Practice Quiz 3 – Chapters 8,9,
and 10
Mystical Choice
Devine
the choice that best completes the statement or answers the question. Assure
that you are able to convincingly demonstrate the appropriate justification for
the question when and where necessary.
____ 1. All else equal, risk averse
investors generally require ____ returns to purchase investments with ____
risks.
a. 
higher; lower 
b. 
lower; higher 
c. 
higher; higher 
d. 
None of the above is
correct. 
____ 2. According to the following information, which
of the stocks would be considered riskiest in a diversified
portfolio of investments?
Stock 


ABC 
12.5% 
1.0 
FGH 
8.0% 
0.5 
MNO 
20.2% 
2.4 
TUV 
15.3% 
3.0 
a. 
Stock MNO, because it has
the highest standard deviation. 
b. 
Stock TUV, because it has
the highest beta. 
c. 
Stock FGH, because it has
the highest s/b ratio 
d. 
Stock ABC, because its
beta is the same as the market beta (1.0) and the market is always very, very
risky. 
____ 3. Which of the following statements is most
correct?
a. 
The required return on a
firm's common stock is determined by the firm's systematic (or market) risk.
If its systematic risk is known, and if it is expected to remain constant,
the analyst has sufficient information to specify the firm's required return. 
b. 
A security's beta
measures its nondiversifiable (systematic, or
market) risk relative to that of most other securities. 
c. 
If the returns of two
firms are negatively correlated, one of them must have a negative beta. 
d. 
A stock's beta is less
relevant as a measure of risk to an investor with a welldiversified
portfolio than to an investor who holds only one stock. 
e. 
Statements b and c are
both correct. 
____ 4. Which of the following is not a
difficulty concerning beta and its estimation?
a. 
Sometimes a security or
project does not have a past history which can be used as a basis for
calculating beta. 
b. 
Sometimes, during a
period when the company is undergoing a change such as toward more leverage
or riskier assets, the calculated beta will be drastically different than the
"true" or "expected future" beta. 
c. 
The beta of an
"average stock," or "the market," can change over time,
sometimes drastically. 
d. 
Sometimes the past data
used to calculate beta do not reflect the likely risk of the firm for the
future because conditions have changed. 
e. 
All of the above are
potentially serious difficulties. 
____ 5. If a stock has a beta coefficient, ,
equal to 1.20, the risk premium associated with the market is 9 percent,
and the riskfree rate is 5 percent, application of the capital asset pricing
model indicates the appropriate return should be ____.
a. 
9.8% 
b. 
14% 
c. 
5% 
d. 
15.8% 
e. 
None of the above is
correct. 
____ 6. Sharon Stonewall currently has an investment
portfolio that contains 10 stocks that have a total value equal to $160,000.
The portfolio has a beta () equal to 1.0. Sharon wants to invest an
additional $40,000 in a stock with = 2.0. After
Sharon adds the new stock to her portfolio, what will be the portfolio's beta?
a. 
1.2 
b. 
1.5 
c. 
2.0 
d. 
Not enough information is
given to compute the portfolio's beta (). 
e. 
None of the above is
correct. 
____ 7. Steve Brickson
currently has an investment portfolio that contains four stocks with a total
value equal to $80,000. The portfolio has a beta ()
equal to 1.4. Steve wants to invest an additional $20,000 in a stock that has =
2.4. After Steve adds the new stock to his portfolio, what will be the
portfolio's beta?
a. 
1.6 
b. 
1.9 
c. 
2.0 
d. 
Not enough information is
given to compute the portfolio's beta (). 
e. 
None of the above is
correct. 
____ 8. Given the following information, compute the
coefficient of variation for Cyber Soda, Inc.:
Probability 
Return 
0.2 
2.0% 
0.3 
12.0% 
0.5 
5.0% 
Expected return: = 6.5%
a. 
3.78 
b. 
0.58 
c. 
0.00 
d. 
1.72 
e. 
None of the above is
correct. 
____ 9. HR Corporation has a beta of 2.0, while LR
Corporation's beta is 0.5. The riskfree rate is 10%, and the required rate of
return on an average stock is 15%. Now the expected rate of inflation built
into r_{RF} falls by 3 percentage points, the
real riskfree rate remains constant, the required return on the market falls
to 11%, and the betas remain constant. When all of these changes are made, what
will be the difference in required returns on HR's and LR's stocks?
a. 
1.0% 
b. 
2.5% 
c. 
4.5% 
d. 
5.4% 
e. 
6.0% 
____ 10. Assume that a new law is passed
which restricts investors to holding only one asset. A riskaverse investor is
considering two possible assets as the asset to be held in isolation. The
assets' possible returns and related probabilities (i.e., the probability
distributions) are as follows:
Asset
X 
Asset
Y 

Pr 
r 
Pr 
r 
0.10 
3% 
0.05 
3% 
0.10 
2 
0.10 
2 
0.25 
5 
0.30 
5 
0.25 
8 
0.30 
8 
0.30 
10 
0.25 
10 
Which asset should be
preferred?
a. 
Asset X, since its
expected return is higher. 
b. 
Asset Y, since its beta
is probably lower. 
c. 
Either one, since the
expected returns are the same. 
d. 
Asset X, since its
standard deviation is lower. 
e. 
Asset Y, since its
coefficient of variation is lower and its expected return is higher. 
____ 11. You hold a diversified portfolio
consisting of a $5,000 investment in each of 20 different common stocks. The
portfolio beta is equal to 1.15. You have decided to sell one of your stocks, a
lead mining stock whose = 1.0, for $5,000 net and to use the proceeds
to buy $5,000 of stock in a steel company whose =
2.0. What will be the new beta of the portfolio?
a. 
1.12 
b. 
1.20 
c. 
1.22 
d. 
1.10 
e. 
1.15 
____ 12. You are managing a portfolio of 10
stocks which are held in equal amounts. The current beta of the portfolio is
1.64, and the beta of Stock A is 2.0. If Stock A is sold, what would the beta
of the replacement stock have to be to produce a new portfolio beta of 1.55?
a. 
1.10 
b. 
1.00 
c. 
0.90 
d. 
0.75 
e. 
0.50 
CAPM Analysis
You have been asked to use
a CAPM analysis to choose between stocks R and s, with your choice being the
one whose expected rate of return exceeds its required rate of by the widest
margin. The riskfree rate is 6%, and the required return on an average stock
(or "the market") is 10%. Your security analyst tells you that Stock
S's expected rate of return is = 11%, while Stock R's expected rate of return
in = 13%. The CAPM is assumed to be a valid
method for selecting stocks, but the expected return for any given investor
(such as you) can differ from the required rate of return for a given stock.
The following past rates of return are to be used to calculate the two stocks'
beta coefficients, which are then to be used to determine the stocks' required
rates of return.
Year 
Stock
R 
Stock
S 
Market 
1 
15% 
0% 
5% 
2 
5 
5 
5 
3 
25 
10 
15 
Note:
The averages of the historical returns are not needed, and they are generally not
equal to the expected future returns.
____ 13. Refer to CAPM Analysis.
Calculate both stocks' betas. What is the difference between the betas,
i.e., what is the value of beta_{R} beta_{S}? (Hint: The graphical method of
calculating the rise over run, or (Y_{2} Y_{1})
divided by (X_{2} X_{1}) may aid you.)
a. 
0.0 
b. 
1.0 
c. 
1.5 
d. 
2.0 
e. 
2.5 
____ 14. Here are the expected returns on two
stocks:

