in the plant
>+) ac'uiring
ac'uiring a small
small supplie
supplierr
>) purchasing
purchasing a new computer
computer system
system
nswer! -$
"opic!
"o
pic! <utually $clusive
$clusive 8rojects
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills
1;) If a firm has unlimited funds to invest, all the mutually eclusive projects that meet its
minimum investment criteria can be implemented.
nswer! -$
"opic!
"o
pic! <utually $clusive
$clusive 8rojects
(uestion tatus! #evised
%& *uidelines!
*uidelines! #eflective thinking
thinking skills
skills

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+0) <utually eclusive projects are projects whose cash flows are unrelated to one another? the
acceptance of one does not eliminate the others from further consideration.
nswer! -$
"opic! <utually $clusive 8rojects
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+1) "o increase its production capacity, a firm is considering! 1) to epand its plant, +) to ac'uire
another company, or ) to contract with another company for production. "hese three projects
would appear to be good eamples of independent projects.
nswer! -$
"opic! Independent 8rojects
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
++) Independent projects are those whose cash flows are unrelated to one another? the acceptance
of one does not eliminate any others from further consideration.
nswer! "#U$
"opic! Independent versus <utually $clusive 8rojects
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+) <utually eclusive projects are those whose cash flows are unrelated to one another? the
acceptance of one does not eliminate any others from further consideration.
nswer! -$
"opic! Independent versus <utually $clusive 8rojects
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+) <utually eclusive projects are those whose cash flows compete with one another? the
acceptance of one does not eliminate any others from further consideration.
nswer! -$
"opic! Independent versus <utually $clusive 8rojects
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+2) <utually eclusive projects are those whose cash flows compete with one another? the
acceptance of one eliminates others from further consideration.
nswer! "#U$
"opic! Independent versus <utually $clusive 8rojects
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills

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+5) If a firm is subject to capital rationing, it is able to accept all independent projects that
provide an acceptable return.
nswer! -$
"opic! %apital #ationing
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+9) If a firm has unlimited funds, it is able to accept all independent projects that provide an
acceptable return.
nswer! "#U$
"opic! %apital #ationing
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+:) If a firm is subject to capital rationing, it has only a fied number of dollars available for
capital ependitures, and numerous projects compete for these dollars.
nswer! "#U$
"opic! %apital #ationing
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+;) "he ranking approach involves the ranking of capital ependiture projects on the basis of
some predetermined measure such as the rate of return.
nswer! "#U$
"opic! ccept3#eject versus #anking pproaches
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
0) "he accept3reject approach involves the ranking of capital ependiture projects on the basis
of some predetermined measure such as the rate of return.
nswer! -$
"opic! ccept3#eject versus #anking pproaches
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1)  conventional cash flow pattern is one in which an initial outflow is followed only by a
series of inflows.
nswer! "#U$
"opic! %onventional versus =onconventional %ash lows
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+)  nonconventional cash flow pattern is one in which an initial outflow is followed only by a
series of inflows.
nswer! -$
"opic! %onventional versus =onconventional %ash lows
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
2
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)  nonconventional cash flow pattern is one in which an initial outflow is followed by a series
of both inflows and outflows.
nswer! "#U$
"opic! %onventional versus =onconventional %ash lows
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
) @@@@@@@@ is the process of evaluating and selecting long3term investments consistent with
the firm/s goal of owner wealth maimi4ation.
) #ecapitali4ing assets
&) %apital budgeting
%) #atio analysis
A) #estructuring debt
nswer! &
"opic! %oncept of %apital &udgeting
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
2) ied assets that provide the basis for the firm/s profit and va lue are often called
) tangible assets.
&) non3current assets.
%) earning assets.
A) book assets.
nswer! %
"opic! %apital &udgeting "erminology
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
5) "he most common motive for adding fied assets to the firm is
) epansion.
&) replacement.
%) renewal.
A) transformation.
nswer! 
"opic! <otives for %apital &udgeting $penditures
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
9) "he final step in the capital budgeting process is
) implementation.
&) follow3up.
%) re3evaluation.
A) education.
nswer! &
"opic! teps in %apital &udgeting 8rocess
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
5
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:) "he first step in the capital budgeting process is
) review and analysis.
&) implementation.
%) decision3making.
A) proposal generation.
nswer! A
"opic! teps in %apital &udgeting 8rocess
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
;)  650,000 outlay for a new machine with a usable life of 12 years is called
) capital ependiture.
&) operating ependiture.
%) replacement ependiture.
A) none of the above.
nswer! 
"opic! %apital &udgeting "erminology
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
0)  capital ependiture is all of the following $B%$8"
) an outlay made for the earning assets of the firm.
&) epected to produce benefits over a period of time greater than one year.
