Corporate Finance: The Core (Berk/DeMarzo)

Corporate Finance: The Core (Berk/DeMarzo)

Chapter 6– Investment Decision Rules

Use the information for the question(s) below.

Boulderado has come up with a new composite snowboard. Development will take Boulderado four years and cost $250,000 per year, with the first of the four equal investments payable today upon acceptance of the project. Once in production the snowboard is expected to produce annual cash flows of $200,000 each year for 10 years. Boulderado’s discount rate is 10%.

 

1)

 

The NPV for Boulderado’s snowboard project is closest to:

 

A)

 

$228,900

 

B)

 

$46,900

 

C)

 

$51,600

 

D)

 

$23,800

 

:

 

A

6.2 Alternative Decision Rules

2)

 

Which of the following statements is false?

 

A)

 

It is possible that an IRR does not exist for an investment opportunity.

 

B)

 

If the payback period is less than a pre-specified length of time you accept the project

 

C)

 

The internal rate of return (IRR) investment rule is based upon the notion that if the return on other alternatives is greater than the return on the investment opportunity you should undertake the investment opportunity.

 

D)

 

It is possible that there is no discount rate that will set the NPV equal to zero.

 

3)

 

Which of the following statements is false?

 

A)

 

The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea.

 

B)

 

An IRR will always exist for an investment opportunity.

 

C)

 

A NPV will always exist for an investment opportunity.

 

D)

 

In general, there can be as many IRRs as the number of times the project’s cash flows change sign over time.

 

4)

 

Which of the following statements is false?

 

A)

 

The IRR investment rule states you should turn down any investment opportunity where the IRR is less than the opportunity cost of capital.

 

B)

 

The IRR investment rule states that you should take any investment opportunity where the IRR exceeds the opportunity cost of capital.

 

C)

 

Since the IRR rule is based upon the rate at which the NPV equals zero, like the NPV decision rule, the IRR decision rule will always identify the correct investment decisions.

 

D)

 

There are situations in which multiple IRRs exist.

 

:

 

5)

 

Which of the following statements is false?

 

A)

 

In general, the IRR rule works for a stand-alone project if all of the project’s positive cash flows precede its negative cash flows.

 

B)

 

There is no easy fix for the IRR rule when there are multiple IRRs.

 

C)

 

The payback rule is primarily used because of its simplicity.

 

D)

 

No investment rule that ignores the set of alternative investment alternatives can be optimal.

 

6)

 

Which of the following statements is false?

 

A)

 

The payback rule is useful in cases where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the NPV.

 

B)

 

The payback rule is reliable because it considers the time value of money and depends on the cost of capital.

 

C)

 

For most investment opportunities expenses occur initially and cash is received later.

 

D)

 

Fifty percent of firms surveyed reported using the payback rule for making decisions.

 

Use the table for the question(s) below.

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

 

7)

 

The payback period for project A is closest to:

 

A)

 

2.0 years

 

B)

 

2.4 years

 

C)

 

2.5 years

 

D)

 

2.2 years

 

:

 

8)

 

The payback period for project B is closest to:

 

A)

 

2.5 years

 

B)

 

2.0 years

 

C)

 

2.2 years

 

D)

 

2.4 years

 

:

 

9)

 

Which of the following statements is correct?

 

A)

 

You should accept project A since its IRR> 15%

 

B)

 

You should reject project B since its NPV> 0

 

C)

 

Your should accept project A since its NPV < 0

 

D)

 

You should accept project B since its IRR< 15%