Returns 

Probability 
X 
Y 
0.1 
20% 
10% 
0.8 
20 
15 
0.1 
40 
20 
If you form a 5050
portfolio of the two stocks, what is the portfolio's standard deviation?
a. 
8.1% 
b. 
10.5% 
c. 
13.4% 
d. 
16.5% 
e. 
20.0% 
____ 15. Woodson Inc. has two possible
projects, Project A and Project B, with the following cash flows:
Year 
Project
A 
Project
B 
0 
150,000 
100,000 
1 
100,000 
45,000 
2 
105,000 
65,000 
3 
40,000 
80,000 
At what required rate of
return do the two projects have the same net present value (NPV)? (In other
words, what is the "crossover rate" of the projects' NPV profiles?)
a. 
10.3% 
b. 
13.5% 
c. 
15.8% 
d. 
21.7% 
e. 
34.8% 
____ 16. MidState Electric Company must
clean up the water released from its generating plant. The company's required
rate of return is 10 percent for average projects, and that rate is normally
adjusted up or down by 2 percentage points for high and lowrisk projects.
Cleanup Plan A, which is of average risk, has an initial cost of $1,000
at time 0, and its operating cost will be $100 per year for
its 10year life. Plan B, which is a highrisk
project, has an initial cost of $300,
and its annual operating cost over Years 1 to 10 will be $200. What is the
proper PV of costs for the better project?
a. 
$1,430.04 
b. 
$1,525.88 
c. 
$1,614.46 
d. 
$1,642.02 
e. 
$1,728.19 
____ 17. Your company is considering a
machine that will cost $1,000 at Time 0 and which can be sold after 3 years for
$100. To operate the machine, $200 must be invested at Time 0 in inventories;
these funds will be recovered when the machine is retired at the end of Year 3.
The machine will produce sales revenues of $900/year for 3 years; variable
operating costs (excluding depreciation) will be 50 percent of sales. Operating
cash inflows will begin 1 year from today (at Time 1). The machine will have
depreciation expenses of $500, $300, and $200 in Years 1, 2, and 3,
respectively. The company has a 40 percent tax rate, enough taxable income from
other assets to enable it to get a tax refund from this project if the
project's income is negative, and a 10 percent required rate of return.
Inflation is zero. What is the project's NPV?
a. 
$6.24 
b. 
$7.89 
c. 
$8.87 
d. 
$9.15 
e. 
$10.41 
____ 18. Your company is considering a
machine which will cost $50,000 at Time 0 and which can be sold after 3 years
for $10,000. $12,000 must be invested at Time 0 in inventories and receivables;
these funds will be recovered when the operation is closed at the end of Year
3. The facility will produce sales revenues of $50,000/year for 3 years;
variable operating costs (excluding depreciation) will be 40 percent of sales.
No fixed costs will be incurred. Operating cash inflows will begin 1 year from
today (at t = 1). By an act of Congress, the machine will have depreciation
expenses of $40,000, $5,000, and $5,000 in Years 1, 2, and 3 respectively. The
company has a 40 percent tax rate, enough taxable income from other assets to
enable it to get a tax refund on this project if the project's income is
negative, and a 15 percent required rate of return. Inflation is zero. What is
the project's NPV?
a. 
$7,673.71 
b. 
$12,851.75 
c. 
$17,436.84 
d. 
$24,989.67 
e. 
$32,784.25 
____ 19. A major disadvantage of the payback
period method is it
a. 
Is useless as a risk
indicator. 
b. 
Ignores cash flows beyond
the payback period. 
c. 
Does not directly account
for the time value of money. 
d. 
All of the above are
correct. 
e. 
Only answers b and c are
correct. 
____ 20. Which of the following statements is
correct?
a. 
The NPV method assumes
that cash flows will be reinvested at the required rate of return while the
IRR method assumes reinvestment at the IRR. 
b. 
The NPV method assumes
that cash flows will be reinvested at the riskfree rate while the IRR method
assumes reinvestment at the IRR. 
c. 
The NPV method assumes
that cash flows will be reinvested at the required rate of return while the
IRR method assumes reinvestment at the riskfree rate. 
d. 
The NPV method does not
consider the inflation premium. 
e. 
The IRR method does not
consider all relevant cash flows, and particularly cash flows beyond the
payback period. 
____ 21. Which of the following is not a
rationale for using the NPV method in capital budgeting?
a. 
An NPV of zero signifies
that the project's cash flows are just sufficient to repay the invested
capital and to provide the required rate of return on that capital. 
b. 
A project whose NPV is
positive will increase the value of the firm if that project is accepted. 
c. 
A project is considered
acceptable if it has a positive NPV. 
d. 
A project is not
considered acceptable if it has a negative NPV. 
e. 
All of the above are
true. 
____ 22. The present value of the expected
net cash inflows for a project will most likely exceed the present value of the
expected net profit after tax for the same project because
a. 
Income is reduced by
taxes paid, but cash flow is not. 
b. 
There is a greater probability
of realizing the projected cash flow than the forecasted income. 
c. 
Income is reduced by
dividends paid, but cash flow is not. 
d. 
Income is reduced by
depreciation charges, but cash flow is not. 
e. 
Cash flow reflects any
change in net working capital, but sales do not. 
____ 23. Which of the following statements is
false?
a. 
The NPV will be positive
if the IRR is less than the required rate of return. 
b. 
If the multiple IRR problem does not exist, any independent project acceptable
by the NPV method will also be acceptable by the IRR method. 
c. 
When IRR = r (the
required rate of return), NPV = 0. 
d. 
The IRR can be positive
even if the NPV is negative. 
e. 
The NPV method is not
affected by the multiple IRR problem. 
____ 24. The internal rate of return of a
capital investment
a. 
Changes when the required
rate of return changes. 
b. 
Is equal to the annual
net cash flows divided by one half of the project's cost when the cash flows
are an annuity. 
c. 
Must exceed the required
rate of return in order for the firm to accept the investment. 
d. 
Is similar to the yield
to maturity bond. 
e. 
Answers c and d are both
correct. 
____ 25. The advantage of the payback period
over other capital budgeting techniques is that
a. 
it
is the simplest and oldest formal model to evaluate capital budgeting model. 
b. 
it
directly accounts for the time value of money. 
c. 
it
ignores cash flows beyond the payback period. 
d. 
it
always leads to decisions that maximize the value of the firm. 
e. 
it
incorporates risk into the discount rate used to solve the payback period. 
____ 26. Which of the following statements
concerning the internal rate of return is false?
a. 
The internal rate of
return for a capital budgeting project is the same for all firms regardless
of their cost of capital. 
b. 
A project is acceptable
long as the project's internal rate of return is greater than the hurdle rate
for the project. 
c. 
The internal rate of
return is dependent on the timing of the cash flows. 
d. 
A project with a positive
internal rate of return will always increase the value of the firm if the
project is accepted. 
e. 
You do not need to know
the required rate of return to solve for the internal rate of return. 
____ 27. All of the following factors can
complicate the postaudit process except
a. 
each
element of the cash flow forecast is subject to uncertainty. 
b. 
projects
sometimes fail to meet expectations for reasons beyond the control of
operating executives. 
c. 
it
is often difficult to separate the operating results of one investment from
those of a larger system. 
d. 
executives
who were responsible for a given decision might have moved on by the time the
time the results of the long term project are known. 
e. 
the
most successful firms, on average, are the ones that put the least emphasis
on the postaudit. 
____ 28. Benefits of the postaudit include
all of the following except
a. 
when
decision makers are forced to compare their projections to actual outcomes,
there is a tendency to improve. 
b. 
conscious
or unconscious biases are removed. 
c. 
negative
NPV projects are identified before they begin. 
d. 
forecasts
are improved. 
e. 
all
of the above are benefits of the postaudit. 
____ 29. Two projects being considered are
mutually exclusive and have the following cash flows:
Year 
Project
A 
Project
B 
0 
$50,000 
$50,000 
1 
15,625 
0 
2 
15,625 
0 
3 
15,625 
0 
4 
15,625 
0 
5 
15,625 
99,500 
If the required rate of
return on these projects is 10 percent, which would be chosen and why?
a. 
Project B because of
higher NPV. 
b. 
Project B because of
higher IRR. 
c. 
Project A because of
higher NPV. 
d. 
Project A because of
higher IRR. 
e. 
Neither, because both
have IRRs less than the cost of capital. 
____ 30. The Seattle Corporation has been
presented with an investment opportunity which will yield end of year cash
flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5
through 9, and $40,000 in Year 10. This investment will cost the firm $150,000
today, and the firm's required rate of return is 10 percent. What is the NPV
for this investment?
a. 
$135,984 
b. 
$18,023 
c. 
$219,045 
d. 
$51,138 
e. 
$92,146 
____ 31. Two projects being considered by a
firm are mutually exclusive and have the following projected cash flows:
Year 
Project
A 
Project
B 
0 
($100,00) 
($100,000) 
1 
39,500

