FINANCIAL MANAGEMENT 2017 - QUIZ AND CASE STUDY GUIDES

Financial Management: Core Concepts, 3e(Brooks)

Chapter 9 Capital Budgeting Decision Models

*Financial Management: Core Concepts, 3e*** (Brooks)**

**Chapter 9 Capital Budgeting Decision Models**

** **

9.1 Short-Term and Long-Term Decisions

1) ________ is at the heart of corporate finance, because it is concerned with making the best choices about project selection.

- A) Capital budgeting
- B) Capital structure
- C) Payback period
- D) Short-term budgeting

Answer: A

Diff: 2

Topic: 9.1 Short-Term and Long-Term Decisions

AACSB: 6 Reflective Thinking

LO: 9.1 Explain capital budgeting and differentiate between short-term and long-term budgeting decisions.

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

2) The ________ model is usually considered the best of the capital budgeting decision-making models.

- A) internal rate of return (IRR)
- B) net present value (NPV)
- C) profitability index (PI)
- D) discounted payback period

Answer: B

Diff: 1

Topic: 9.1 Short-Term and Long-Term Decisions

AACSB: 6 Reflective Thinking

LO: 9.1 Explain capital budgeting and differentiate between short-term and long-term budgeting decisions.

3) We can separate short-term and long-term decisions into three dimensions. Which of the below is NOT one of these?

- A) Degree of information gathering prior to the decision
- B) Cost
- C) Personality of CEO making the decisions
- D) Length of impact

Answer: C

Explanation: C) We can separate short-term and long-term decisions into three dimensions: 1. Length of impact; 2. Cost; 3. Degree of information gathering prior to the decision.

Diff: 1

Topic: 9.1 Short-Term and Long-Term Decisions

AACSB: 6 Reflective Thinking

LO: 9.1 Explain capital budgeting and differentiate between short-term and long-term budgeting decisions.

4) Because money is often limited, companies must be careful to choose projects that are feasible and profitable.

Answer: TRUE

Diff: 1

Topic: 9.1 Short-Term and Long-Term Decisions

AACSB: 6 Reflective Thinking

5) Capital budgeting decisions are typically long-term decisions.

Answer: TRUE

Diff: 1

Topic: 9.1 Short-Term and Long-Term Decisions

AACSB: 6 Reflective Thinking

6) Name and describe three key observations that we can make about the capital budgeting decision.

Answer: There are three key observations we can make about the capital budgeting decision:

1) A capital budgeting decision is typically a go or no-go decision on a product, service, facility, or activity of the firm. That is, we either accept the business proposal or we reject it. The choice of accepting or rejecting a proposed project is the cornerstone of financial management at all levels of a business.

2) A capital budgeting decision will require sound estimates of the time and amount of appropriate cash flow for the proposal. Thus, the appropriate future cash flow is a necessary input into all capital budgeting decisions.

3) The capital budgeting model has predetermined accept or reject criteria. We need to examine the validity of these criteria within each decision model.

Diff: 3

Topic: 9.1 Short-Term and Long-Term Decisions

AACSB: 6 Reflective Thinking

9.2 Payback Period

1) The ________ model answers one basic question: How soon will I recover my initial investment?

- A) payback period
- B) IRR
- C) NPV
- D) profitability index

Answer: A

Diff: 1

Topic: 9.2 Payback Period

AACSB: 6 Reflective Thinking

LO: 9.2 Explain the payback period model and its two significant weaknesses and how the discounted payback period model addresses one of the problems.

2) The ________ model determines at what point in time cash outflow is recovered by the corresponding future cash inflow.

- A) NPV
- B) buyback
- C) net present value
- D) payback period

Answer: D

Diff: 1

Topic: 9.2 Payback Period

AACSB: 6 Reflective Thinking

LO: 9.2 Explain the payback period model and its two significant weaknesses and how the discounted payback period model addresses one of the problems.

3) Consider the following four-year project. The initial after-tax outlay or after-tax cost is $1,000,000. The future after-tax cash inflows for years 1, 2, 3 and 4 are: $400,000, $300,000, $200,000 and $200,000, respectively. What is the payback period without discounting cash flows?