%) an outlay for current asset epansion.
A) commonly used to epand the level of operations.
nswer! %
"opic! %oncept of %apital &udgeting
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1) ll of the following are motives for capital budgeting ependitures $B%$8"
) epansion.
&) replacement.
%) renewal.
A) invention.
nswer! A
"opic! <otives for %apital &udgeting $penditures
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
9
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+) ll of the following are steps in the capital budgeting process $B%$8"
) implementation.
&) follow3up.
%) transformation.
A) decision3making.
nswer! %
"opic! teps in %apital &udgeting 8rocess
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
) @@@@@@@@ projects do not compete with each other? the acceptance of one @@@@@@@@ the
others from consideration.
) %apital? eliminates
&) Independent? does not eliminate
%) <utually eclusive? eliminates
A) #eplacement? does not eliminate
nswer! &
"opic! Independent 8rojects
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
) @@@@@@@@ projects have the same function? the acceptance of one @@@@@@@@ the others from
consideration.
) %apital? eliminates
&) Independent? does not eliminate
%) <utually eclusive? eliminates
A) #eplacement? does not eliminate
nswer! %
"opic! <utually $clusive 8rojects
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
2)  firm with limited dollars available for capital ependitures is subject to
) capital dependency.
&) mutually eclusive projects.
%) working capital constraints.
A) capital rationing.
nswer! A
"opic! %apital #ationing
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
:
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5)  conventional cash flow pattern associated with capital investment projects consists of an
initial
) outflow followed by a broken cash series.
&) inflow followed by a broken series.
%) outflow followed by a series of inflows.
A) inflow followed by a series of outflows.
nswer! %
"opic! %onventional versus =onconventional %ash lows
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
9)  non3conventional cash flow pattern associated with capital investment projects consists of
an initial
) outflow followed by a series of both cash inflows and outflows.
&) inflow followed by a series of both cash inflows and outflows.
%) outflow followed by a series of inflows.
A) inflow followed by a series of outflows.
nswer! 
"opic! %onventional versus =onconventional %ash lows
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
:) @@@@@@@@ is a series of e'ual annual cash flows.
)  mied stream
&)  conventional
%)  non3conventional
A) n annuity
nswer! A
"opic! nnuity %ash lows
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
;) "he cash flows of any project having a conventional pattern include all of the basic
components $B%$8"
) initial investment.
&) operating cash outflows.
%) operating cash inflows.
A) terminal cash flow.
nswer! &
"opic! %onventional versus =onconventional %ash lows
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
;
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20) 8rojects that compete with one another, so that the acceptance of one eliminates the others
from further consideration are called
) independent projects.
&) mutually eclusive projects.
%) replacement projects.
A) none of the above.
nswer! &
"opic! <utually $clusive 8rojects
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
21) "he evaluation of capital ependiture proposals to determine whether they meet the firm/s
minimum acceptance criteria is called
) the ranking approach.
&) an independent investment.
%) the accept3reject approach.
A) a mutually eclusive investment.
nswer! %
"opic! ccept3#eject versus #anking pproaches
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
2+) Chich pattern of cash flow stream is the most difficult to use when evaluating projectsD
) <ied stream.
&) %onventional flow.
%) =onconventional flow.
A) nnuity.
nswer! %
"opic! %onventional versus =onconventional %ash lows
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
10
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Table 10.1
2) "he cash flow pattern depicted is associated with a capital investment and may be
characteri4ed as @@@@@@@@. >ee "able 10.1)
) an annuity and conventional cash flow
&) a mied stream and non3conventional cash flow
%) an annuity and non3conventional cash flow
A) a mied stream and conventional cash flow
nswer! 
"opic! %onventional versus =onconventional %ash lows
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
Table 10.2
2) "he cash flow pattern depicted is associated with a capital investment and may be
characteri4ed as @@@@@@@@. >ee "able 10.+)
) an annuity and conventional cash flow
&) a mied stream and non3conventional cash flow
%) an annuity and non3conventional cash flow
A) a mied stream and conventional cash flow
nswer! A
"opic! %onventional versus =onconventional %ash lows
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
11
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10.+ %alculate, interpret, and evaluate the payback period.