0

2 
39,500

0

3 
39,500

133,000

Based only on the
information given, which of the two projects would be preferred, and why?
a. 
Project A, because it has
a shorter payback period. 
b. 
Project B, because it has
a higher IRR. 
c. 
Indifferent, because the
projects have equal IRRs. 
d. 
Include both in the
capital budget, since the sum of the cash inflows exceeds the initial
investment in both cases. 
e. 
Choose neither, since
their NPVs are negative. 
____ 32. Two projects being considered are
mutually exclusive and have the following projected cash flows:
Year 
Project
A 
Project
B 
0 
$50,000 
$ 50,000 
1 
15,990 
0 
2 
15,990 
0 
3 
15,990 
0 
4 
15,990 
0 
5 
15,990 
100,560 
At what rate
(approximately) do the NPV profiles of Projects A and B cross?
a. 
6.5% 
b. 
11.5% 
c. 
16.5% 
d. 
20.0% 
e. 
The NPV profiles of these
two projects do not cross. 
____ 33. Which of the following is most
correct? The modified IRR (MIRR) method:
a. 
Always leads to the same
ranking decision as NPV for independent projects. 
b. 
Overcomes the problem of
multiple rates of return. 
c. 
Compounds cash flows at
the required rate of return. 
d. 
Overcomes the problem of
cash flow timing and the problem of project size that leads to criticism of
the regular IRR method. 
e. 
Answers b and c are both
correct. 
____ 34. Which of the following statements is
correct?
a. 
The modified internal
rate of return (MIRR) of a project increases as the discount rate increases. 
b. 
The internal rate of
return (IRR) of a project increases as the required rate of return increases. 
c. 
Both IRR and MIRR can
produce the multiple rates of return. 
d. 
When comparing two
projects, the project with the higher IRR will also have the higher MIRR. 
e. 
Both a
and c are correct. 
____ 35. Alyeska
Salmon Inc., a large salmon canning firm operating out of Valdez, Alaska, has a
new automated production line project it is considering. The project has a cost
of $275,000 and is expected to provide aftertax annual cash flows of $73,306
for eight years. The firm's management is uncomfortable with the IRR
reinvestment assumption and prefers the modified IRR approach. You have
calculated a required rate of return for the firm of 12 percent. What is the
project's MIRR?
a. 
15.0% 
b. 
14.0% 
c. 
12.0% 
d. 
16.0% 
e. 
17.0% 
____ 36. Project A has a cost of $1,000, and
it will produce endofyear net cash inflows of $500 per year for 3 years. The
project's required rate of return is 10 percent. What is the difference
between the project's IRR and its MIRR?
a. 
3.88% 
b. 
4.31% 
c. 
5.09% 
d. 
5.75% 
e. 
6.21% 
____ 37. International Transport Company is
considering building a new facility in Seattle. If the company goes ahead with
the project, it will spend $2 million immediately (at t = 0) and another $2
million at the end of Year 1(t = 1). It will then receive net cash flows of $1
million at the end of Years 25, and it expects to sell the property for $2
million at the end of Year 6. The company's required rate of return is 12
percent, and it uses the modified IRR criterion for capital budgeting
decisions. Which of the following statements is most correct?
a. 
The project should be
rejected because the modified IRR is less than the regular IRR. 
b. 
The project should be
accepted because the modified IRR is greater than the required rate of
return. 
c. 
The regular IRR is less
than the required rate of return. Under this condition, the modified IRR will
also be less than the regular IRR. 
d. 
If the regular IRR is
less than the required rate of return, then the modified IRR will be greater
than the regular IRR. 
e. 
Given the data in the
problem, the NPV is negative. This demonstrates that the modified IRR
criterion is not always a valid decision method for projects such as this
one. 
____ 38. Which of the following is not
a cash flow that results from the decision to accept a project?
a. 
Changes in working
capital. 
b. 
Shipping and installation
costs. 
c. 
Sunk costs. 
d. 
Opportunity costs. 
e. 
Externalities. 
____ 39. Which of the following statements is
correct?
a. 
If a firm's stockholders
are well diversified, we know from theory and from studies of market behavior
that corporate risk is not important. 
b. 
Undiversified
stockholders, including the owners of small businesses, are more concerned
about corporate risk than market risk. 
c. 
Empirical studies of the
determinants of required rates of return (k) have found that only market risk
affects stock prices. 
d. 
Market risk is important
but does not have a direct effect on stock price because it only affects
beta. 
____ 40. Which of the following statements is
correct?
a. 
An asset that is sold for
less than book value at the end of a project's life will generate a loss for
the firm and will cause an actual cash outflow attributable to the project. 
b. 
Only incremental cash
flows are relevant in project analysis and the proper incremental cash flows
are the reported accounting profits because they form the true basis for
investor and managerial decisions. 
c. 
It is unrealistic to
expect that increases in net working capital that are required at the start
of an expansion project are simply recovered at the project's completion.
Thus, these cash flows are included only at the start of a project. 
d. 
Equipment sold for more
than its book value at the end of a project's life will increase income and,
despite increasing taxes, will generate a greater cash flow than if the same
asset is sold at book value. 
e. 
All of the above are
false. 
____ 41. Suppose the firm's required rate of
return is stated in nominal terms, but the project's expected cash flows are
expressed in real dollars. In this situation, other things held constant, the
calculated NPV would
a. 
Be correct. 
b. 
Be biased downward. 
c. 
Be biased upward. 
d. 
Possibly have a bias, but
it could be upward or downward. 
e. 
More information is
needed; otherwise, we can make no reasonable statement. 
____ 42. Monte Carlo simulation
a. 
Can be useful for
estimating a project's standalone risk. 
b. 
Is capable of using
probability distributions for variables as input data instead of a single
