Question

1.Select one advantage of IRR as a capital budget method.

• a) It is more useful than NPV analysis when evaluating mutually exclusive projects.
• b) It accurately reflects the reinvestment rate risk.
• c) It is simple to understand because it ignores the time value of money.
• d) The IRR can easily be evaluated alongside a company's threshold rate.

2. A company invests $600,000 in a project with the following net cash flows:

• Year 1: $130,000
• Year 2: $113,000
• Year 3: $98,000
• Year 4: $92,000
• Year 5: $89,000
• Year 6: $95,000

In what year does payback occur?

• a) After Year 6
• b) Year 4
• c) Year 6
• d) Year 5

3. Determine whether the following description is true of a capital lease, an operating lease, neither or both.

"A method of financing an asset like equipment without purchasing it outright with equity"

• a) Capital lease
• b) Operating lease
• c) Both
• d) Neither

4.What can a business that has too little working capital do to increase it?

• a) Reduce current assets
• b) Increase short-term liabilities
• c) Increase cash on hand
• d) Decrease inventory

5.Which of the following investors would likely prefer a cash dividend over a stock dividend?

• a) Karen prefers knowing that the company she invested in has adequate liquidity.
• b) Paul doesn't mind taking on some additional risk if it means a larger reward down the road.
• c) Zakir wants to be able to purchase more shares so that he owns a larger stake in the company.
• d) Vladamir chooses stocks strategically in order to maximize his capital gains.

6.Rose is concerned about a stock in her portfolio because in recent periods, the dividend she has received for each share has gotten smaller while the share price has remained relatively constant.

What financial metric is Rose analyzing?

• a) Dividend cover
• b) Dividend per share
• c) Payout ratio
• d) Dividend yield

7.What is one disadvantage of NPV as a capital budget method?

• a) It is rarely used, so there is disagreement as to what an adequate NPV is.
• b) It cannot be used to compare investments with different upfront costs.
• c) It can be misleading if inputs like cash flow turn out to be wrong.
• d) It does not deliver an overall picture of the gain or loss of implementing a project.

Answer 1

1) d) The IRR can easily be evaluated alongside a company's threshold rate

IRR can be compared with the cost of capital and can be decided if the project is profitable or not. a is incorrect as NPV is more useful method. b is incorrect as IRR ignores reinvestment risk. c is incorrect as IRR takes into account time value of money.

2) c) Year 6

Payback period is the time taken for the cumulative cash flows to become 0

A B C D E 1 2 Cumulative cash flows Year Net cash flows 0 -600000 3 -600000 4 1 130000 -470000 5 2 113000 -357000 6 3 -259000 7 4 98000 92000 89000 - 167000 8 Ол - 78000 9 6 95000 17000 10 11 Payback period 5.821052632 12

А B C D E 1 Year Cumulative cash flows 2 3 4 0 1 5 2 Net cash flows -600000 130000 113000 98000 92000 89000 95000 6 3 =C3 =C4+D3 =C5+D4 =C6+D5 =C7+D6 =C8+D7 =C9+D8 7 8 9 4 5 6 10 11 Payback period =B8+D8/(D8-D9) 12 13 14

Hence, payback occurs in year 6

3) c) Both

A lease is associated with ongoing expense without purchasing it directly.

4) c) Increase cash on hand

Inventories consists of current assets which inturn includes cash on hand. Rest all the options would decrease the inventories

5) a) Karen prefers knowing that the company she invested in has adequate liquidity

A cash dividend is a safe option if the company's financial situation is not well known or bad. Rest all the options will compel the investor to take the stock dividend

6) d) Dividend yield

Since she is directly observing the absolute value of the dividend and the share price, she is looking at the the Dividend yield metric. Dividend yield is the ratio of annual dividend by the per share price.

7) c) It can be misleading if inputs like cash flow turn out to be wrong.

If the cash flows are incorrect, NPV will give misleading values as in NPV the cashflows are discounted to present value