1) In the case of annuity cash inflows, the payback period can be found by dividing the initial
investment by the annual cash inflow.
nswer! "#U$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+) "he payback period is the amount of time re'uired for the firm to dispose of a replaced asset.
nswer! -$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
) "he payback period is generally viewed as an unsophisticated capital budgeting techni'ue,
because it does not eplicitly consider the time value of money by discounting cash flows to find
present value.
nswer! "#U$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
) &y measuring how 'uickly the firm recovers its initial investment, the payback period gives
implicit >though not eplicit) consideration to the timing of cash flows and therefore to the time
value of money.
nswer! "#U$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
2) Ene strength of payback period is that it fully accounts for the time value of money.
nswer! -$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
5) Ene weakness of payback is its failure to recogni4e cash flows that occur after the p ayback
period.
nswer! "#U$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1+
%opyright 7 +01+ 8earson $ducation
9)  project must be rejected if its payback period is less than the maimum acceptable payback
period.
nswer! -$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
:) ince the payback period can be viewed as a measure of risk eposure, many firms use it as a
supplement to sophisticated decision techni'ues.
nswer! "#U$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
;) "he major weakness of payback period in evaluating projects is that it cannot specify the
appropriate payback period in light of the wealth maimi4ation goal.
nswer! "#U$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
10) If a project/s payback period is less than the maimum acceptable payback period, we would
reject it.
nswer! -$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
11) Chich of the following capital budgeting techni'ues ignores the time value of moneyD
) 8ayback.
&) =et present value.
%) Internal rate of return.
A) "wo of the above.
nswer! 
"opic! %apital &udgeting "echni'ues
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1+) If a project/s payback period is less than the maimum acceptable payback period, we would
accept it.
nswer! "#U$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1
%opyright 7 +01+ 8earson $ducation
1) If a project/s payback period is greater than the maimum acceptable payback period, we
would reject it.
nswer! "#U$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1) If a project/s payback period is greater than the maimum acceptable payback period, we
would accept it.
nswer! -$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
12) "he payback period of a project that costs 61,000 initially and promises after3ta cash
inflows of 600 for the net three years is . years.
nswer! "#U$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! nalytic skills
15) "he payback period of a project that costs 61,000 initially and promises after3ta cash
inflows of 600 each year for the net three years is 0. years.
nswer! -$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! nalytic skills
19) "he payback period of a project that costs 61,000 initially and promises after3ta cash
inflows of 6,000 each year for the net three years is 0. years.
nswer! "#U$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! nalytic skills
1:) "he payback period of a project that costs 61,000 initially and promises after3ta cash
inflows of 6,000 each year for the net three years is . years.
nswer! -$
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! nalytic skills
1
%opyright 7 +01+ 8earson $ducation
1;) $amples of sophisticated capital budgeting techni'ues include all of the following $B%$8"
) internal rate of return.
&) payback period.
%) annuali4ed net present value.
A) net present value.
nswer! &
"opic! %apital &udgeting "echni'ues
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+0) "he @@@@@@@@ measures the amount of time it takes the firm to recover its initial investment.
) average rate of return
&) internal rate of return
%) net present value
A) payback period
nswer! A
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+1) Unsophisticated capital budgeting techni'ues do not
) eamine the si4e of the initial outlay.
&) use net profits as a measure of return.
%) eplicitly consider the time value of money.
A) take into account an unconventional cash flow pattern.
nswer! %
"opic! %apital &udgeting "echni'ues
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
++) ll of the following are weaknesses of the payback period $B%$8"
) a disregard for cash flows after the payback period.
&) only an implicit consideration of the timing of cash flows.
%) the difficulty of specifying the appropriate payback period.
A) it uses cash flows, not accounting profits.
nswer! A
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
12
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+) <any firms use the payback method as a guideline in capital investment decisions. #easons
they do so include all of the following $B%$8"
) it gives an implicit consideration to the timing of cash flows.
&) it recogni4es cash flows which occur after the payback period.
%) it is a measure of risk eposure.
A) it is easy to calculate.
nswer! &
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+) 8ayback is considered an unsophisticated capital budgeting because it
) gives eplicit consideration to the timing of cash flows and therefore the time value of money.
&) gives eplicit consideration to risk eposure due to the use of the cost of capital as a discount
rate.
%) gives eplicit consideration to the timing of cash flows and therefore the time value of money.
A) none of the above.
nswer! A
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+2) ome firms use the payback period as a decision criterion or as a supplement to sophisticated
decision techni'ues, because
) it eplicitly considers the time value of money.
&) it can be viewed as a measure of risk eposure because of its focus on li'uidity.
%) the determination of the re'uired payback period for a project is an objectively determined
criteria.
A) none of the above.
nswer! &
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+5)  firm is evaluating a proposal which has an initial investment of 62,000 and has cash flows
of 610,000 in year 1, 6+0,000 in year +, and 610,000 in year . "he payback period of the project
is
) 1 year.
&) + years.
%) between 1 and + years.
A) between + and  years.
nswer! A
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! nalytic skills
15
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+9)  firm is evaluating a proposal which has an initial investment of 620,000 and has cash flows
of 612,000 per year for five years. "he payback period of the project is
) 1.2 years.
&) + years.
%) . years.