numerical estimate for each variable. 
c. 
Produces both an expected NPV (or IRR) and a measure of the
riskiness of the NPV or IRR. 
d. 
All of the above. 
e. 
Only answers a and b are correct. 
____ 43. If the firm is being operated so as
to maximize shareholder wealth, and if our basic assumptions concerning the
relationship between risk and return are true, then which of the following
should be true?
a. 
If the beta of the asset
is larger than the firm's beta, then the required return on the asset is less
than the required return on the firm. 
b. 
If the beta of the asset
is smaller than the firm's beta, then the required return on the asset is
greater than the required return on the firm. 
c. 
If the beta of the asset
is greater than the corporate beta prior to the addition of that asset, then
the corporate beta after the purchase of the asset will be smaller
than the original corporate beta. 
d. 
If the beta of an asset
is larger than the corporate beta prior to the addition of that asset, then
the required return on the firm will be greater after the purchase of
that asset than prior to its purchase. 
e. 
None of the above is a
true statement. 
____ 44. Which of the following statements is
correct?
a. 
A relatively risky future
cash outflow should be evaluated using a relatively low discount rate. 
b. 
If a firm's managers want
to maximize the value of the stock, they should concentrate exclusively on
projects' market, or beta, risk. 
c. 
If a firm evaluates all
projects using the same required rate of return to determine NPVs, then the
riskiness of the firm as measured by its beta will probably decline over
time. 
d. 
If a firm has a beta
which is less than 1.0, say 0.9, this would suggest that its assets' returns
are negatively correlated with the returns of most other firms' assets. 
e. 
The above statements are
all false. 
____ 45. Using the Security Market Line
concept in capital budgeting, which of the following is correct?
a. 
If the expected rate of
return on a given capital project lies above the SML, the project should be
accepted even if its beta is above the beta of the firm's average project. 
b. 
If a project's return
lies below the SML, it should be rejected if it has a beta greater than the
firm's existing beta but accepted if its beta is below the firm's beta. 
c. 
If two mutually exclusive
projects' expected returns are both above the SML, the project with the lower
risk should be accepted. 
d. 
If a project's expected
rate of return is greater than the expected rate of return on an average
project, it should be accepted. 
____ 46. Depreciation must be considered when
evaluating the incremental operating cash flows associated with a capital
budgeting project because
a. 
it
represents a taxdeductible cash expense. 
b. 
the
firm has a cash outflow equal to the depreciation expense each year. 
c. 
although
it is a noncash expense, depreciation has an impact on the taxes paid by the
firm, which is a cash flow. 
d. 
depreciation
is a sunk cost. 
e. 
None of the above is
correct. 
____ 47. Hill Top Lumber Company is
considering building a sawmill in the state of
Washington because the company doesn't have such a facility to service its
growing customer base that is located on the west coast. Hill Top's executives
believe that future growth in west coast customers will make the sawmill
project a good investment. When evaluating the acceptability of the project,
which of the following would not be considered a relevant cash flow that
should be included when determining its initial investment outlay?
a. 
Hill Top owns acreage
that is large enough and would be an ideal location for the
sawmill. The land, which was purchased five years ago, has a current
value of $3 million. 
b. 
It is estimated that the
cost of building the sawmill will be $175 million. 
c. 
It will cost $3 million
to clear the land on which Hill Top wants to build the
sawmill. 
d. 
It is estimated that $20
million of business from existing customers will move to the new sawmill. 
e. 
All of these cash flows
should be included in the computation of the sawmill's initial
investment outlay. 
____ 48. A firm is evaluating a new machine
to replace an existing, older machine. The old (existing) machine is being
depreciated at $20,000 per year, whereas the new machine's depreciation will be
$18,000. The firm's marginal tax rate is 30 percent. Everything else equal, if
the new machine is purchased, what effect will the change in depreciation have
on the firm's incremental operating cash flows?
a. 
There should be no effect
on the firm's cash flows, because depreciation is a noncash expense. 
b. 
Operating cash flows will
increase by $2,000. 
c. 
Operating cash flows will
increase by $1,400. 
d. 
Operating cash flows will
decrease by $600. 
e. 
None of the above is
correct. 
____ 49. Express Press evaluates many
different capital budgeting projects each year. The risks of the projects often
differ significantly, from very little risk to risks that are substantially
greater than the average risk associated with the firm. If Express Press always
uses its weighted average cost of capital, or average required rate of return,
to evaluate all of these capital budgeting projects, then the company might
make an incorrect decision, or a mistake, by
a. 
accepting
projects that actually should be rejected. 
b. 
accepting
projects with internal rates of return that are too high. 
c. 
rejecting
projects that actually should be rejected. 
d. 
rejecting
projects with internal rates of return that are lower than the appropriate
riskadjusted required rate of return. 
e. 
accepting
project that actually should be accepted. 
____ 50. When determining the marginal cash
flows associated with an expansion capital budgeting project, which of the
following would be included as an incremental operating cash flow?
a. 
depreciation 
b. 
shipping and installation 
c. 
increase in working
capital 
d. 
salvage value 
e. 
decrease in sales 
____ 51. An evaluation of four independent
capital budgeting projects by the director of capital budgeting for Ziker Golf Company yielded the following results:

Internal
rate of 

Project 
of
return, IRR 
Risk level 
L 
19.0% 
Average 
E 
15.0 
High 
M 
12.0 
Low 
Q 
11.0 
Average 
The firm's weighted average
cost of capital is 12 percent. Ziker Golf generally
evaluates projects that are riskier than average by adjusting its required rate
of return by 4 percent, whereas projects with lessthanaverage risk are
evaluated by adjusting the required rate of return by 2 percent. Which
project(s) should the firm purchase?
a. 
Project L 
b. 
Projects L and E 
c. 
Projects L and M 
d. 
Projects L, E, and M 
e. 
None of the above is a
correct answer. 
____ 52. How do most firms deal with the
risks of projects when making capital budgeting decisions?
a. 
Projects risks are not
considered directly because the weighted average cost of capital (WACC) that
is used as the required rate of return for capital budgeting decisions is
based on the riskiness of the firm. As a result, all projects, no matter
their risks, can be evaluated using WACC. 
b. 
Evaluating risk is
important only when the projects are similar to the firm's existing assets. 
c. 
Most firms adjust the
discount rates used to evaluate new projects that have significantly
different risks than the risk associated with the firm's existing assets. 
d. 
Firms generally increase
the required rate of return used to evaluate projects that have significantly
different risks than the risk associated with the firm's existing assets,
regardless of whether the new projects' risks are higher or lower. 
e. 
None of the above is a
correct answer. 
____ 53. Dick Boe
Enterprises, an allequity firm, has a corporate beta coefficient of 1.5. The
financial manager is evaluating a project with an IRR of 21 percent, before any
risk adjustment. The riskfree rate is 10 percent, and the required rate of
return on the market is 16 percent. The project being evaluated is riskier than
Boe's average project, in terms of both beta risk and
total risk. Which of the following statements is correct?
a. 
The project should be
accepted because its IRR (before risk adjustment) is greater than its
required return. 
b. 
The project should be
rejected because its IRR (before risk adjustment) is less than its required
return. 
c. 
The accept/reject
decision depends on the riskadjustment policy of the firm. If the firm's
policy were to reduce a riskierthanaverage project's IRR by 1 percentage
point, then the project should be accepted. 
d. 
Riskierthanaverage
projects should have their IRRs increased to reflect their added riskiness.
Clearly, this would make the project acceptable regardless of the amount of
the adjustment. 
e. 
Projects should be
evaluated on the basis of their total risk alone. Thus, there is insufficient
information in the problem to make an accept/reject decision. 
____ 54. Whitney Crane Inc. has the following
independent investment opportunities for the coming year:


Annual
Cash 


Project 
Cost 
Inflows 
Life
(years) 
IRR 
A 
$10,000 
$11,800 
1 

B 
5,000 
3,075 
2 
15 
C 
12,000 
5,696 
3 

D 
3,000 
1,009 
4 
13 
The IRRs for Project A and
C, respectively, are:
a. 
16% and 14% 
b. 
18% and 10% 
c. 
18% and 20% 
d. 
18% and 13% 
e. 
16% and 13% 
____ 55. Alabama Pulp Company (APC) can
control its environmental pollution using either "Project Old Tech"
or "Project New Tech." Both will do the job, but the actual costs
involved with Project New Tech, which uses unproved, new stateoftheart
technology, could be much higher than the expected cost levels. The cash outflows
associated with Project Old Tech, which uses standard proven technology, are
less riskythey
are about as uncertain as the cash flows associated with an average project.
APC's required rate of return for average risk projects normally is set
at 12 percent, and the company adds 3 percent for high risk projects but
subtracts 3 percent for low risk projects. The two projects in question meet
the criteria for high and average risk, but the financial manager is concerned
about applying the normal rule to such costonly projects. You must decide
which project to recommend, and you should recommend the one with the lower PV
of costs. What is the PV of costs of the better project?
Cash Outflows 

Years 
0

1 
2 
3 
4 
Project
New Tech 
1,500 
315 
315 
315 
315 
Project
Old Tech 
600 
600 
600 
600 
600 
a. 
2,521 
b. 
2,399 
c. 
2,457 
d. 
2,543 
e. 
2,422 
____ 56. Meals on Wings Inc. supplies
prepared meals for corporate aircraft (as opposed to public commercial
airlines), and it needs to purchase new broilers. If the broilers are
purchased, they will replace old broilers purchased 10 years ago for $105,000
and which are being depreciated on a straight line basis to a zero salvage
value (15year depreciable life). The old broilers can be sold for $60,000. The
new broilers will cost $200,000 installed and will be depreciated using MACRS
over their 5year class life; they will be sold at their book value at the end
of the 5th year. The firm expects to increase its revenues by $18,000 per year
if the new broilers are purchased, but cash expenses will also increase by
$2,500 per year. If the firm's required rate of return is 10 percent and its
tax rate is 34 percent, what is the NPV of the broilers?
a. 
$61,019 
b. 
$17,972 
c. 
$28,451 
d. 
$44,553 
e. 
$5,021 
____ 57. Mom's Cookies Inc. is considering
the purchase of a new cookie oven. The original cost of the old oven was
$30,000; it is now 5 years old, and it has a current market value of
$13,333.33. The old oven is being depreciated over a 10year life towards a zero
estimated salvage value on a straight line basis, resulting in a current book
value of $15,000 and an annual depreciation expense of $3,000. The old oven can
be used for 6 more years but has no market value after its depreciable life is
over. Management is contemplating the purchase of a new oven whose cost is
$25,000 and whose estimated salvage value is zero. Expected beforetax cash
savings from the new oven are $4,000 a year over its full MACRS depreciable
life. Depreciation is computed using MACRS over a 5year life, and the required
rate of return is 10 percent. Assume a 40 percent tax rate. What is the net
present value of the new oven?
a. 
$2,418 
b. 
$1,731 
c. 
$1,568 
d. 
$163 
e. 
$1,731 
____ 58. California Mining is evaluating the
introduction of a new ore production process. Two alternatives are available.
Production Process A has an initial cost of $25,000, a 4year life, and a
$5,000 net salvage value, and the use of Process A will increase net cash flow
by $13,000 per year for each of the 4 years that the equipment is in use.
Production Process B also requires an initial investment of $25,000, will also
last 4 years, and its expected net salvage value is zero, but Process B will
increase net cash flow by $15,247 per year. Management believes that a
riskadjusted discount rate of 12 percent should be used for Process A. If
California Mining is to be indifferent between the two processes, what
riskadjusted discount rate must be used to evaluate B?
a. 
8% 
b. 
10% 
c. 
12% 
d. 
14% 
e. 
16% 
Exhibit 101
You have been asked by the
president of your company to evaluate the proposed acquisition of a new
specialpurpose truck. The truck's basic price is $50,000, and it will cost
another $10,000 to modify it for special use by your firm. The truck falls into
the MACRS threeyear class, and it will be sold after three years for $20,000.
Use of the truck will require an increase in net working capital (spare parts
inventory) of $2,000. The truck will have no effect on revenues, but it is
expected to save the firm $20,000 per year in beforetax operating costs,
mainly labor. The firm's marginal tax rate is 40 percent.
[MACRS table required]
____ 59. Refer to Exhibit 101. What
is the initial investment outlay for the truck? (That is, what is the Year 0
net cash flow?)
a. 
$50,000 
b. 
$52,600 
c. 
$55,800 
d. 
$62,000 
e. 
$65,000 
____ 60. Refer to Exhibit 101. What
is the terminal (nonoperating) cash flow at the end
of Year 3?
a. 
$10,000 
b. 
$12,000 
c. 
$15,680 
d. 
$16,000 
e. 
$18,000 
Practice Quiz 3  8910
Answer Section
MULTIPLE CHOICE
1. ANS: C PTS: 1 DIF: Easy OBJ: TYPE: Conceptual
TOP: Risk and return
2. ANS: B PTS: 1 DIF: Easy OBJ: TYPE: Conceptual
TOP: Portfolio risk
3. ANS: E PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Risk analysis
4. ANS: C PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Beta coefficient
5. ANS: D PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: CAPM
6. ANS: A PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Beta coefficient
7. ANS: A PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Beta coefficient
8. ANS: B PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Coefficient of variation
9. ANS: E
_{HR} =
2.0; _{LR} = 0.5. No changes occur.
r_{RF} = 10%. Decreases by 3% to
7%.
r_{M} = 15%. Falls
to 11%.
Now SML: r_{i} = r_{RF} + (r_{M} r_{RF})_{I}
r_{HR}
= 7% + (11% 7%)2 = 7% + 4%(2) 
= 
15% 
r_{LR}
= 7% + (11% 7%)0.5 = 7% + 4%(0.5) 
= 
9 
Difference 

