SOLVED

1) A company uses the Profitability Index to assess investment opportunities when: A) The flows from the investment alternatives are unequal. B) The investment alternatives are mutually exclusive. C) Insufficient funding exists to invest in all the non-divisible projects. D) A company is subject to capital rationing. E) Risks from inflation impact projects individually. 2) LaVerendrye Inc. has $20 million to invest and is looking at three projects. The company’s hurdle rate is 14%. Project A’s initial investment is $11 million and the cash flow over four years is $1 million, $2 million, $8 million, and $10 million, respectively. Project B’s initial investment is $14 million and cash flow over the same period is $10 million, $7 million, $4 million and $4 million. Project C’s initial investment is $18 million and its cash flow is $2 million, $5 million, $9 million, and $11 million, respectively. The projects are divisible. Because La Verendrye cannot undertake all three projects, what is their best investment decision? A) All of C and 14% of B B) All of B and 55% of A C) All of B and 33% of C D) All of A and 64% of B E) All of A and 50% of C 3) Mercury Metals has up to $100 million budgeted to purchase high efficiency smelters. The company has an 12% hurdle rate. A part of a smelter cannot be purchased. If Smelter A will cost $55 million and provide an expected income before depreciation of $16 million for each of 20 years and Smelter B will cost $90 million and provide an expected income before depreciation of $22 million in each of 20 years, which is the project Mercury Metals should undertake? A) Project A with the higher profitability index at 2.2. B) Project B has the higher profitability index at 1.8. C) Project A has the higher NPV at $64.5 million. D) Project A has the higher IRR at 29%. E) Project B with the higher NPV at $74.3 million. 4) A company looking for a return of 12% has capital available for projects equalling $100,000 and three projects under consideration. Each of the projects will last five years. While all the projects are divisible, if the company selects project B, it cannot do project C.  Project A costs $54,000 and provides and income before amortization of $25,000, $25,000, $28,000, $26,000, and $22,000, respectively. Project B costs $63,000 and provides $12,000, $16,000, $20,000, $30,000 and $45,000 respectively. Project C costs $70,000 and provides $35,000 $24,000 $18,000 $19,000 and $10,000 respectively. The company should do A) Project A and part of Project B as the NPV is highest for Project A and NPV is higher for Project B than Project C B) Project A and part of Project C as profitability index is highest for Project A and is higher for Project C than for Project B C) Project B and part of Project A as NPV is highest for Project B and higher for Project A than Project C D) All of Project C and part of Project A as this maximizes cash flow according to the profitability index E) All of Project B and part of Project A as this maximizes cash flow according to the profitability index 5) Kendle Knitting Mills is looking to purchase additional weaving looms of different sizes. One supplier has offered an appropriate configuration of machines valued at $175,000. Kendle projects incremental income from these looms before depreciation at $40,000 a year over an eight year period. Kendle can purchase similar used machines for $85,000 but the equipment is less efficient and will only last four years. Income from these is projected at $40,000, $37,000, $33,000, and $28,000 respectively. Both used and new machines will have no salvage value at the end of their useful lives. If Kendle is looking for a 14% return, determine if Kendle should buy new or used looms using common-shortest period of time approach. What should Kendle buy? A) Neither new looms nor old as the NPV for both is negative. B) Used looms as they have a NPV that is $17,164 higher than new. C) Used looms as they have a NPV that is $67,494 higher than new. D) New looms as they have a NPV that is $90,568 higher than old. E) New looms as they have a NPV that is $3,324 higher than old. 6) Merton Distillers Ltd. has a discount rate of 10% and two possible projects. Both projects allow reinvestment at the end of the term. The first is three years long and has a NPV of $1.3 million. The second is four years long and has a NPV of $1.4 million. Merton Distillers Ltd. should undertake A) The second project because it has a NPV of $1.4 B) The first project because it has a positive NPV and allows for more rapid reinvestment C) The second project because it has a higher NPV when calculated by the shortest-common-period-of time approach D) The first project because its annualized equivalent is higher than that for the second project E) Neither project because the results from the analytical methods provide conflicting conclusions 7) Opportunity 1 calls for a $24,000 investment which will yield income before depreciation of $18,000 the first year and $20,000 the second year. Opportunity 2 calls for an investment of $36,000 resulting, over three years, in an expected income before depreciation of $15,000, $17,000, and $28,000, respectively. The investments are mutually exclusive. The company’s hurdle rate is 12%. Using the equivalent-annual-annuity approach what can be concluded about the investments? A) Opportunity 1 as it has the higher equivalent annuity of $4,743. B) Opportunity 2 as it has the higher equivalent annuity of $5,643. C) Opportunity 1 as its NPV is higher at $11,573. D) Opportunity 2 as its NPV is higher at $10,875. E) Opportunity 2 as its cash in flow is larger by $10,000. 8) Martin Rose Associates have included the cost of theft of their intangible assets in calculating the NPV of several biometric security scanning systems for the company’s research facilities. A new generation of biometrics is likely to be unveiled within 12 to 18 months that could double the benefits that the current biometric system would deliver. The company should A) Install the security system that achieves the highest NPV immediately B) Wait until the technology is launched and costs are established before generating a NPV analysis on biometrics and selecting a system C) Add the anticipated benefits from the new systems to the initial expenditures in the current NPV analysis D) Install the security system that achieves the highest NPV immediately and reserve the cost of upgrades in a contingency fund E) Re-open the investigation into improving security for the research facilities to determine if the benefits from the future of biometrics can be achieved in another way now 9) The current general purchasing power of cash flows is determined by A) Applying a general rate of inflation to all cash flows B) Including an inflation factor when determining the hurdle rate and then applying it to all cash flows C) Ignoring inflation in the calculations as it affects various items differently and ultimately the effects cancel each other out D) Determining and applying the specific rate of inflation for each item in a cash flow as well as specific rates of inflation to each type of cash flow E) Determining the monetary cash flows from each item and deflating these amounts by the general rate of inflation 10) Which of the following may bias the NPV calculation upward? A) Failure to adjust cash flows but not the discount rate for inflation. B) Adjusting lease rates where there are long term agreements. C) Increasing the income tax rate by the inflation rate. D) Failure to expand working capital. E) Adjusting wage expense if a union contract with a lower rate is in effect. 1