- A) 2.5 years
- B) 3.0 years
- C) 3.5 years
- D) 4.0 years

Answer: C

Explanation: C) We can see that after three years, we will have paid back $900,000. Thus, we only need $100,000 in after-tax cash flows in the 4th year. Because we get $200,000 in the fourth year, the rule of thumb is to divide what is needed by the cash inflows we will get next period and add the results to the number of previous periods of cash inflows, e.g., ($100,000 divided by $200,000) + 3 which gives 3.500. Thus, the payback period is **3.5 years**.

Diff: 2

Topic: 9.2 Payback Period

AACSB: 3 Analytical Thinking

LO: 9.2 Explain the payback period model and its two significant weaknesses and how the discounted payback period model addresses one of the problems.

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

4) Consider the following ten-year project. The initial after-tax outlay or after-tax cost is $1,000,000. The future after-tax cash inflows each year for years 1 through 10 are $200,000 per year. What is the payback period without discounting cash flows?

- A) 10 years
- B) 5 years
- C) 2.5 years
- D) 0.5 years

Answer: B

Explanation: B) $1,000,000/$200,000 per year = 5 years.

Diff: 1

Topic: 9.2 Payback Period

AACSB: 3 Analytical Thinking

5) The initial outlay or cost is $1,000,000 for a four-year project. The respective future cash inflows for years 1, 2, 3 and 4 are: $500,000, $300,000, $300,000 and $300,000. What is the payback period without discounting cash flows?

- A) About 2.50 years
- B) About 2.67 years
- C) About 3.67 years
- D) About 4.50 years

Answer: B

Explanation: B) We can see that after two years, we will have paid back $800,000. Thus, we only need $200,000 in after-tax cash flows in the third year. Since we get $300,000 in the third year, the rule of thumb is to divide what is needed by the cash inflows we will get next period and add the results to the number of previous periods of cash inflows, e.g., ($200,000 divided by $300,000) + 2, which gives about 2.67. Thus, the payback period is about .

Diff: 3

Topic: 9.2 Payback Period

AACSB: 3 Analytical Thinking

6) Acme, Inc. is considering a four-year project that has an initial outlay or cost of $100,000. The respective future cash inflows from its project for years 1, 2, 3 and 4 are: $50,000, $40,000, $30,000 and $20,000. Will it accept the project if it's payback period is 31 months?

- A) Yes, because it pays back in 25 months.
- B) Yes, because it pays back in 28 months.
- C) No, because it pays back in over 31 months.
- D) No, because it pays back in over 35 months.

Answer: B

Explanation: B) We can see that after two years, we will have paid back $90,000. Thus, we only need $10,000 in after-tax cash flows in the third year. Since we get $30,000 in the third year, the rule of thumb is to divide what is needed by the cash inflows we will get next period and add the result to the number of previous periods of cash inflows, e.g., ($10,000 divided by $30,000) + 2. Doing this gives 2-1/3 years. The payback period in months is 2-1/3 * 12 = **28 months.** Thus, Acme can accept the project as it pays back within 31 months.

Diff: 3

Topic: 9.2 Payback Period

AACSB: 3 Analytical Thinking

7) Which of the statements below is TRUE of the payback period method?

- A) It ignores the cash flow after the initial outflow has been recovered.
- B) It is biased against projects with early-term payouts.
- C) It incorporates time-value-of-money principles.
- D) It focuses on cash flows after the initial outflow has been recovered.

Answer: A

Explanation: A) By ignoring the cash flow after the initial outflow has been recovered, the payback period is biased toward those projects that have higher early-year cash inflow and against those with higher late-year inflow.

Diff: 2

Topic: 9.2 Payback Period

AACSB: 6 Reflective Thinking

8) Which of the statements below is FALSE?

- A) Firms rarely use the payback period for small-dollar decisions.
- B) Many companies use the payback period for small-dollar decisions because the time spent gathering the accurate cash flow may be lowered substantially if it is necessary to estimate only through the first few years.
- C) Many companies use the payback period for small-dollar decisions because the future cash flows on these smaller projects may be quite difficult to accurately estimate far into the future.
- D) Many companies use the payback period for small-dollar decisions because it does prevent a serious error when the future cash flow is insufficient to recover the initial cash outlay.

Answer: A

Explanation: A) Many companies use the payback period for small-dollar decisions. This is because for small-dollar decisions, the time spent gathering the accurate cash flows may be lowered substantially if it is necessary to estimate only through the first few years. The future cash flows on these smaller projects may be quite difficult to accurately estimate far into the future. Therefore, the company establishes a short arbitrary cut-off date for handling the initial screening of many small-dollar opportunities. And finally, it does prevent a serious error when the future cash flow is insufficient to recover the initial cash outlay.

