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MCQ Investment Decision

Methods of Capital Budgeting
Choose the appropriate answer from the following Multiple-choice question

1.The net present value (NPV) rule can be best stated as:
A) An investment should be accepted if, and only if, the NPV is exactly equal to
zero.
B) An investment should be rejected if the NPV is positive and accepted if it is
negative.
C) An investment should be accepted if the NPV is positive and rejected if its is
negative.
D) An investment with greater cash inflows than cash outflows, regardless of
whenthe cash flows occur, will always have a positive NPV and therefore should
always be accepted.
2.The difference between the market value of an investment and its cost is the:
A) Net present value.
B) Internal rate of return.
C) Payback period.
D) Profitability index.
3.The payback rule can be best stated as:
A) An investment is acceptable if its calculated payback period is less than some
prespecified number of years.
B) An investment should be accepted if the payback is positive and rejected if it is
negative.
C) An investment should be rejected if the payback is positive and accepted if it is
negative.
D) An investment is acceptable if its calculated payback period is greater than some
prespecified number of years.
4.The length of time required for an investment to generate cash flows sufficient to recover
its initial cost is the:
A) Net present value.
B) Internal rate of return.
C) Payback period.
D) Profitability index.

5.The discount rate that makes the net present value of an investment exactly equal to zero is
the:
A) Payback period.
B) Internal rate of return.
C) Average accounting return.
D) Profitability index.
6.Situations where taking one investment prevents the taking of another is(are) called:

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A) Net present value profiling.

B) Operational ambiguity.
C) Mutually exclusive projects.
D) Issues of scale.
7.The internal rate of return (IRR) rule can be best stated as:
A) An investment is acceptable if its IRR is exactly equal to its net present value
(NPV).
B) An investment is acceptable if its IRR is exactly equal to zero.
C) An investment is acceptable if its IRR is less than the required return, else it
should be rejected.
D) An investment is acceptable if its IRR exceeds the required return, else it should
be rejected.
8.The profitability index (PI) rule can be best stated as:
A) An investment is acceptable if its PI is greater than one.
B) An investment is acceptable if its PI is less than one.
C) An investment is acceptable if its PI is greater than the internal rate of return
(IRR).
D) An investment is acceptable if its PI is less than the net present value

9.The present value of an investment's future cash flows divided by its intial cost is the:
A) Net present value.
B) Internal rate of return.
C) Average accounting return.
D) Profitability index

10. Which of the following statements is true?

A) NPV should never be used if the project under consideration has nonconventional
cash flows.
B) NPV is similar to a cost/benefit ratio.
C) If the financial manager relies on NPV in making capital budgeting decisions, she
acts in the shareholders' best interests.
D) NPV can normally be directly observed in the marketplace.

11. Net present value _____________.

A) is equal to the initial investment in a project
B) is equal to the present value of the project benefits
C) is equal to zero when the discount rate used is equal to the IRR
D) is simplified by the fact that future cash flows are easy to estimate

12. The _______ decision rule is considered the "best" in principle.

A) internal rate of return

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B) payback period
C) average accounting return
D) net present value
13. Which of the following decision rules is best for evaluating projects for which cash
flows beyond a specified point in time, and the time value of money, can both be
ignored?
A) Payback
B) Net present value
C) Average accounting return
D) Profitability index
14. An investment generates $1.10 in present value benefits for each dollar of invested
costs. This conclusion was most likely reached by calculating the project's:
A) Net present value
B) Profitability index
C) Internal rate of return
D) Payback period
15. The use of which of the following would lead to correct decisions when comparing
mutually exclusive investments?

I. Profitability index
II. Net present value
III. Average accounting return
A) I only
B) II only
C) III only
D) I and II only
16. You own some manufacturing equipment that must be replaced. Two different suppliers
present a purchase and installation plan for your consideration. This is an example of a
business decision involving _____________ projects.
A) mutually exclusive
B) independent
C) working capital
D) positive NPV
17. If a project with conventional cash flows has an IRR less than the required return, then:
A) The profitability index is less than one.
B) The IRR must be zero.
C) The AAR is greater than the required return.
D) The payback period is less than the maximum acceptable period.

18. Calculate the NPV of the following project using a discount rate of 10%:
Year 0 = –$800; Year 1 = –$80; Year 2 = $100; Year 3 = $300; Year 4 = $500; Year 5 =
$500
A) $ 8.04