A)  years.
nswer! %
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! nalytic skills
+:) Chich of the following statements is falseD
) If the payback period is less than the maimum acceptable payback period, accept the project.
&) If the payback period is greater than the maimum acceptable payback period, reject the
project.
%) If the payback period is less than the maimum acceptable payback period, reject the project
A) "wo of the above.
nswer! %
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+;) Chich of the following statements is falseD
) If the payback period is greater than the maimum acceptable payback period, accept the
project.
&) If the payback period is less than the maimum acceptable payback period, reject the project.
%) If the payback period is greater than the maimum acceptable payback period, reject the
project.
A) "wo of the above.
nswer! A
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
0) Chat is the payback period for "angshan <ining company/s new project if its initial after ta
cost is 62,000,000 and it is epected to provide after3ta operating cash inflows of 61,:00,000 in
year 1, 61,;00,000 in year +, 6900,000 in year  and 61,:00,000 in year D
) . years
&) . years
%) +. years
A) =one of the above
nswer! &
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! nalytic skills
19
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1) hould "angshan <ining company accept a new project if its maimum payback is .2 years
and its initial after ta cost is 62,000,000 and it is epected to provide after3ta operating cash
inflows of 61,:00,000 in year 1, 61,;00,000 in year +, 6900,000 in year  and 61,:00,000 in year
D
) Fes.
&) =o.
%) It depends.
A) =one of the above.
nswer! 
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! nalytic skills
+) hould "angshan <ining company accept a new project if its maimum payback is .+2
years and its initial after ta cost is 62,000,000 and it is epected to provide after3ta operating
cash inflows of 61,:00,000 in year 1, 61,;00,000 in year +, 6900,000 in year  and 61,:00,000 in
year D
) Fes.
&) =o.
%) It depends.
A) =one of the above.
nswer! &
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! nalytic skills
) $valuate the following projects using the payback method assuming a rule of  years for
payback.
Fear
0
1
+


8roject 
310,000
,000
,000
,000
0
8roject &
310,000
,000
,000
+,000
1,000,000
) 8roject  can be accepted because the payback period is +.2 years but 8roject & can not be
accepted because it/s payback period is longer than  years.
&) 8roject & should be accepted because even thought the payback period is +.2 years for project
 and .001 project &, there is a 61,000,000 payoff in the th year in 8roject &.
%) 8roject & should be accepted because you get more money paid back in the long run.
A) &oth projects can be accepted because the payback is less than  years.
nswer! 
"opic! 8ayback <ethod
(uestion tatus! =ew
%& *uidelines! nalytic skills
1:
%opyright 7 +01+ 8earson $ducation
10. %alculate, interpret, and evaluate the net present value >=8G) and economic value added
>$G).
1) =et present value is considered a sophisticated capital budgeting techni'ue since it gives
eplicit consideration to the time value of money.
nswer! "#U$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+) "he discount rate >which is also known as the re'uired return, cost of capital, or opportunity
cost) is the minimum return that must be earned on a project to leave the firm/s market value
unchanged.
nswer! "#U$
"opic! 8roject #e'uired #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
) If net present value of a project is greater than 4ero, the firm will earn a return greater than its
cost of capital. "he acceptance of such a project would enhance the wealth of the firm/s owners.
nswer! "#U$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
) "he net present value is found by subtracting a project/s initial investment from the present
value of its cash inflows discounted at a rate e'ual to the project/s internal rate of return.
nswer! -$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
2)  sophisticated capital budgeting techni'ue that can be computed by subtracting a project/s
initial investment from the present value of its cash inflows discounted at a rate e'ual to the
firm/s cost of capital is called net present value.
nswer! "#U$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
5)  sophisticated capital budgeting techni'ue that can be computed by subtracting a project/s
initial investment from the present value of its cash inflows discounted at a rate e'ual to the
firm/s cost of capital is called internal rate of return.
nswer! -$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1;
%opyright 7 +01+ 8earson $ducation
9) If the =8G is greater than the cost of capital, a project should be accepted.
nswer! -$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
:) If the =8G is greater than the initial investment, a project sho uld be accepted.
nswer! -$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
;) If the =8G is greater than 60.00, a project should be accepted.
nswer! "#U$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
10) "he =8G of an project with an initial investment of 61,0 00 that provides after3ta operating
cash flows of 600 per year for four years where the firm/s cost of capital is 12 percent is
6:25.;.
nswer! -$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
11) "he =8G of an project with an initial investment of 61,000 that provides after3ta operating
cash flows of 600 per year for four years where the firm/s cost of capital is 12 percent is
61.21.
nswer! -$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
1+) "he =8G of an project with an initial investment of 61,0 00 that provides after3ta operating
cash flows of 600 per year for four years where the firm/s cost of capital is 12 percent is 3
61.21.