Diff: 2

Topic: 9.2 Payback Period

AACSB: 6 Reflective Thinking

9) The initial outlay or cost for a four-year project is $1,000,000. The respective cash inflows for years 1, 2, 3 and 4 are: $500,000, $300,000, $300,000 and $300,000. What is the discounted payback period if the discount rate is 10%?

- A) About 2.67 years
- B) About 3.35 years
- C) About 3.67 years
- D) About 4.50 years

Answer: B

Explanation: B) We first discount all after-tax cash inflows, which gives us after-tax cash inflows of $454,545.45, $247,933.88, $225,394.44 and $204,904.04. After three years, we will have paid back $927,873.77 leaving $72,126.23 to pay back in after-tax cash flows in the fourth year. Since we get $204,904.04 in the fourth year, the rule of thumb is to divide what is needed by the cash inflows we will get next period and add it to the number of previous periods of cash inflows, e.g., ($72,126.23 divided by $204,904.04) + 3. Doing this gives 3.352. Thus, the payback period is about **3.35 years**.

Diff: 3

Topic: 9.2 Payback Period

AACSB: 3 Analytical Thinking

10) Acme, Inc. is considering a four-year project that has initial outlay or cost of $100,000. The respective cash inflows for years 1, 2, 3 and 4 are: $50,000, $40,000, $30,000 and $20,000. Acme uses the discounted payback period method, and has a discount rate of 11.50%. Will Acme accept the project if it's payback period is 37 months?

- A) Yes, because it pays back in less than 37 months.
- B) No, because it pays back in over 37 months.
- C) No, because it pays back in over 38 months.
- D) No, because it pays back in over 40 months.

Answer: B

Explanation: B) We first discount all after-tax cash inflows, which gives us after-tax cash inflows of $44,843.05, $32,174.39, $21,641.96, and $12,939.89. After three years or 36 months, we will have paid back $98,659.40, leaving $1,340.60 to pay back in after-tax cash flows in the fourth year. Since we get $12,939.89 in the fourth year, the rule of thumb is to divide what is needed by the cash inflows we will get next period and add it to the number of previous periods of cash inflows, e.g., ($1,340.60 divided by $12,939.89) + 3. Doing this gives 3.104. Thus, the payback period in months is 3.104 × 12 = **37.243 months**. Because this is over 37 months, Acme **does not accept **the project.

Diff: 3

Topic: 9.2 Payback Period

AACSB: 3 Analytical Thinking

11) Which of the statements below is FALSE?

- A) In order to account for the time value of money with the Payback Period Model, the future cash flow needs to be restated in current dollars.
- B) The Discounted Payback Period method is the time it takes to recover the initial investment in current dollars.
- C) When we discount a future cash flow with our standard time-value-of-money concepts, we inherently assume that the entire cash flow was received at the end of the year.
- D) The Payback Period method (with no discounting) is the dollar amount that it takes to recover the initial investment in current dollars.

Answer: D

Explanation: D) The Discounted Payback Period method is the TIME it takes to recover the initial investment in current dollars.

Diff: 2

Topic: 9.2 Payback Period

AACSB: 3 Analytical Thinking

12) Which of the statements below is FALSE?

- A) To account for the time value of money with the Payback Period Model, the future cash flow needs to be restated in current dollars.
- B) The Discounted Payback Period method is the time it takes to recover the initial investment in future dollars.
- C) When we discount a future cash flow with our standard time-value-of-money concepts, we inherently assume that the entire cash flow was received at the end of the year.
- D) The Discounted Payback Period method does not correct for the cash flow after the recovery of the initial outflow.

Answer: B

Explanation: B) The Discounted Payback Period method is the time it takes to recover the initial investment in CURRENT dollars.

Diff: 2

Topic: 9.2 Payback Period

AACSB: 6 Reflective Thinking

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

13) Consider the following four-year project. The initial outlay or cost is $180,000. The respective cash inflows for years 1, 2, 3 and 4 are: $100,000, $80,000, $80,000 and $20,000. What is the discounted payback period if the discount rate is 11%?

