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ASSIGNMENT 3 - SUGGESTED ANSWER

Capital Budgeting

1. What is meant by mutually exclusive projects? a. projects that clash and would cause the company to exclude the benefits of the project on its cash flows b. when the option to invest in future projects occurs sequentially c. when the cash flows of one project are excluded because they are uncertain d. two competing projects, such as whether to buy a blue delivery truck or a red one

2. Gerhardt Corporation is planning on spending £45 million to build a new plant. They believe the plant will lower costs by £14 million for the next five years. If Gerhardt Corporation’s cost of capital is 15%, should they accept this project? a. yes, the NPV is £25 million b. yes, the NPV is £1.93 million c. yes, the IRR is greater than 15% d. b and c

3. The payback of an investment is 2.25 years. The project’s cash flows are as indicated below. What s the IRR of the investment project? Year Cash Flow 1 $1,000 2 $1,500 3 $2000 4 $2500

a. not enough information b. 3.73% c. 37.3% d. 29.2%

4. What is the average book value of a project with an initial outlay of $500,000 that is depreciated to a salvage value of $150,000 over 5 years? a. $ 30,000 b. $ 70,000 c. $100,000 d. $325,000

5. What is the profitability index of a capital investment project that cost the firm $100,000 and has cash flows of $20,000, $25,000, $40,000, $50,000 in years one through four, respectively? The cost of capital is 9% a. 1.057 b. 1.350 c. 1.642 d. 1.683

6. What is the reason a project can have a positive net present value, yet the project’s internal rate of return is less than the cost of capital? a. this situation cannot exist –

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