6% 
PTS: 1 DIF: Easy OBJ: TYPE: Problem
TOP: CAPM and required return
10. ANS: E

= 0.10 (3%)
+ 0.10 (2%) + 0.25 (5%) + 0.25 (8%) + 0.30 (10%) = 6.15% 

= 0.05 (3%)
+ 0.10 (2%) + 0.30 (5%) + 0.30 (8%) + 0.25 (10%) = 6.45% 



= 0.10 (3%
6.15%)^{2} + 0.10 (2%
6.15%)^{2} + 0.25 (5%
6.15%)^{2} 

+ 0.25 (8%
6.15%)^{2} + 0.30 (10%
6.15%)^{2} 

=15.73; _{x}=
3.97. 


CV_{x} 
= 3.97/6.15 = 0.645. 



= 0.05 (3
6.45%)^{2} + 0.10 (2%
6.45%)^{2} + 0.30 (5%
6.45%)^{2} 

+ 0.30 (8%
6.45)^{2} + 0.25 (10%
6.45%)^{2} 

= 10.95; _{y}
= 3.31. 


CV_{y} 
= 3.31/6.45 = 0.513. 
Therefore, Asset Y has a
higher expected return and lower coefficient of variation and hence it would be
preferred.
PTS: 1 DIF: Medium OBJ: TYPE: Problem
TOP: Expected return
11. ANS: B
Before:
1.15 = 0.95(_{R}) +
0.05(1.0)
0.95(_{R}) =
1.10
_{R }=
1.158
After:
_{P} =
0.95(_{R}) + 0.05(2.0) = 1.10 + 0.10
= 1.20.
PTS: 1 DIF: Medium OBJ: TYPE: Problem
TOP: Portfolio beta
12. ANS: A
Before:
_{p} 
= 1.64 = 0.9 (_{R})
+ 0.1 (2.0) 
_{R} 
= Average beta of the
other 9 stocks in the portfolio 

= 1.44/0.9 = 1.60 
After:
_{New} 
= 1.55 m= 0.9(_{R})
+ 0.1() = 1.44 + 0.1() 

= 1.01(0.11) = 1.10. 
PTS: 1 DIF: Medium OBJ: TYPE: Problem
TOP: Portfolio beta
13. ANS: C
a. 
Plot the returns of
Stocks R & S and the market. 






b. 
Calculate beta using rise
over run method or calculator regression method. 

= 

_{R}
= 

_{S}
= 


c. 
The difference in betas
is: _{R} _{S}
= 2.0 0.5 = 1.5 
PTS: 1 DIF: Medium OBJ: TYPE: Problem
TOP: Beta Calculation
14. ANS: A
Fill in the columns for
"XY" and "product," and then use the formula to calculate
the standard deviation. We did each P calculation with a calculator, stored the
value, did the next calculation and added it to the first one, and so forth.
When all three calculations had been done, we recalled the stored memory value,
took its square root, and had .
Probability 
Portfolio
X Y 
Product 
0.1 
5.0% 
0.5% 
0.8 
17.5 
14.0 
0.1 
30.0 
3.0 


= 16.5% 
Covariance:
PTS: 1 DIF: Medium OBJ: TYPE: Financial Calculator
TOP: Portfolio standard deviation
15. ANS: D
To determine the crossover
rate, find the differential cash flows between the 2 projects and then
calculate the IRR of those differential cash flows.

Project
, 

A
B 
0 
50,000 
1 
55,000 
2 
40,000 
3 
40,000 
IRR_{} =
21.7%
Alternatively, you could
draw the NPV profiles of the 2 projects. We can obtain the Y and X axis
intercept points to draw the NPV profiles.

A 
B 
Yintercept, r = 0 
$95,000 
$90,000 
Xintercept, IRR 
33.8% 
36.0% 
The intersection point or
crossover rate occurs between 20% and 25% so the correct choice must be d.
PTS: 1 DIF: Medium OBJ: TYPE: Financial Calculator
TOP: NPV profiles
16. ANS: C
The first thing to note is
that risky cash outflows should be discounted at a lower discount
rate, so in this case we would discount the riskier Project B's cash flows at
10% 2% = 8%. Project A's cash flows would be
discounted at 10%.
Now we would find the PV of
the costs as follows:
Project A
= 1,000
= 100
I = 10.0%
Solve for NPV = $1,614.46.
Project B
= 300
= 200
I = 8.0%
Solve for NPV = $1,642.02.
Project A has the lower PV
of costs. If Project B had been evaluated with a 12% cost of capital, its PV of
costs would have been $1,430.04, but that would have been wrong.
PTS: 1 DIF: Medium OBJ: TYPE: Financial Calculator
TOP: Discounting risky outflows
17. ANS: B

0 
1 
2 
3 
Sales 

$900 
$900 
$900 
Costs 

(450) 
(450) 
(450) 
Deprn 

(500) 
(300) 
(200) 
EBT 

($ 50) 
$150 
$250 
Taxes (40%) 

20 
(60) 
(100) 
Net income 

($ 30) 
$ 90 
$150 
Add deprn 

500 
300 
200 


$470

$390 
$350 
Cost 
(1,000) 



Inventory 
(200) 



Salvage value 



100 
Tax on SV 



(40) 
Ret. of inv. 
_____ 
____ 
____ 
200 

(1,200) 
$470 
$390 
$610 
NPV = $7.89; IRR = 10.36%
PTS: 1 DIF: Medium OBJ: TYPE: Financial Calculator
TOP: New project NPV
18. ANS: A
Purchase 
(50,000) 



Sales 

50,000 
50,000 
50,000 
VC 

(20,000) 
(20,000) 
(20,000) 
Deprec. 

