The net-present-value method assumes that project funds are reinvested at the:

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1.	The process of determining which long-term projects to acquire is called

a. Asset Planning.b. Asset Acquisition.c. Cash Budgeting.d. Capital Budgeting.

2.	____________ are capital budgeting models that identify criteria for accepting or rejecting projects without considering the time value of money.

a. Net Present Value models.b. Nondiscounting models.c. Discounting Models.d. Capital return models.

3.	Firms may select projects with short paybacks because

a. Projects with longer paybacks may be riskier.b. Shorter paybacks may help reduce liquidity problems.c. If the risk of obsolescence is high, the firm may want to recover the funds rapidly.d. All of the above.

4.	Which of the following methods uses income instead of cash flows?

a. Payback.b. Simple (Accounting) Rate of Return.c. Internal Rate of Return.d. Net Present Value.

Use the following information for question 5

Inhaltsverzeichnis Show

What does the NPV method assume?
What assumes returns are reinvested at the cost of capital?
What is the inherent assumption about how the cash inflows for the NPV are reinvested?
Which method assumes a reinvestment rate equal to the discount rate?

	Project A	Project B
Year 1	$40,000	$140,000
Year 2	60,000	60,000
Year 3	140,000	40,000

Each project requires an investment of $120,000

5.	Which project will have the higher net present value?

a. Project A.b. Project B.c. Project A and Project B will have the same net present value.d. It is not possible to answer the question based upon the information provided.

6.	The discount rate used when calculating NPV can be

a. The minimum required rate of return.b. The weighted average cost of capital.c. The hurdle rate.d. All of the above

7.	Why do the NPV method and the IRR method sometimes produce different rankings of mutually exclusive investment projects?

a. The NPV method does not assume reinvestment of cash flows while the IRR method assumes the cash flows will be reinvested at the IRR.b. The NPV method assumes a reinvestment rate equal to the discount rate while the IRR method assumes a reinvestment rate equal to the IRR.c. The IRR method does not assume reinvestment of the cash flows while the NPV method assumes the reinvestment rate is equal to the discount rate. d. The NPV method assumes a reinvestment rate equal to the bank loan interest rate while the IRR method assumes a reinvestment rate equal to the discount rate.

8.	A decrease in the discount rate:

a. Will increase present values of future cash flows.b. Is one way to compensate for greater risk in a project.c. Will reduce present values of future cash flows.d. Responses a and b are both correct.

(Ignore income taxes in this problem). Doro company is considering the purchase of a $100,000 machine that is expected to reduce operating cash expenses by $25,000 per year. This machine, which has no salvage value, has an estimated useful life of 10 years and will be depreciated on a straight-line basis. For this machine, the simple rate of return would b e:

a. 10% b. 15%c. 25%d. 35%

10.

(Ignore income taxes in this problem). Peter wants to buy a computer that he expects to save him $4,000 each year in bookkeeping costs. The computer will last for five years, and at the end of five years it will have no salvage value. If Peter's required rate of return is 12%, what is the maximum price Peter would be willing to pay for the cvomputer now?

a. $20,000b. $14,420c. $11,340d. $10,830

Part II: Problems

Problem 1

A capital investment project requires an investment of $350,000. It has an expected life of ten years with annual cash flows of $50,000 received at the end of each year.

Required

Compute payback for the project.
Determine the simple (accounting) rate of return for the project.
Compute the internal rate of return for the project.
Compute the net present value of the project using a 14% discount rate.
Would you recommend this project to be accepted? Why or why not?

Problem 2

Jansen Medical Clinic is investigating the possibility of investing in new X-Ray and blood analysis equipment. The after-tax cash inflows for the two independent investment projects are as follows:

Year	X-Ray Equipment	Blood Analysis Equipment
1	$120,000	$20,000
2	60,000	20,000
3	80,000	120,000
4	40,000	160,000
5	20,000	180,000

The cash flows for the X-Ray machine decline over time due to expected increases in operating and maintenance costs. The cash flows for blood analysis are expected to increase as word is spread that the clinic is performing these new services. Both projects require an initial investment of $200,000. In both cases, assume the equipment has a life of five years, with no salvage value.

Required:

Assuming a discount rate of 12 percent, compute the net present value of each piece of equipment.
Compute the payback period for each item. Assume that the manager of the clinic accepts only projects with a payback period of three years or less. Offer some reasons why this may be a rational strategy even though the NPV computed in Requirement 1 may indicate otherwise.

Last Modified December 7, 2004

What does the NPV method assume?

The NPV method assumes that cash flows will be reinvested at the cost of capital while the IRR method assumes reinvestment at the risk-free rate.

What assumes returns are reinvested at the cost of capital?

The modified internal rate of return (MIRR) assumes that positive cash flows are reinvested at the firm's cost of capital and that the initial outlays are financed at the firm's financing cost.

What is the inherent assumption about how the cash inflows for the NPV are reinvested?

NPV does not have a reinvestment rate assumption, so reinvestment will not change the final outcome of NPV of a project. IRR does consider reinvestment rate assumption. The IRR assumes that the company will reinvest cash inflows at the rate of return for the entire lifetime of the project.