nswer! "#U$
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
+0
%opyright 7 +01+ 8earson $ducation
1) $conomic value added is the difference between an investment/s net operating profit after
taes and the cost of funds used to finance the investment, which is found by multiplying the
dollar amount of the funds used to finance the investment by the firm/s weighted average cost of
capital.
nswer! "#U$
"opic! $conomic Galue dded
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1) "he investment operating schedule is the difference between an investment/s net operating
profit after taes and the cost of funds used to finance the investment, which is found by
multiplying the dollar amount of the funds used to finance the investment by the firm/s weighted
average cost of capital.
nswer! -$
"opic! $conomic Galue dded
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
12)  firm is evaluating three capital projects. "he net present values for the projects are as
follows!
"he firm should
) accept 8rojects 1 and + and reject 8roject .
&) accept 8rojects 1 and  and reject 8roject +.
%) accept 8roject 1 and reject 8rojects + and .
A) reject all projects.
nswer! 
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
15) ophisticated capital budgeting techni'ues do not
) eamine the si4e of the initial outlay.
&) use net profits as a measure of return.
%) eplicitly consider the time value of money.
A) take into account an unconventional cash flow pattern.
nswer! &
"opic! %apital &udgeting "echni'ues
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+1
%opyright 7 +01+ 8earson $ducation
19) "he minimum return that must be earned on a project in order to leave the firm/s value
unchanged is
) the internal rate of return.
&) the interest rate.
%) the cost of capital.
A) the compound rate.
nswer! %
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1:)  firm would accept a project with a net present value of 4ero because
) the project would maintain the wealth of the firm/s owners.
&) the project would enhance the wealth of the firm/s owners.
%) the return on the project would be positive.
A) the return on the project would be 4ero.
nswer! 
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1;)  firm is evaluating an investment proposal which has an initial investment of 62,000 and
cash flows presently valued at 6,000. "he net present value of the investment is @@@@@@@@.
) 361,000
&) 60
%) 61,000
A) 61.+2
nswer! 
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
+0) Chat is the =8G for the following project if its cost of capital is 12 p ercent and its initial
after ta cost is 62,000,000 and it is epected to provide after3ta operating cash inflows of
61,:00,000 in year 1, 61,;00,000 in year +, 61,900,000 in year  and 61,00,000 in year D
) 61,900,000
&) 691,95
%) >619,02)
A) =one of the above
nswer! %
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
++
%opyright 7 +01+ 8earson $ducation
+1) Chat is the =8G for the following project if its cost of capital is 0 percent and its initial after
ta cost is 62,000,000 and it is epected to provide after3ta operating cash inflows of
61,:00,000 in year 1, 61,;00,000 in year +, 61,900,000 in year  and 61,00,000 in year D
) 61,900,000
&) 691,95
%) 619,02
A) =one of the above
nswer! 
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
++) Chat is the =8G for the following project if its cost of capital is 1+ p ercent and its initial
after ta cost is 62,000,000 and it is epected to provide after3ta operating cash flows of
61,:00,000 in year 1, 61,;00,000 in year +, 61,900,000 in year  and >61,00,000) in year D
) 6>1,;,5)
&) 61,;,5
%) 612:,011
A) "wo of the above
nswer! 
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
Table 10.1
+) *iven the information in "able 10.1 and 12 percent cost of capital,
>a) compute the net present value.
>b) should the project be acceptedD
nswer!
>a) =8G H >1,000.12)J131>1.12)2K 3 +,200
H 1,000 >.2+) 3 +,200 H 6:2+
>b) ince =8G L 0, the project should be accepted.
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
+
%opyright 7 +01+ 8earson $ducation
Table 10.2
+) *iven the information in "able 10.+ and 12 percent cost of capital,
>a) compute the net present value.
>b) should the project be acceptedD
nswer!
>a)
=8G H ;:,:+0 3 100,000 H 361,1:0 M 0
>b) ince =8G M 0, the project should be rejected.
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
10. %alculate, interpret, and evaluate the internal rate of return >I##).