- A) About 1.667 years
- B) About 2.000 years
- C) About 2.135 years
- D) About 2.427 years

Answer: D

Explanation: D) We first discount all after-tax cash inflows, which gives us after-tax cash inflows of $90,090.09, $64,929.79, $58,495.31, and $13,174.62. After two years, we will have paid back $155,019.88, leaving $24,980.12 to pay back in after-tax cash flows in the third year. Since we get $58,495.31 in the third year, the rule of thumb is to divide what is needed by the cash inflows we will get next period and add it to the number of previous periods of cash inflows, e.g., ($24,980.12 divided by $58,495.31) + 2. Doing this gives **2.427 years **as the discounted payback period.

Diff: 3

Topic: 9.2 Payback Period

AACSB: 3 Analytical Thinking

14) A company usually establishes a short, arbitrary cutoff date for handling the initial screening of many small-dollar opportunities.

Answer: TRUE

Diff: 1

Topic: 9.2 Payback Period

AACSB: 6 Reflective Thinking

15) By switching to monthly cash flows, we cannot get a more accurate estimate of the discounted payback period.

Answer: FALSE

Explanation: By switching to monthly cash flows, we CAN GET a more accurate estimate of the discounted payback period.

Diff: 2

Topic: 9.2 Payback Period

AACSB: 6 Reflective Thinking

16) The Discounted Payback Period method is a modified payback period model that considers how long it takes to recover the initial investment in current dollars.

Answer: TRUE

Diff: 1

Topic: 9.2 Payback Period

AACSB: 6 Reflective Thinking

17) Identify and describe the shortcomings of the payback period model or method (without discounting).

Answer: The payback period method ignores cash inflows after the initial outflow has been recovered. Thus, this method is biased toward those projects that have higher cash inflows in earlier years and against those with higher inflows in later years. The payback period has a fundamental flaw from a finance perspective: it fails to account for the time value of money. This problem can be easily corrected by adjusting to a payback period model with discounting.

Diff: 2

Topic: 9.2 Payback Period

AACSB: 6 Reflective Thinking

18) Acme, Inc. is considering a four-year project that has an initial outlay or cost of $80,000. The respective future cash inflows for years 1, 2, 3 and 4 are: $40,000, $40,000, $30,000 and $30,000. Acme uses the discounted payback period method and has a discount rate of 12%. Will Acme accept the project if it's payback period is two and one-half years?

Answer: We first discount all after-tax cash inflows, which gives us after-tax cash inflows of $35,714.29, $31,887.76, $21,353.41, and $19,065.54. After two years or 24 months, we will have paid back $67,602.04 leaving $12,397.95 to pay back in after-tax cash flows in the third year. Since we get $21,353.41 in the third year, the rule of thumb is to divide what is needed by the cash inflows we will get next period and add it to the number of previous periods of cash inflows, e.g., (12,397.95 divided by $21,353.41) + 2. Doing this gives 2.581. Thus, the payback period is about **2.58 years** (or in months it is 2.581 × 12 = **30.967 months**). **Acme does not accept the projec**t because the payback period is over two and one-half years (or over 30 months).

Diff: 3

Topic: 9.2 Payback Period

AACSB: 6 Reflective Thinking

9.3 Net Present Value

1) The capital budgeting decision model that utilizes all the discounted cash flow of a project is the ________ model, which is one of the single most important models in finance.

- A) net present value (NPV)
- B) internal rate of return (IRR)
- C) profitability index (PI)
- D) discounted payback period

Answer: A

Diff: 1

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

LO: 9.3 Understand the net present value (NPV) decision model and appreciate why it is the preferred criterion for evaluating proposed investments.

2) The net present value of an investment is ________.

- A) the present value of all benefits (cash inflows)
- B) the present value of all benefits (cash inflows) minus the present value of all costs (cash outflows) of the project
- C) the present value of all costs (cash outflows) of the project
- D) the present value of all costs (cash outflow) minus the present value of all benefits (cash inflow) of the project

Answer: B

Diff: 1

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

LO: 9.3 Understand the net present value (NPV) decision model and appreciate why it is the preferred criterion for evaluating proposed investments.

3) In the NPV model, all cash flows are stated ________.

- A) in future value dollars, and the total inflow is "netted" against the outflow to see if the net amount is positive or negative
- B) in present value or current dollars, and the outflow is "netted" against the total inflow to see if the gross amount is positive or negative
- C) in present value or current dollars, and the total inflow is "netted" against the initial outflow to see if the net amount is positive or negative
- D) in future dollars, and the initial outflow is "netted" against the total inflow to see if the net amount is positive

Answer: C

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

LO: 9.3 Understand the net present value (NPV) decision model and appreciate why it is the preferred criterion for evaluating proposed investments.

