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Part I: Chapter 8 Multiple Choice

(a). Which one of the following statements is correct for a project with a positive NPV?

A. The IRR must be greater than 0.

B. Accepting the project has an indeterminate effect on shareholders.

C. The discount rate exceeds the cost of capital.

D. The profitability index equals 1.

(b). If the net present value of a project that costs $20,000 is $5,000 when the discount rate is 10%, then the:

A. project’s IRR equals 10%.

B. project’s rate of return is greater than 10%.

C. net present value of the cash inflows is $4,500.

D. project’s cash inflows total $25,000.

(c). What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%?

A. $13,397.57

B. $14,473.44

C. $16,081.60

D. $33,748.58

(d). What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years?

A. 0.57%

B. 1.21%

C. 5.69%

D. 12.10%

(e). The profitability index selects projects based on the:

A. highest net discounted value at time zero.

B. highest internal rate of return.

C. largest dollar investment per rate of return.

D. largest return per dollar invested.

(f). Which of the following investment criteria takes the time value of money into consideration?

A. Net present value only

B. Profitability index and net present value only

C. Internal rate of return and net present value only

D. Profitability index, internal rate of return, and net present value

(g). When calculating a project’s payback period, cash flows are:

A. discounted at the opportunity cost of capital.

B. discounted at the internal rate of return.

C. discounted at the risk-free rate of return.

D. not discounted at all.

Part II: Chapter 9 Capital Analysis

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $6 million. The equipment will be depreciated straight-line over 6 years to a value of zero, but, in fact, it can be sold after 6 years for $500,000. The firm believes that working capital at each date must be maintained at a level of 10% of next year’s forecast sales. The firm estimates production costs equal to $1.50 per trap and believes that the traps can be sold for $4 each. Sales forecasts are given in the following table. The project will come to an end in 5 years when the trap becomes technologically obsolete. The firm’s tax bracket is 35%, and the required rate of return on the project is 12%.

Year: 0 1 2 3 4 5 6 Thereafter

Sales (millions of traps) 0 0.5 0.6 1.0 1.0 0.6 0.2 0

a. What is project NPV?

b. What is the IRR?