Multiple Choice: Consider the following two projects: Project Year 0 Cash Flow Y
ID: 2777925 • Letter: M
Question
Multiple Choice:
Consider the following two projects:
Project
Year 0
Cash Flow
Year 1
Cash Flow
Year 2
Cash Flow
Year 3
Cash Flow
Year 4
Cash Flow
Discount Rate
A
-100
40
50
60
N/A
.15
B
-73
30
30
30
30
.15
1. The NPV of project B is closest to:
a. 12.6
b. 23.3
c. 12.0
d. 15.0
Consider the following two projects:
Project
Year 0
C/F
Year 1
C/F
Year 2
C/F
Year 3
C/F
Year 4
C/F
Year 5
C/F
Year 6
C/F
Year 7
C/F
Discount
Rate
Alpha
-79
20
25
30
35
40
N/A
N/A
15%
Beta
-80
25
25
25
25
25
25
25
16%
2. The payback period for project Alpha is closest to:
a. 3.2 years
b. 2.9 years
c. 3.1 years
d. 2.6 years
3. The payback period for project Beta is closest to:
a. 2.9 years
b. 3.1 years
c. 2.6 years
d. 3.2 years
4. You are trying to decide between three mutually exclusive investment opportunities. The most appropriate tool for identifying the correct decision is:
a. NPV.
b. profitability index.
c. IRR.
d. incremental IRR.
5. Which of the following statements is FALSE?
a. The profitability index measures the value created in terms of NPV per unit of resource consumed.
b. The profitability index is the ratio of value created to resources consumed.
c. The profitability index can be easily adapted for determining the correct investment decisions when multiple resource constraints exist.
d. The profitability index measures the "bang for your buck."
Project
Year 0
Cash Flow
Year 1
Cash Flow
Year 2
Cash Flow
Year 3
Cash Flow
Year 4
Cash Flow
Discount Rate
A
-100
40
50
60
N/A
.15
B
-73
30
30
30
30
.15
Explanation / Answer
1 Answer -- a. 12.6 Year 0 Year 1 Year 2 Year 3 Year 4 NPV Project B -73 30 30 30 30 PV F @15% 1 0.86957 0.75614 0.65752 0.57175 PV -73 26.0871 22.6842 19.7256 17.1525 12.6494 2. Payback period for Alpha - Answer- c. 3.1 years Year 1 Year 2 Year 3 Total C/F C/F C/F 20 25 30 75 To paybck $ 75 - 3 completed yrs. To paybck bal. $ 4 of the initial investment($ 79) -1/35*4= 0.11 yrs. So, total Payback period= 3+ 0,11= 3.11 years. 3. Payback period for Beta - Answer- d. 3.2 years Year 1 Year 2 Year 3 Total C/F C/F C/F 25 25 25 75 To paybck $ 75 - 3 completed yrs. To payback bal. $ 5 of the initial investment ($ 80) -1/25*5= 0.2 yrs. So, total Payback period= 3+ 0,2= 3.2years. 4. Answer-- a. NPV Because NPV is an absolute figure arrived at, after taking into account the present values of all inflows and outflows , till the end of the project,thus helping to maximise shareholders' wealth. Profitability index is a relative measure or a ratio of discounted cash inflow expressed in relation to the initial cash outflow/investment. Absolute figures may have vast differences. Whereas, IRR is the internal rate generated by the particular project without taking into account the required rate of return . A project may also have mutiple IRRs. NPV is only one. Incremental IRR is the comparison of the additional IRR of one project over another and is fraught with the same disadvantages as IRR. 5. Answer- ALL OPTIONS ARE TRUE. NO statement is FALSE PI= Value created/resource consumed = NPV/Resorce consumed= Bang for your buck PI helps to rank projects or undertake combinations of projects under resource constraints or capital rationing.
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