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Question;6.3 The Payback Rule;Use the;following information to answer the question(s) below.;Rearden Metals;is considering opening a strip mining operation to provide some of the raw;materials needed in producing Rearden metal. The initial purchase of the land;and the associated costs of opening up mining operations will cost $100 million;today. The mine is expected to generate $16 million worth of ore per year for;the next 12 years. At the end of the 12th year Rearden will need to spend $20;million to restore the land to its original pristine nature appearance.;1) The payback;period for Rearden's mining operation is closest to;A) 5.00 years;B) 6.00 years;C) 6.25 years;D) 6.50 years;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) 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.;5) 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.;Consider a;project with the following cash flows;Year;Cash;Flow;0;-10,000;1;4,000;2;4,000;3;4,000;4;4,000;6) Assume the;appropriate discount rate for this project is 15%. The payback period for this project is;closest to;A) 3;B) 2.5;C) 2;D) 4;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;Use the table;for the question(s) below.;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%;9) 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;10) 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;Use the;information for the question(s) below.;The Sisyphean;Company is planning on investing in a new project. This will involve the purchase of some new;machinery costing $450,000. The;Sisyphean Company expects cash inflows from this project as detailed below;Year;One;Year;Two;Year;Three;Year;Four;$200,000;$225,000;$275,000;$200,000;The appropriate;discount rate for this project is 16%.;11) The payback;period for this project is closest to;A) 2.1 years;B) 3.0 years;C) 2 years;D) 2.2 years;6.4 Choosing Between Projects;1) Which of the;following statements is false?;A) Problems can;arise using the IRR method when the mutually exclusive investments have;different cash flow patterns.;B) The IRR is;affected by the scale of the investment opportunity.;C) Multiple;incremental IRRs might exist.;D) The;incremental IRR rule assumes that the riskiness of the two projects is the;same.;2) Which of the;following statements is false?;A) The;incremental IRR investment rule applies the IRR rule to the difference between;the cash flows of the two mutually exclusive alternatives.;B) When a;manager must choose among mutually exclusive investments, the NPV rule provides;a straightforward answer.;C) The;likelihood of multiple IRRs is greater with the regular IRR rule than with the;incremental IRR rule.;D) Problems can;arise using the IRR method when the mutually exclusive investments have;differences in scale.;3) Which of the;following statements is false?;A) When using;the incremental IRR rule, you must keep track of which project is the;incremental project and ensure that the incremental cash flows are initially;positive and then become negative.;B) Picking one;project over another simply because it has a larger IRR can lead to mistakes.;C) Problems;arise using the IRR method when the mutually exclusive investments have;differences in scale.;D) When the;risks of two projects are different, only the NPV rule will give a reliable;answer.;4) Which of the;following statements is false?;A) The;incremental IRR need not exist.;B) If a change;in the timing of the cash flows does not affect the NPV, then the change in;timing will not impact the IRR.;C) Although the;incremental IRR rule can provide a reliable method for choosing among projects;it can be difficult to apply correctly.;D) When projects;are mutually exclusive, it is not enough to determine which projects have;positive NPVs.;5) Consider two;mutually exclusive projects A & B.;If you subtract the cash flows of opportunity B from the cash flows of;opportunity A, then you should;A) take;opportunity A if the regular IRR exceeds the cost of capital.;B) take;opportunity A if the incremental IRR exceeds the cost of capital.;C) take;opportunity B if the regular IRR exceeds the cost of capital.;D) take;opportunity B if the incremental IRR exceeds the cost of capital.;6) 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.;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) Assume that;projects A and B are mutually exclusive.;The correct investment decision and the best rational for that decision;is to;A) invest in;project A since NPVB IRRA.;C) invest in;project B since NPVB > NPVA.;D) invest in;project A since NPVA > 0.;8) The;incremental IRR of Project B over Project A is closest to;A) 12.6%;B) 23.3%;C) 1.7%;D) 17.3%;Answer: A;9) The maximum;number of incremental IRRs that could;exist for project B over project A is;A) 1;B) 2;C) 0;D) 3;Use the table;for the question(s) below.;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%;10) Assume that;projects Alpha and Beta are mutually exclusive.;The correct investment decision and the best rational for that decision;is to;A) invest in;project Beta since NPVBeta > 0.;B) invest in;project Alpha since NPVBeta IRRA.;D) invest in;project Beta since NPVBeta > NPVAlpha> 0.;ects Alpha and;Beta are mutually exclusive. Which of;the following statements is true regarding the investment decision tools;suitability for deciding between projects Alpha & Beta.;A) The;incremental IRR should not be used since the projects have different lives.;B) The;incremental IRR should not be used since the projects have different discount;rates;C) The;incremental IRR should not be used since the projects have different cash flow;patterns.;D) Both the NPV;and incremental IRR approaches are appropriate to solve this problem.;12) When;choosing between projects, an alternative to comparing their IRRs is;A) to compute;the incremental IRR, which tells us the discount rate at which it becomes;profitable to switch from one project to the other.;B) to compute;the incremental payback period, which tells us the number of years during which;it becomes profitable to switch from one project to the other.;C) to compute;the incremental NPV, which tells us the discount rate at which it becomes;profitable to switch from one project to the other.;D) There is no;alternative selection criterion to comparing IRRs.;Use the table;for the question(s) below.;Consider two;mutually exclusive projects with the following cash flows;Project;C/F0;C/F1;C/F2;C/F3;C/F4;C/F5;C/F6;A;$(41,215);$12,500;$14,000;$16,500;$18,000;20,000;N/A;B;$(46,775);$15,000;$15,000;$15,000;$15,000;$15,000;$15,000;13) You are;considering using the incremental IRR approach to decide between the two;mutually exclusive projects A & B.;How many potential incremental IRRs could there be?;A) 3;B) 0;C) 2;D) 1;14) If the;discount rate for project A is 16%, then what is the NPV for project A?;15) If the;discount rate for project B is 15%, then what is the NPV for project B?;16) What is the;incremental IRR for project B over project A?;Would you feel comfortable basing your decision on the incremental IRR?;17) Assuming;that the discount rate for project A is 16% and the discount rate for B is 15%;then given that these are mutually exclusive projects, which project would you;take and why?

 

Paper#62455 | Written in 18-Jul-2015

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