School of Banking and Finance
FINS5514 Capital Budgeting and Financing Decisions
Tutorial Covering Week 3 – Investment Criteria and Project Cash Flows
Multiple Choice Questions
Use the following information to answer questions 1 to 4.
You are analyzing a proposed project and have compiled the following information:
Year Cash flow
0 -$135,000
1 $ 28,600
2 $ 65,500
3 $ 71,900
The required payback period is 3 years and the required return is 8.50 percent
1. What is the net present value of the proposed project?
a. $3,289.86 b. $3,313.29 c. $4,289.06 d. $4,713.71
2. What is the discounted payback period?
a. 2.57 years b. 2.64 years c. 2.87 years d. 2.94 years
3. Should the proposed project be accepted based on the IRR?
a. Yes; The project IRR is greater than the required return.
b. Yes; The project IRR is equal to zero.
c. No; The project IRR is greater than the required return.
d. No; The project IRR is greater than zero.
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4. Should the proposed project be accepted based on the profitability index (PI)?
a. Yes; The PI is less than 1.0
b. Yes; The PI is greater than 1.0.
c. No; The PI is less than 1.0.
d. No; The PI is greater than 1.0.
5. Which of the following statements are correct concerning the internal rate of
return?
I. IRR is used to determine which one of two mutually exclusive projects should
be accepted.
II. IRR is the discount rate that makes the net present value equal to zero.
III. There can be multiple IRRs if the cash flows are unconventional.
IV. You should accept a project when the IRR is less than the required return.
a. I and III only
b. II and IV only
c. II and III only
d. I and II only
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Short answer questions
6. You are evaluating projects that are independent and have conventional cash
flows. The analysis methods available to you are Internal Rate of Return, Payback,
Average Accounting Return and Net Present Value. In which order would you use
these approaches?
7. You own a piece of land, which you purchased ten years ago at a price of $29,900.
Three years ago, you were offered $38,000 for the land but refused the offer. You
are now considering using this land to build a general store to service the local
community. You have just had the land appraised so that you can use it as collateral
for a construction loan. The appraisal value is $36,900. What value should you place
on this land, which is currently debt free, when you conduct your analysis of the
proposed store?
8. An investment project has annual cash flows of $3,200, $4,100, $5,300 and $4,500
and a discount rate of 14 percent. What is the discounted payback period if the
initial cost is $5,900? What if it is $8,000? What if it is $11,000?
9. NPV v IRR. Consider two mutually exclusive projects.
Year Cash flow (A) Cash flow (B)
0 -$29,000 -$29,000
1 $14,400 $4,300
2 $12,300 $9,800
3 $9,200 $15,200
4 $5,100 $16,800
(a) What is the IRR for each project? Which should you accept? Reject?
(b) If the required rate of return is 11%, what is the NPV for each project?
Which would you choose?
(c) Over what range of discount rates would you choose project A? Project B?
At what rate would the firm be indifferent? Explain.
10. Consider two mutually exclusive projects.
Year Cash flow (A) Cash flow (B)
0 -$350,000 -$50,000
1 45,000 24,000
2 65,000 22,000
3 65,000 19,500
4 440,000 14,600
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15% required rate of return on all projects.
a. Payback criterion. Which investment would you choose? Why?
b. Discounted payback criterion. Which investment would you choose? Why?
c. NPV criterion. Which investment would you choose? Why?
d. IRR criterion. Which investment would you choose? Why?
e. Profitability index criterion. Which investment would you choose? Why?
f. Based on these answers, which project would you choose?
