You have been asked to analyze a capital investment proposal. The project's cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project's MIRR?
A) 12.62%
B) 10.44%
C) 16.73%
D) 19.99%
Dizzyland Enterprises 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 cost of capital is 10%. What is the profitability index for this investment?
A) 1.34
B) 0.87
C) 1.85
D) 0.21
We compute the profitability index of a capital-budgeting proposal by
A) multiplying the IRR by the cost of capital.
B) dividing the present value of the annual after-tax cash flows by the cost of capital.
C) dividing the present value of the annual after-tax cash flows by the cost of the project.
D) multiplying the cash inflow by the IRR.
What is the payback period for a $20,000 project that is expected to return $6,000 for the first two years and $3,000 for Years 3 through 5?
A) 3 1/2
B) 4 1/2
C) 4 2/3
D) 5
The payback method focuses primarily on the length of time required to recover the cost of the investment rather than estimating the total value the project will add to the firm.
Answer: TRUE
One advantage of the payback method is that it can be readily understood by people with no special training in finance.
Answer: TRUE
When several sign reversals in the cash flow stream occur, the IRR equation can have more than one positive IRR.
Answer: TRUE
If the project's internal rate of return is greater than or equal to zero, the project should always be accepted.
Answer: FALSE
The profitability index provides the same accept/reject decision result as the net present value (NPV) method but would not necessarily rank mutually exclusive projects the same way.
Answer: TRUE
The internal rate of return (IRR) will increase as the required rate of return of a project is increased.
Answer: FALSE
The IRR assumes that cash flows are reinvested at the cost of capital.
Answer: FALSE
If the NPV of a project is zero, then the profitability index should equal one.
Answer: TRUE
Unlike the basic IRR method, the MIRR method allows the analyst to specify a reinvestment rate for positive cash flows.
Answer: TRUE
According to the modified internal rate of return (MIRR) technique, when a project's MIRR is greater than its cost of capital, the project should be accepted.
Answer: TRUE
The IRR is the discount rate that equates the present value of the project's future net cash flows with the project's initial outlay.
Answer: TRUE