1) "he internal rate of return >I##) is defined as the discount rate that e'uates the net present
value with the initial investment associated with a project.
nswer! -$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+) "he I## is the discount rate that e'uates the =8G of an investment opportunity with 60.
nswer! "#U$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+
%opyright 7 +01+ 8earson $ducation
) "he I## is the compound annual rate of return that the firm will earn if it invests in a project
and receives the estimated cash inflows.
nswer! "#U$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
) n internal rate of return greater than the cost of capital guarantees that the firm earns at least
its re'uired return. Investing in such an project would enhance the market value of the firm and
therefore the wealth of its owners.
nswer! "#U$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
2)  sophisticated capital budgeting techni'ue that can be computed by solving for the discount
rate that e'uates the present value of a projects inflows with the present value of its outflows is
called net present value.
nswer! -$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
5)  sophisticated capital budgeting techni'ue that can be computed by solving for the discount
rate that e'uates the present value of a projects inflows with the present value of its outflows is
called internal rate of return.
nswer! "#U$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
9) If its I## is greater than 60.00, a project should be accepted.
nswer! -$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
:) If its I## is greater than 0 percent, a project should be accepted.
nswer! -$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
;) If its I## is greater than the cost of capital, a project should be accepted.
nswer! "#U$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+2
%opyright 7 +01+ 8earson $ducation
10) Chat is the I## for the following project if its initial after ta cost is 62,000,000 and it is
epected to provide after3ta operating cash inflows of 61,:00,000 in year 1, 61,;00,000 in year
+, 61,900,000 in year  and 61,00,000 in year D
) 12.29N
&) 0.00N
%) 1.29N
A) =one of the above
nswer! %
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! nalytic skills
11) Chat is the I## for the following project if its initial after ta cost is 62,000,000 and it is
epected to provide after3ta operating cash flows of >61,:00,000) in year 1, 6+,;00,000 in year
+, 6+,900,000 in year  and 6+,00,000 in year D
) 2.:N
&) ;.59N
%) 11.N
A) =one of the above
nswer! 
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! nalytic skills
10.2 Use net present value profiles to compare =8G and I## techni'ues.
1) or conventional projects, both =8G and I## techni'ues will always generate the same
accept3reject decision, but differences in their underlying assumptions can cause them to rank
mutually eclusive projects differently.
nswer! "#U$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+) "he I## method assumes the cash flows are reinvested at the internal rate of return rather than
the re'uired rate of return
nswer! "#U$
"opic! Internal #ate of #eturn
(uestion tatus! =ew
%& *uidelines! #eflective thinking skills
)  project/s net present value profile is a graph that plots a project/s =8G for various discount
rates.
nswer! "#U$
"opic! =et 8resent Galue 8rofile
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+5
%opyright 7 +01+ 8earson $ducation
)  project/s net present value profile is a graph that plots a project/s I## for various discount
rates.
nswer! -$
"opic! =et 8resent Galue 8rofile
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
2) =et present value profiles are most useful when selecting among independent projects.
nswer! -$
"opic! =et 8resent Galue 8rofile
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
5) =et present value profiles are most useful when selecting among mutually eclusive projects.
nswer! "#U$
"opic! =et 8resent Galue 8rofile
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
9) "here is sometimes a ranking problem among =8G and I## when selecting among mutually
eclusive investments. "his ranking problem only occurs when
) the =8G is greater than the crossover point.
&) the =8G is less than the crossover point.
%) the cost of capital is to the right of the crossover point.
A) the cost of capital is to the left of the crossover point.
nswer! A
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
:) %onsider the following projects, B and F, where the firm can only choose one. 8roject B costs
6500 and has cash flows of 600 in each of the net + years. 8roject F also costs 6500, and
generates cash flows of 6200 and 6+92 for the net + years, respectively. Chich investment
should the firm choose if the cost of capital is 10 percentD
) 8roject B.
&) 8roject F.
%) =either.
A) =ot enough information to tell.
nswer! 
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! nalytic skills
+9
%opyright 7 +01+ 8earson $ducation
;) %onsider the following projects, B and F where the firm can only choose on e. 8roject B costs
6500 and has cash flows of 600 in each of the net + years. 8roject & also costs 6500, and
generates cash flows of 6200 and 6+92 for the net + years, respectively. Chich investment
should the firm choose if the cost of capital is +2 percentD
) 8roject B.
&) 8roject F.
%) =either.
A) =ot enough information to tell.
nswer! %
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! nalytic skills
10) "angshan <ining %ompany is considering investing in a new mining project. "he firm/s cost
of capital is 1+ percent and the project is epected to have an initial after ta cost of 62,000,000.
urthermore, the project is epected to provide after3ta operating cash flows of 6+,200,000 in
year 1, 6+,00,000 in year +, 6+,+00,000 in year  and >61,00,000) in year D
>a) %alculate the project/s =8G.
>b) %alculate the project/s I##.
>c) hould the firm make the investmentD
nswer!
=o the firm should not accept the project.
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! nalytic skills
10.5 Aiscuss =8G and I## in terms of conflicting rankings and the theoretical and practical
strengths of each approach.