(40,000) 
(5,000) 
(5,000) 
EBT 

(10,000) 
25,000 
25,000 
Taxes 

4,000 
(10,000) 
(10,000) 
Net income 

(6,000) 
15,000 
15,000 
+Depreciation 

40,000 
5,000 
5,000 


34,000 
20,000 
20,000 
NWC 
(12,000) 


12,000 
RV(AT) 
______ 
______ 
______ 
6,000 
NCF 
(62,000) 
34,000 
20,000 
38,000 
NPV_{15%} =
$7,673.71.
PTS: 1 DIF: Medium OBJ: TYPE: Financial Calculator
TOP: New project NPV
19. ANS: E PTS: 1 DIF: Easy OBJ: TYPE: Conceptual
TOP: Payback period
20. ANS: A PTS: 1 DIF: Easy OBJ: TYPE: Conceptual
TOP: Ranking conflicts
21. ANS: E PTS: 1 DIF: Easy OBJ: TYPE: Conceptual
TOP: NPV
22. ANS: D PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: PV of cash flows
23. ANS: A PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: NPV and IRR
24. ANS: E PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: IRR
25. ANS: A PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Payback period
26. ANS: D PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: IRR
27. ANS: E PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Postaudit
28. ANS: C PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Postaudit
29. ANS: A
Financial calculator
solution:
Project A
Inputs: N = 5; I = 10; PMT
= 15,625
Output: PV = 59,231.04
NPV_{A} =
$59,231.04 $50,000 = $9,231.04
Project B
Inputs: N = 5; I = 10; FV =
99,500
Output: PV = 61,781.67
NPV_{B} =
$61.781.67 $50,000 = $11,781.67
Alternate method by cash
flows
Project A:
Inputs: = 50,000; = 15,625; N_{j} = 5; I =10
Output: NPV = $9,231.04
Project B:
Inputs: = 50,000; = 0; N_{j}
= 4; = 99,500; I = 10
Output: NPV = $11,781.67
PTS: 1 DIF: Easy OBJ: TYPE: Problem
TOP: NPV analysis
30. ANS: D
Financial calculator
solution: (In thousands)
Inputs: = 150; = 30; N_{j}
= 4; = 35; N_{j}
= 5; = 40; I =10
Output: NPV = $51.13824 =
$51,138.24 $51,138
PTS: 1 DIF: Medium OBJ: TYPE: Problem
TOP: NPV analysis
31. ANS: B
Cash flow time line:
Financial calculator
solution:
Project A:
Inputs: = 100,000; = 39,500; N_{j} = 3
Output: IRR_{A} =
8.992% 9.0%
Project B:
Inputs: = 10,000; = 0; N_{j}
= 2; = 133,000
Output: IRR_{B} =
9.972% 10.0%
PTS: 1 DIF: Medium OBJ: TYPE: Problem
TOP: IRR
32. ANS: B
Cash flow time line:
Financial calculator
solution:
Solve for IRR_{A}
Inputs: = 50,000; = 15,990; N_{j} = 5
Output: IRR = 18.0%
Solve for IRR_{B}
Inputs: = 50,000; = 0; N_{j}
= 5; = 100,560
Output: IRR = 15.0%
Solve for crossover rate using the differential project CFs, CF_{AB}
Inputs: = 0; = 15,990; N_{j} =4; = 84,570
Output: IRR = 11.49% The crossover rate is 11.49%.
PTS: 1 DIF: Tough OBJ: TYPE: Problem
TOP: NPV profiles
33. ANS: E PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Modified IRR
34. ANS: A
Statement a is correct. The MIRR is dependent on the required rate of
return. As the required rate of return increases, so does the terminal value.
Because the MIRR is the rate which equates the PV with the terminal value, the
MIRR increases as the terminal value increases. All the other statements are
false.
PTS: 1 DIF: Tough OBJ: TYPE: Conceptual
TOP: MIRR and IRR
35. ANS: D
Numerical Solution:
3.27869^{1/8} = 1 +
MIRR
MIRR = 16%.
Financial calculator
solution:
TV
Inputs: N = 8; I = 12; PMT = 73,306.
Output: FV = 901,641.31.
MIRR
Inputs: N = 8; PV = 275,000; FV = 901,641.31.
Output: I = 16.0%.
Alternate method
Inputs: = 0; = 73,306; N_{j} = 8; I =12
Output: NFV = $901,641.31.
Inputs: = 275,000; = 0; N_{j}
= 7; = 901,641.31.
Output: IRR = 16.0% = MIRR.
PTS: 1 DIF: Medium OBJ: TYPE: Problem
TOP: MIRR
36. ANS: C
Cash flow time line:
IRR_{A} = 23.38%.
Calculate MIRR: Find PV of
CFs at 10%:
N = 3; I = 10; PMT = 500;
FV = 0. Solve for PV = $1,243.43.
Find FV of this PV:
N = 3; I = 10; PV = 1,243.43;
PMT = 0.
Solve for FV = TV =
$1,655.00.
Find MIRR = 18.29%:
N = 3; PV = 1,000;
PMT = 0; FV = 1,655.
Solve for I = MIRR =
18.29%.
Difference = 23.38%
18.29% = 5.09%.
PTS: 1 DIF: Medium OBJ: TYPE: Problem
TOP: IRR and MIRR
37. ANS: D
1 + MIRR = [7,352,816/3,785,714]^{1/6}
MIRR = 11.7%.
Since the MIRR is less than
the required rate of return, the IRR is less than the MIRR. Thus, Answer d is
correct.
Financial calculator
solution:
Calculate TV of inflows
Inputs: = 0; = 1,000,000; N_{j} = 4; = 2,000,000; I = 12.
Output: NFV =
$7,352,847.36.
Calculate MIRR
Inputs: N = 6; PV = 3,785,714;
FV = 7,352,847.
Output: I = 11.70%.
Calculate IRR
Inputs: = 2,000,000; = 2,000,000; = 1,000,000; N_{j} = 4; = 2,000,000.
Output: IRR = 11.50%.
r
> MIRR > IRR.
12.0% > 11.7% >
11.50%.
PTS: 1 DIF: Tough OBJ: TYPE: Problem
TOP: Modified IRR
38. ANS: C PTS: 1 DIF: Easy OBJ: TYPE: Conceptual
TOP: Determining incremental cash flows
39. ANS: B PTS: 1 DIF: Easy OBJ: TYPE: Conceptual
TOP: Corporate risk
40. ANS: D PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Cash flows and accounting measures
41. ANS: B PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Inflation effects
42. ANS: D PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Monte Carlo simulation
43. ANS: D PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Risk and project betas
44. ANS: A PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Beta and project risk
45. ANS: A PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: SML and capital budgeting
46. ANS: C PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Relevant cash flows
47. ANS: E PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Relevant cash flows
48. ANS: D PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Determining incremental cash flows
49. ANS: A PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Riskadjusted discount rate
50. ANS: D PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Incremental cash flows
51. ANS: C PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Risk adjustment
52. ANS: C PTS: 1 DIF: Medium OBJ: TYPE: Conceptual
TOP: Risk adjustment
53. ANS: C
r_{s} = 10% + (16%
10%)1.5 = 10% + 9% = 19%.
Original IRR = 21%. 21%
Risk adjustment 1% = 20%.
Risk adjusted IRR = 20%
> r_{s} = 19%.
PTS: 1 DIF: Easy OBJ: TYPE: Problem
TOP: Risk adjustment
54. ANS: C
Financial calculator
solution:
Project A
Inputs: N = 1; PV = 10,000;
FV = 11,800.
Output: I = 18% = IRR_{A}.
Project B
Inputs: N = 3; PV = 12,000;
PMT = 5,696.
Output: I = 19.99%
20% = IRR_{B}.
PTS: 1 DIF: Medium OBJ: TYPE: Problem
TOP: IRRs
55. ANS: E
Recognize that (1) risk outflows
must be discounted at lower rates, and (2) since Project New Tech is risky, it
must be discounted at a rate of 12% 3% = 9%. Project
Old Tech must be discounted at 12%.
PV_{Old}_{
Tech} is a smaller outflow than NPV_{New}_{
Tech}, thus, Project Old Tech is the better project.
Financial calculator
solution:
Project New Tech
Inputs: = 1,500; = 315; N_{j} = 4; I = 9.
Output: NPV = $2,520.51.
Project Old Tech
Inputs: = 600; = 600; N_{j} = 4; I = 12.
Output: NPV = $2,422.41.
PTS: 1 DIF: Medium OBJ: TYPE: Problem
TOP: Discounting risky outflows
56. ANS: A
[MACRS table required]
Depreciation cash flows*:

