FIN 571 Wk 3 – Practice: Wk 3 Practice Questions

“Give me $5,000 today and I’ll return $10,000 to you in 5 years,” offers the investment broker. To the nearest percent, what annual interest rate is being offered?

Multiple Choice

• 12.29%
• 13.67%
• 14.87%
• 12.84%

If $120,000 is borrowed for a home mortgage, to be repaid at 9% interest over 30 years with annual payments of $11,680.36, how much interest (as opposed to return of capital) is paid in the last year of the loan?

Multiple Choice

• $918.25
• $942.51
• $978.43
• $964.43

What is the relationship between an annually compounded rate and the annual percentage rate (APR) which is calculated for truth-in-lending laws for a loan requiring monthly payments?

Multiple Choice

• The APR is lower than the annually compounded rate.
• The APR is higher than the annually compounded rate.
• The APR equals the annually compounded rate.
• The answer depends on the interest rate.

For mutually exclusive projects, the IRR can be used to select the best project:

Multiple Choice

• by calculating the modified internal rate of return.
• by calculating the IRR based on incremental cash flows.
• by using the discount rate to calculate the IRR.
• never. IRR cannot be utilized for mutually exclusive projects.

Firms that make investment decisions based on the payback rule may be biased toward rejecting projects:

Multiple Choice

• with short lives.
• with long lives.
• with late cash inflows.
• that have negative NPVs.

An investment costs $100,000 and provides a cash inflow of $17,000 per year. If the discount rate is 13%, how long must the cash inflows last for it to be an acceptable investment?

Multiple Choice

• 24 years
• 6 years
• 10 years
• 12 years

Which one of the following is least likely to influence the opportunity cost of an asset?

Multiple Choice

• Its current market value
• Alternative uses for the asset
• The current demand for the asset
• Its current book value

What effect is likely at the end of the life of a project that required a $20,000 investment in net working capital?

Multiple Choice

• The $20,000 must now be paid by the firm.
• The firm receives a $20,000 cash inflow.
• Taxable income is reduced by $20,000.
• No effects are expected because the $20,000 is now a sunk cost.

New projects can have multiple effects on a firm. Which one of the following appears to be a positive indirect effect?

Multiple Choice

• Additional working capital will be required at the start of the project.
• The sales force will need to be increased over the life of the project.
• Sales of replacement parts are expected in the future.
• The cost of employee benefits will increase due to new hires.

What is the effect on a firm’s net working capital if a new project requires a $30,000 increase in inventory, a $10,000 increase in accounts receivable, a $35,000 expenditure on machinery, and a $20,000 increase in accounts payable?

Multiple Choice

• −$5,000
• $10,000
• $20,000
• $55,000

What is the present value of a four-year annuity of $100 per year that makes its first payment 2 years from today if the discount rate is 9%?

Multiple Choice

$297.22

$323.97

$356.85

$272.68

What is the present value of $100 to be deposited today into an account paying 8%, compounded semiannually for 2 years?

Multiple Choice

$85.48

$100.00

$116.00

$116.99

What is the future value of $10,000 on deposit for 2 years at 6% simple interest?

Multiple Choice

$10,600

$11,236

$11,200

$13,382.26

An amortizing loan is one in which:

Multiple Choice

the principal remains unchanged with each payment.

accrued interest is paid regularly.

the maturity of the loan is variable.

the principal balance is reduced with each payment.

Prizes are often not “worth” as much as claimed. What is the value of a prize of $5,000,000 that is to be received in 20 equal yearly payments, with the first payment beginning today? Assume an interest rate of 7%.

Multiple Choice

$2,833,898.81

$2,911,015.68

$2,609,144.14

$2,738,304.13

What is the annually compounded rate of interest on an account with an APR of 10% and monthly compounding?

Multiple Choice

10.00%

10.47%

10.52%

11.05%

Occasionally projects may have positive initial cash flows. Such projects:

Multiple Choice

are like lending money.

are like borrowing money.

have no IRR.

their IRR increases as the cost of capital increases.

Given the various investment options listed, what investment criteria concept might make an investor select Project B over other projects?

Project    NPV       Profitability Index

A     $     1.3   mil  0.23

B     $     2.2   mil  0.54

C     $     3.5   mil  0.49

D     $     4.6   mil  0.38

________________________________________

Multiple Choice

The Gold Standard

The Rate of Return Rule

Capital rationing

Selection bias criteria

If the IRR for a project is 15%, then the project’s NPV would be:

Multiple Choice

negative at a discount rate of 10%.

positive at a discount rate of 20%.

negative at a discount rate of 20%.

positive at a discount rate of 15%.

The modified internal rate of return can be used to  for:

Multiple Choice

negative NPV calculations.

multiple internal rates of return.

undefined payback periods.

borrowing projects.

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%?

Multiple Choice

$13,397.57

$14,473.44

$16,081.60

$33,748.58

A firm plans to use the profitability index to select between two mutually exclusive investments. If no capital rationing has been imposed, which project should be selected?

Multiple Choice

Select the project with the higher profitability index

Select the project with the lower profitability index

Without capital rationing, both projects can be selected

Without capital rationing, the NPV method must be used instead

When calculating a project’s payback period, cash flows are:

Multiple Choice

discounted at the opportunity cost of capital.

discounted at the internal rate of return.

discounted at the risk-free rate of return.

not discounted at all.

Bonus depreciation allows an increase:

Multiple Choice

in total depreciation over the asset’s life.

in depreciation in the first year only.

in real but not nominal depreciation expense.

in the asset’s depreciable cost basis.

When is it appropriate to include sunk costs in the evaluation of a project?

Multiple Choice

Whenever they are relatively large

If they improve the project’s NPV

If they are considered to be overhead costs

Never

Capital budgeting proposals should be evaluated as if the project were financed:

Multiple Choice

entirely by debt.

entirely by equity.

half by debt and half by equity.

with the highest cost source of funds, to be safe.

The present value of the depreciation tax shield at any given discount rate is:

Multiple Choice

equal for all depreciation methods.

higher with bonus depreciation than with straight-line depreciation.

higher for the 7-year recovery period than for the 5-year recovery period class.

likely to increase annually due to inflation.

A tax shield is equal to the reduction in a firm’s:

Multiple Choice

total tax liability resulting from a tax deductible expense.

taxable income resulting from depreciation.

taxable income resulting from a decrease in long-term debt.

net income caused by depreciation.

Which one of the following methods will provide a  analysis for capital budgeting purposes?

Multiple Choice

Discounting real cash flows with real rates.

Discounting real cash flows with nominal rates.

Discounting nominal cash flows with real rates.

Discounting nominal cash flows with either real or nominal rates.

If inflation is forecast to increase, which of the company’s following cash flows is most likely to change?

Multiple Choice

The depreciation tax shield.

Labor costs.

Costs of raw materials purchased on a fixed price contract.

Interest payments on its long-term debt.