1) %onflicting rankings in the case of mutually eclusive projects using =8G and I## often
results from differences in the magnitude andor timing of cash flows.
nswer! "#U$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+:
%opyright 7 +01+ 8earson $ducation
+) 8rojects having higher cash inflows in the early years tend to be less sensitive to changes in
the cost of capital and are therefore often acceptable at higher discount rates compared to
projects with higher cash inflows that occur in the later years.
nswer! "#U$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
) En a purely theoretical basis, =8G is a better approach to capital budgeting than I## because
=8G implicitly assumes that any intermediate cash inflows generated by an investment are
reinvested at the firm/s cost of capital.
nswer! "#U$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
) En a purely theoretical basis, =8G is the better approach to capital budgeting than I##
because I## implicitly assumes that any intermediate cash inflows generated by an investment
are reinvested at the firm/s cost of capital.
nswer! -$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
2) %ertain mathematical properties may cause a project with a nonconventional cash flow pattern
to have multiple I##s? this problem does not occur with the =8G approach.
nswer! "#U$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
5) =et present value >=8G) assumes that intermediate cash inflows are reinvested at the cost of
capital, whereas internal rate of return >I##) assumes that intermediate cash inflows can be
reinvested at a rate e'ual to the project/s I##.
nswer! "#U$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
9) ince the cost of capital tends to be a reasonable estimate of the rate at which the firm could
actually reinvest intermediate cash inflows, the use of =8G is in theory preferable to I##.
nswer! "#U$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+;
%opyright 7 +01+ 8earson $ducation
:) In general, projects with similar3si4ed investments and lower early3year cash inflows >lower
cash inflows in the early years) tend to be preferred at higher discount rates.
nswer! -$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
;) In general, the greater the difference between the magnitude andor timing of cash inflows, the
greater the likelihood of conflicting ranking between =8G and I##.
nswer! "#U$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
10) "he internal rate of return assumes that a project/s intermediate cash inflows are reinvested at
a rate e'ual to the firm/s cost of capital.
nswer! -$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
11) lthough differences in the magnitude and timing of cash flows eplain conflicting rankings
under the =8G and I## techni'ues, the underlying cause is the implicit assumption concerning
the reinvestment of intermediate cash inflows cash inflows received prior to the termination of
a project.
nswer! "#U$
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills

1+) En a purely theoretical basis, =8G is a better approach when selecting among two mutually
eclusive projects.
nswer! "#U$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1) En a purely theoretical basis, I## is a better approach when selecting among two mutually
eclusive projects.
nswer! -$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
0
%opyright 7 +01+ 8earson $ducation
1) In spite of the theoretical superiority of =8G, financial managers prefer to use I##.
nswer! "#U$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
12) In spite of the theoretical superiority of I##, financial managers prefer to use =8G.
nswer! -$
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
15) "he @@@@@@@@ is the discount rate that e'uates the present value of the cash inflows with the
initial investment.
) payback period
&) average rate of return
%) cost of capital
A) internal rate of return
nswer! A
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
19) "he @@@@@@@@ is the compound annual rate of return that the firm will earn if it invests in the
project and receives the given cash inflows.
) discount rate
&) internal rate of return
%) opportunity cost
A) cost of capital
nswer! &
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
1
%opyright 7 +01+ 8earson $ducation
1:)  firm with a cost of capital of 1 percent is evaluating three capital projects. "he internal
rates of return are as follows!
"he firm should
) accept 8roject + and reject 8rojects 1 and .
&) accept 8rojects + and  and reject 8roject 1.
%) accept 8roject 1 and reject 8rojects + and .
A) accept 8roject  and reject 8rojects 1 and +.
nswer! &
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! nalytic skills
Table 10.3
 firm is evaluating two projects that are mutually eclusive with initial investments and cash
flows as follows!
1;) If the firm in "able 10. has a re'uired payback of two >+) years, it should
) accept projects  and &.
&) accept project  and reject &.
%) reject project  and accept &.
A) reject both.
nswer! &
"opic! 8ayback <ethod
(uestion tatus! #evised
%& *uidelines! nalytic skills
+
%opyright 7 +01+ 8earson $ducation
+0) "he new financial analyst does not like the payback approach >"able 10.) and determines
that the firm/s re'uired rate of return is 12 percent. Ois recommendation would be to
) accept projects  and &.
&) accept project  and reject &.
%) reject project  and accept &.
A) reject both.
nswer! %
"opic! =et 8resent Galue
(uestion tatus! #evised
%& *uidelines! nalytic skills
Table 10.4
 firm must choose from si capital budgeting proposals outlined below. "he firm is subject to
capital rationing and has a capital budget of 61,000,000? the firm/s cost of capital is 12 percent.
+1) Using the internal rate of return approach to ranking projects, which projects should the firm
acceptD >ee "able 10.)