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B) $ 87.28
C) $208.04 D) $459.17
19. You are considering a project that costs $600 and has expected cash flows of $224,
$250.88 and $280.99 over the next three years. If the appropriate discount rate for the
project's cash flows is 12%, what is the net present value of this project?
A) The NPV is negative
B) $ 0.00
C) $ 9.34
D) $49.34
20. A project costs $300 and has cash flows of $75 for the first three years and $50 in each
of the project's last three years. What is the payback period of the project?
A) The project never pays back
B) 3.75 years
C) 4.50 years
D) 5.25 years
21. Suppose a project costs $2,500 and produces cash flows of $400 over each of the
following 8 years. What is the IRR of the project?
A) There is not enough information; a discount rate is required
B) 3.27%
C) 5.84%
D) 9.61%
22. A project has an initial investment of $25,000, with $6,500 annual inflows for each of
the subsequent 5 years. If the required return is 12%, what is the NPV?
A) –$6,500.00
B) –$2,447.02
C) –$1,568.95
D) $ 215.46
23.What is the NPV of the following set of cash flows if the required return is 15%?
Year 0 1 2 3 4

Cashflow -10,000 -1,000 10,000 10,000 -5,000

A) The NPV is negative

B) $ 408.27
C) $ 950.44
D) $1,247.90
24. Would you accept a project which is expected to pay $2,500 a year for 6 years if the
initial investment is $10,000 and your required return is 8%?
A) Yes; the NPV is $1,557
B) Yes; the NPV is $928

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C) Yes; the NPV is $63

D) No; the NPV is –$346

25. What is the payback period of a $15,000 investment with the following cash flows?

Year 1 2 3 4 5

Cashflow 3,000 4,000 5,000 6,000 7,000

A) 2.75 years
B) 3.50 years
C) 3.75 years
D) 4.50 years
26. You are considering an investment which has the following cash flows. If you require a 5
year payback period, should you take the investment?
Year 0 1 2 3 4 5 6

Cashflow -30,000 10,000 5,000 5,000 7,500 10,000 20,000

A) Yes, the payback is 3.000 years.

B) Yes, the payback is 3.75 years.
C) Yes, the payback is 4.25 years.
D) No, the payback is 5.25 years.

27. Your required return is 15%. Should you accept a project with the following cash flows?
Ye a r 0 1 2 3
Ca s h Fl o w – $ 25 $10 $10 $25
A) No, because the IRR is 5%.
B) No, because the IRR is 10%.
C) Yes, because the IRR is 20%.
D) Yes, because the IRR is 30%.
28. You are going to choose between two investments. Both cost $50,000, but investment A
pays $25,000 a year for 3 years while investment B pays $20,000 a year for 4 years. If
your required return is 12%, which should you choose?
A) A because it pays back sooner.
B) A because its IRR exceeds 12%.
C) A because it has a higher IRR.
D) B because it has a higher NPV.

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29. Using the profitability index, which of the following projects would you choose if you
have limited funds?
Project Initial Investment NPV
1 $50,000 $10,000
2 75,000 25,000
3 60,000 15,000
4 40,000 17,000
5 90,000 40,000
A) Project 1
B) Project 2
C) Project 3
D) Project 5
30. You have a choice between 2 mutually exclusive investments. If you require a 15%
return, which investment should you choose?
A B
Ye a r Ca s h Flow CashFlow
0 –$100, 000 – $ 125, 000
1 20,000 75, 000
2 40,000 45,000
3 80,000 40,000

A) Project A, because it has a smaller initial investment.

B) Project B, because it has a higher NPV.
C) Either one, because they have the same profitability indexes.
D) Project A, because it has the higher internal rate of return.

31. For a project with an initial investment of $8,000 and cash inflows of $2,000 each year
for 6 years, calculate NPV given a required return of 13%.
A) –$846
B) –$263
C) $ 0
D) $149
32. What is the IRR of an investment that costs $18,500 and pays $5,250 a year for 5 years?
A) 13%
B) 15%
C) 19%
D) 25%

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33. What is the profitability index of the following investment if the required return =
10%?
Ye a r 0 1 2 3
Ca s h Fl o w – $150 $50 $75 $75

A) 0.94
B) 1.09
C) 1.18
D) 1.27

34. What is the payback period for the following investment?

Year 0 1 2 3 4
Cashflow -25,000 10,000 8,000 4,000 2,000

A) 4 years
B) 3 years
C) 2 years
D) The investment doesn't payback

From the following information answer the questions 35-38:

Bill plans to open a do-it-yourself dog bathing center in a storefront. The bathing equipment will
cost $50,000. Bill expects the after-tax cash inflows to be $15,000 annually for 8 years, after
which he plans to scrap the equipment and retire to the beaches of Jamaica.

35. What is the project's payback period?

A) 2.67 years
B) 3.33 years
C) 3.67 years
D) 4.33 years
36. Assume the required return is 10%. What is the project's NPV?
A) $ 887
B) $13,322
C) $22,759
D) $30,024
E) $45,001
37. Assume the required return is 20%. What is the project's IRR? Should it be accepted?
A) 15%; yes
B) 15%; no
C) 25%; yes
D) 25%; no
E) 20%; indifferent

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38. Assume the required return is 20%. What is the project's PI? Should it be accepted?
A) 0.85; yes
B) 0.85; no
C) 1.00; indifferent
D) 1.15; yes
E) 1.15; no

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