MACRS 
New
Asset 
Old
Asset 
Change
in 
Year 
Percent 
Depreciation 
Depreciation 
Depreciation 
1 
0.20 
$40,000 
$7,000 
$33,000 
2 
0.32 
64,000 
7,000 
57,000 
3 
0.19 
38,000 
7,000 
31,000 
4 
0.12 
24,000 
7,000 
17,000 
5 
0.11 
22,000 
7,000 
15,000 
6 
0.06 
12,000 
 
12,000 
*Depreciation old
equipment: 105,000/15 = 7,000 per year 10 years = 70,000
in accumulated depreciation.
Book value = 
$105,000 

70,000 

$ 35,000 
Replacement analysis
worksheet:
I 
Initial investment outlay 


1) New equipment cost 
($200,000) 


2) Market value old
equip. 
60,000 


3) Taxes on sale of old
equip. 
(8,500)* 


4) Increase in NWC 
 


5) Total net investment 
($148,500) 






*(Market value
Book value)(Tax rate) 



(60,000
35,000) (0.34) 





II 
Incremental operating
cash flows 


Year: 
0 
1 
2 
3 
4 
5 


6) Increase in revenues 

$18,000

$18,000

$18,000

$18,000

$18,000



7) Increase in expenses 

(2,500) 
(2,500) 
(2,500) 
(2,500) 
(2,500) 


8) AT change in earnings 

10,230

10,230

10,230

10,230

10,230



((line 6 + 7)
0.66) 








9) Deprec.
on new machine 
40,000

64,000

38,000

24,000

22,000



10) Deprec.
on old machine 
7,000

7,000

7,000

7,000

7,000



11) Change in deprec. 

33,000

57,000

31,000

17,000

15,000



(line 9
10) 








12) Tax savings from deprec. 
11,220 
19,380 
10,540 
5,780 
5,100 


(line 11
0.34) 








13) Net operating CFs 

$21,450

$29,610

$20,770

$16,010

$15,330



(line 8 + 12) 
















III 
Terminal CF 


14) Estimated salvage
value 




$12,000



15) Tax on salvage value 









16) Return of NWC 









17) Net CF 





12,000











IV 
Net CFs 


18) Total Net CFs 
($148,500)

$21,450 
$29,610 
$20,770 
$16,010 
$27,330 

Financial calculator
solution:
Inputs: = 148,500; = 21,450; = 29,610; = 20,770; = 16,010; = 27,330; I = 10.
Output: NPV = $61,019.29
$61,019.
Note:
Tabular solution differs from calculator solution due to interest factor
rounding.
PTS: 1 DIF: Tough OBJ: TYPE: Problem
TOP: Replacement decision
57. ANS: C
[MACRS table required]
Depreciation cash flows:

MACRS 
New
Asset 
Old
Asset 
Change
In 
Year 
Percent 
Depreciation 
Depreciation 
Depreciation 
1 
0.20 
$ 5,000 
$ 3,000 
$ 2,000 
2 
0.32 
8,000 
3,000 
5,000 
3 
0.19 
4,750 
3,000 
1,750 
4 
0.12 
3,000 
3,000 
0 
5 
0.11 
2,750 
3,000 
(250) 
6 
0.06 
1,500 
______ 
1,500 


$25,000 
$15,000 
$10,000 
Project analysis worksheet:
I 
Initial investment outlay 


1) New equipment cost 
($25,000.00) 


2) Market value old
equip. 
13,333.33 


3) Tax savings sale of
old equip. 
666.67* 


4) Increase in NWC 
 


5) Total net investment 
($11,000.00) 






*(Market value  Book
value)(Tax rate) 



($13,333.33
$15,000) (0.4) = 666.67 





II 
Incremental operating
cash flows 


Year: 
0 
1 
2 
3 
4 
5 
6 


6) Beforetax savings new
equip. 
$4,000 
$4,000 
$4,000 
$4,000 
$4,000

$4,000 


7) Aftertax savings new
equip. 
2,400 
2,400 
2,400 
2,400 
2,400

2,400 


(line 6
0.6) 








8) Dep. new machine 
5,000 
8,000 
4,750 
3,000 
2,750

1,500 


9) Dep. old machine 
3,000 
3,000 
3,000 
3,000 
3,000

0 


10) Change in deprec. 
2,000 
5,000 
1,750 
0 
(250) 
1,500 


(line 8
9) 








11) Tax savings from deprec. 
800 
2,000 
700 
0 
