Practice
1. Which one of the following statements related to the internal rate of return (IRR) is correct?
a. If the IRR exceeds the required return, the payback criteria is satisfied.
b. The IRR is a better evaluation tool than the NPV when two projects are mutually exclusive.
c. When the IRR is less than the required return, the NPV is positive.
d. A project has multiple IRRs if the project's cash flows are unconventional.
e. If two projects are mutually exclusive, you should select the project with the highest IRR.
2. When evaluating two mutually exclusive investments, the best method to use is the:
a. internal rate of return.
b. payback rule.
c. net present value.
d. dividend growth model.
e. the security market line.
3. What is the net present value of a project that has an initial cost of $76,000 and produces cash
inflows of $22,000 a year for 9 years if the discount rate is 16 percent?
a. $16,861.21
b. $19,559.00
c. $21,848.25
d. $25,343.97
e. $28,120.16
4. Chance, Inc. is considering a project with an initial cost of $1 million. The project will not
produce any cash flows for the first two years. Starting in year 3, the project will produce cash
inflows of $625,000 a year for four years. This project is risky, so the firm has assigned it a
discount rate of 20 percent. What is the net present value?
a. -$243,117.95
b. -$63,681.07
c. $123,582.71
d. $348,299.25
e. $617,959.10
5. Dennis wants to determine if the discount rate really makes any difference in the net present
value of a project. He feels that if a project is acceptable at one rate of return, it will be
acceptable at all rates of return. To explain why his thinking is incorrect, you are creating an
example to illustrate your point. The cash flows you are using are as follows: time zero is $71,000, years 1 through 4 are $17,500 each, and years 5 and 6 are $22,500 each. The net present
value at a discount rate of 12 percent is _____ as compared to _____ at 17 percent.
a. $4,668.80; $10,325.14
b. $4,920.72; $2,730.89
c. $5,098.31; $62.64
d. $6,319.92; $3,959.52
e. $13,660.64; $4,256.82
6. Mr. Bailey is considering an investment of $25,000. This investment is supposedly going to
provide him with cash inflows of $8,000 in each of the first two years and $12,000 for the
following year. At a discount rate of zero percent this investment has a net present value (NPV)
of _____, but at the relevant discount rate of 16 percent the project's NPV is _____.
a. $1,000; $4,470.25
b. $3,000; $1,497.60
c. $3,000; $4,470.25
d. $7,000; $1,497.60
e. $7,000; $7,870.60
7. Sue and Tina are both considering the same project with the cash flows shown below. Sue is
content earning 10 percent on the project but Tina wants to earn at least 14 percent. Who, if
either, should accept this project?
a. Sue, but not Tina
b. Tina, but not Sue
c. Sue, Tina can go either accept or reject as her NPV is zero
d. neither Sue nor Tina
e. both Sue and Tina
8. A project has the following cash flows. What is the payback period?
a. 1.31 years
b. 1.48 years
c. 1.53 years
d. 1.77 years
e. 1.82 years
9. Caroline's Candles would like to buy $134,000 of new candle-making equipment. However,
the company has a major loan maturing in three years and needs this money at that time to avoid
bankruptcy. The candle-making equipment is expected to increase the cash flows by $27,000 in
the first year, $48,000 in the second year, and $69,000 a year for the following two years. Should
Caroline's Candles buy the equipment at this time? Why or why not?
a. yes; because the money will be recovered within four years
b. yes; because the money will be recovered within three years
c. yes; because the money will be recovered within two years
d. no; because the project never pays back
e. no; because the money will not be recovered in time to pay the loan
10. A project has the following cash flows. Find the discount rate in which you are indifferent
whether you take on the project or not.
a. 11.64 percent
b. 13.96 percent
c. 15.51 percent
d. 17.23 percent
e. 19.08 percent
11. You are considering an investment for which you require a 10 percent rate of return. The
investment will cost $52,000 and produce cash inflows of $10,000 a year for eight years. Should
you accept this project based on its internal rate of return? Why or why not?
a. yes; because the IRR is 14.08 percent
b. yes; because the IRR is 11.81 percent
c. yes; because the IRR is 10.71 percent
d. no; because the IRR is equal to 10 percent
e. no; because the IRR is 8.04 percent
12. You are considering the following two mutually exclusive projects. At what discount rate are
you indifferent between the two projects? _____ percent.
a. 7.76
b. 9.25
c. 11.89
d. 12.08
e. 13.75
13. You are considering the following two mutually exclusive projects. The crossover point is
_____ and Project _____ should be accepted if the discount rate for the project exceeds the
crossover rate.
a. 9.54 percent; B
b. 9.93 percent; A
c. 9.93 percent; B
d. 11.02 percent; A
e. 11.02 percent; B
1. d
2. c
3.d
4.c
5.d
6.c
7.e
8.e
9.b
10.d
11.c
12.e
13.d