) 1, +, , , and 2
&) 1, +, , and 2
%) +, , , and 5
A) 1, , , and 5
nswer! &
"opic! I## and %apital #ationing
(uestion tatus! #evised
%& *uidelines! nalytic skills
++) Using the net present value approach to ranking projects, which projects should the firm
acceptD >ee "able 10.)
) 1, +, , , and 2
&) 1, +, , 2, and 5
%) +, , , and 2
A) 1, , 2, and 5
nswer! A
"opic! =8G and %apital #ationing
(uestion tatus! #evised
%& *uidelines! nalytic skills

%opyright 7 +01+ 8earson $ducation
+) Chen the net present value is negative, the internal rate of return is @@@@@@@@ the cost of
capital.
) greater than
&) greater than or e'ual to
%) less than
A) e'ual to
nswer! %
"opic! =8G and I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+)  firm is evaluating two independent projects utili4ing the internal rate of return techni'ue.
8roject B has an initial investment of 6:0,000 and cash inflows at the end of each of the net five
years of 6+2,000. 8roject P has a initial investment of 61+0,000 and cash inflows at the end of
each of the net four years of 60,000. "he firm should
) accept both if the cost of capital is at most 12 percent.
&) accept only P if the cost of capital is at most 12 percent.
%) accept only B if the cost of capital is at most 12 percent.
A) none of the above
nswer! %
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! nalytic skills
+2) "he underlying cause of conflicts in ranking for projects by internal rate of return and net
present value methods is
) the reinvestment rate assumption regarding intermediate cash flows.
&) that neither method eplicitly considers the time value of money.
%) the assumption made by the I## method that intermediate cash flows are reinvested at the
cost of capital.
A) the assumption made by the =8G method that intermediate cash flows are reinvested at the
internal rate of return.
nswer! 
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+5) En a purely theoretical basis, the =8G is the better approach to capital budgeting due to all
the following reasons $B%$8"
) that it measures the benefits relative to the amount invested.
&) for the reasonableness of the reinvestment rate assumption.
%) that there may be multiple solutions for an I## computation.
A) that it maimi4es shareholder wealth.
nswer! 
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills

%opyright 7 +01+ 8earson $ducation
+9) %omparing net present value and internal rate of return
) always results in the same ranking of projects.
&) always results in the same acceptreject decision.
%) may give different acceptreject decisions.
A) is only necessary on mutually eclusive projects.
nswer! &
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+:) In comparing the internal rate of return and net present value methods of evaluation,
) internal rate of return is theoretically superior, but financial managers prefer net present value.
&) net present value is theoretically superior, but financial managers prefer to use internal rate of
return.
%) financial managers prefer net present value, because it is presented as a rate of return.
A) financial managers prefer net present value, because it measures benefits relative to the
amount invested.
nswer! &
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
+;) Unlike the net present value criteria, the internal rate of return approach assumes an interest
rate e'ual to
) the relevant cost of capital.
&) the project/s internal rate of return.
%) the project/s opportunity cost.
A) the market/s interest rate.
nswer! &
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
0) Chen evaluating projects using internal rate of return,
) projects having lower early3year cash flows tend to be preferred at higher discount rates.
&) projects having higher early3year cash flows tend to be preferred at higher discount rates.
%) projects having higher early3year cash flows tend to be preferred at lower discount rates.
A) the discount rate and magnitude of cash flows do not affect internal rate of return.
nswer! &
"opic! Internal #ate of #eturn
(uestion tatus! #evised
%& *uidelines! #eflective thinking skills
2
%opyright 7 +01+ 8earson $ducation
1) Chich capital budgeting method is most useful for evaluating the following projectD "he
project has an initial after ta cost of 62,000,000 and it is epected to provide after3ta operating
cash flows of 61,:00,000 in year 1, >6+,;00,000) in year +, 6+,900,000 in year  and 6+,00,000
in year D
) =8G.
&) I##.
%) 8ayback.
A) "wo of the above.
nswer! 
"opic! =8G versus I##
(uestion tatus! #evised
%& *uidelines! nalytic skills
Table 10.5
*alay atellite %o. is attempting to select the best group of independent projects competing for
the firm/s fied capital budget of 610,000,000. ny unused portion of this budget will earn less
than its +0 percent cost of capital.  summary of key data about the proposed projects follows.
+) Use the =8G approach to select the best group of projects. >ee "able 10.2)
nswer! %hoose 8rojects % and A, since this combination maimi4es =8G at 610,000 and only
re'uires 6:,000,000 initial investment.
"opic! =8G and %apital #ationing
(uestion tatus! #evised
%& *uidelines! nalytic skills
) Use the I## approach to select the best group of projects. >ee "able 10.2)
nswer! !! "ppr#ach
%hoose 8rojects & and %, resulting in a =8G of 6:0,000.
"opic! I## and %apital #ationing
(uestion tatus! #evised
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