4) In regard to the NPV method, which of the statements below is TRUE?

- A) In the NPV model, if two projects are being compared, the one with the highest IRR is selected.
- B) In the NPV model, the present cash flows are discounted at the rate r, the cost of capital.
- C) In the NPV model, most future cash flows are stated in present value or current dollars and the inflow is "netted" against the outflow to see if the net amount is positive or negative.
- D) In the NPV model, the net present value of an investment is the present value of all benefits (cash inflow) minus the present value of all costs (cash outflow) of the project.

Answer: D

Explanation: D) In the NPV model, if two projects are being compared, the one with the highest POSITIVE NET PRESENT VALUE is selected. In the NPV model, the FUTURE cash flows are discounted at the rate r, the cost of capital. In the NPV model, ALL cash flows (including the initial costs and future cash inflows) are stated in present value or current dollars and the total inflow is "netted" against the outflow to see if the net amount is positive or negative.

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

5) Which of the statements below is FALSE?

- A) The NPV decision criterion is true when all projects are independent and the company has a sufficient source of funds to accept all positive NPV projects.
- B) Two projects are mutually exclusive if the acceptance of one project has no bearing on the acceptance or rejection of the other project.
- C) Projects are mutually exclusive if picking one project eliminates the ability to pick the other project.
- D) If a company has constrained capital, then it can only take on a limited number of projects.

Answer: B

Explanation: B) Two projects are INDEPENDENT if the acceptance of one project has no bearing on the acceptance or rejection of the other project.

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

6) Projects are mutually exclusive if picking one project eliminates the ability to pick the other project. This mutually exclusive situation can arise for different reasons. Which of the statements below is NOT one of these reasons?

- A) One project will always have a negative NPV.
- B) There is a scarce resource that both projects would need.
- C) There is need for only one project, and both projects can fulfill that current need.
- D) By using funds for one project, there are not enough funds available for the other project.

Answer: A

Explanation: A) Projects are mutually exclusive if picking one project eliminates the ability to pick the other project even if BOTH PROJECTS HAVE POSITIVE net present values. This mutually exclusive situation can arise for one of two reasons: there is need for only one project, and both projects can fulfill that current need; there is a scarce resource that both projects need, and by using it in one project, it is not available for the second project.

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

7) Which of the following may be TRUE regarding mutually exclusive capital budgeting projects?

- A) There is need for only one project, and both projects can fulfill that current need.
- B) By using funds for one project, there are not enough funds available for the other project.
- C) There is a scarce resource that both projects would need.
- D) All of the above

Answer: D

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

8) Which of the statements below is FALSE?

- A) The net present value decision model is an economically sound model when comparing different projects across a wide variety of products, services, and activities under capital constraint.
- B) The greater the NPV of a project, the greater the "bag of money" for doing the project, and more money is better. If a company is short of capital, it would choose those projects that provide the largest "bag of money."
- C) Despite all of the advantages of using the NPV model, it is inconsistent with the concept of the time-value-of-money.
- D) By discounting all future cash flows to the present, adding up all inflows, and subtracting all outflows, we are determining the net present value of the project.

Answer: C

Explanation: C) One of the important aspects of the NPV model is that it IS CONSISTENT with the concept of the time-value-of-money.

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 6 Reflective Thinking

9) There are two ways to correct for projects with unequal lives when using the NPV approach. Which of the answers below is one of these ways?

- A) One way is to find a common life, without the need to extend the projects to the least common multiple of their lives.
- B) One way is to find the present value factors and then compare them.
- C) One way is to compare the lengths of the projects and take the project with the shortest life.
- D) One way is to find a common life by extending the projects to the least common multiple of their lives.

Answer: D

Explanation: D) One way is to find a common life by extending the projects to the least common multiple of the lives. The other way is to deal with unequal lives is by finding the equivalent annual annuity (EAA) for the NPV of each project over the life of the project.

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

10) Which of the statements below is FALSE?

- A) We calculate the equivalent annual annuity by taking the NPV of the project and find the annuity stream that equates to the NPV, using the appropriate discount rate for the project and life of the project.
- B) In dealing with mutually exclusive projects of unequal lives, we can compute the EAA for the NPV of the project over the life of the project.
- C) One of the advantages of NPV over other decision models is that we can select the appropriate discount rate for each individual project and still compare the resulting NPVs across different projects.
- D) By using the EAA approach for mutually exclusive projects, we overcome all potential problems.

