CHP.06
NET PRESENT VALUE AND OTHER INVESTMENT CRITERIA
Q.1.What is the NPV of a project that costs $100,000 and returns $45,000 annually for three
years if the opportunity cost of capital is 14%?
A) $3,397.57
B) $4,473.44
C) $16,100.00
D) $35,000.00
Answer: B Difficulty: Medium Page: 166, 5th paragraph.
NPV =
PV of inflows – required investment
 1

1

  100,000

=
$45,000 
=
=
=
$45,000 [7.1429 – 4.8212]
$45,000 [2.3217] – $100,000
$4,473.44
.14
.14(1.14) 3
Q.2.What is the NPV for the following project cash flows at a discount rate of 15%? CF0 =
($1,000), CF1 = $700, CF2 = $700.
A) ($308.70)
B) ($138.00)
C) $138.00
D) $308.70
Answer: C Difficulty: Medium Page: 166, 5th paragraph.
 1
NPV = $700 

1

2
.15 .15(1.15) 
=
=
=
 $1,000
$700 [6.6667 – 5.0410] –$1,000
$700[1.6257] – $1,000
$138.00
Q.3.The profitability index for a project costing $40,000 and returning $15,000 annually for
four years at an opportunity cost of capital of 12% is:
A) 0.139
B) 0.320
C) 0.500
D) 0.861
Answer: A Difficulty: Medium Page: 188, 7th paragraph.
PV
=
 1


.12 .12(1.12) 4 
15,000 

= 15,000 [8.333 – 5.296]
= 15,000 [3.037]
= 45,555 and
$5,555
 .1389
Profitability Index =
$40,000
1
Q.4.If a project's IRR is 13% and the project provides annual cash flows of $15,000 for four
years, how much did the project cost?
A) $44,617
B) $52,200
C) $60,000
D) $72,747
Answer: A Difficulty: Medium Page: 173, 3rd paragraph.
PV = 15,000
 1
1




4
.13 .13(1.13) 
= 15,000 [7.6923 – 4.7178]
= 15,000 [2.9745]
= 44,616.95
Q.5.ABC Corporation is experiencing hard capital rationing and will not be able to invest
more than $1,000,000 this year. Develop a profitability index for the following four
projects and state that would be selected: All four projects will last three years and
the firm uses a 10% discount rate.
Project
A
B
C
D
Cost
$300,000
$500,000
$125,000
$250,000
Annual Inflows
$130,000
$220,000
$ 60,000
$100,000
Answer:
Project
Index
A
B
C
D
Investment
$300,000
500,000
135,000
250,000
PV @ 10%
323,291
547,107
149,211
248,685
Profitability
0.078
0.094
0.194
-0.005
Select projects C, B, and A for a total capital budget of $925,000. Project D does not
meet the NPV criterion.
Difficulty: Medium Pages: 188-189