Answer: D

Explanation: D) There are some potential problems with the EAA approach to selecting projects with unequal lives when dealing with mutually exclusive projects. For example, it is not always proper to assume that cash flows will be extended into the future. Also, projects that are currently mutually exclusive due to needs or capital constraints may not be mutually exclusive in the future.

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

11) Dweller, Inc. is considering a four-year project that has an initial after-tax outlay or after-tax cost of $80,000. The future cash inflows from its project are $40,000, $40,000, $30,000 and $30,000 for years 1, 2, 3 and 4, respectively. Dweller uses the net present value method and has a discount rate of 12%. Will Dweller accept the project?

- A) Dweller accepts the project because the NPV is greater than $30,000.
- B) Dweller rejects the project because the NPV is less than -$4,000.
- C) Dweller rejects the project because the NPV is -$3,021.
- D) Dweller accepts the project because it has a positive NPV of over $28,000.

Answer: D

Explanation: D) NPV = -CF0 + + + +

= -$80,000 + + + +

= -$80,000 + $35,714.29 + $31,887.76 + $21,353.41 + $19,065.54

= -$80,000 + $108,020.99 = **$28,020.99**.

Thus, Dweller **accepts** the project because it has a positive NPV.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

12) Washington Industries Inc. is considering a project that has an initial after-tax outlay or after-tax cost of $350,000. The respective future cash inflows from its five-year project for years 1 through 5 are $75,000 each year. Washington expects an additional cash flow of $50,000 in the fifth year. The firm uses the net present value method and has a discount rate of 10%. Will Washington accept the project?

- A) Washington accepts the project because it has an NPV greater than $5,000.
- B) Washington rejects the project because it has an NPV less than $0.
- C) Washington accepts the project because it has an NPV greater than $18,000.
- D) There is not enough information to make a decision.

Answer: B

Explanation: B) Using the NPV function in Excel the NPV = -$34,644.93. Because the NPV is less than $0 we reject the project.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

13) Rogue River, Inc. is considering a project that has an initial after-tax outlay or after-tax cost of $220,000. The respective future cash inflows from its four-year project for years 1 through 4 are: $50,000, $60,000, $70,000 and $80,000. Rogue River uses the net present value method and has a discount rate of 11%. Will Rogue River accept the project?

- A) Rogue River accepts the project because the NPV is greater than $10,000.00.
- B) Rogue River rejects the project because the NPV is about -$22,375.73.
- C) Rogue River rejects the project because the NPV is about -$12,375.60.
- D) Rogue River rejects the project because the NPV is about -$2,375.60.

Answer: B

Explanation: B) NPV = -CF0 + + + +

= -$220,000 + + + +

= -$220,000 + $45,045.05 + $48,697.35 + $51,183.40 + $52,698.48

= -$220,000 + $197,624.27 = **-$22,375.73**.

Thus, Rogue River **rejects** the project since it has a negative NPV.

Using the NPV function in Excel yields the same answer.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

14) Simpson, Inc. is considering a five-year project that has an initial after-tax outlay or after-tax cost of $80,000. The respective future cash inflows from its project for years 1, 2, 3, 4 and 5 are: $15,000, $25,000, $35,000, $45,000 and $55,000. Simpson uses the net present value method and has a discount rate of 9%. Will Simpson accept the project?

- A) Simpson accepts the project because the NPV is $129,455.25.
- B) Simpson accepts the project because the NPV is 79,455.25.
- C) Simpson accepts the project because the NPV is $49,455.25.
- D) Simpson accepts the project because the NPV is less than zero.

Answer: C

Explanation: C) NPV = -CF0 + + + + +

= -$80,000 + + + + +

= -$80,000 + $13,761.47 + $21,042.00 + $27,026.42 + $31,879.13 + $35,746.23

= -$80,000 + $129,455.25 = **$49,455.25**.

Thus, Simpson **accepts** the project since it has a positive NPV.

Using the NPV function in Excel yields the same answer.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

15) Meyer, Inc. is considering a five-year project that has an initial after-tax outlay or after-tax cost of $70,000. The future after-tax cash inflows from its project for years 1, 2, 3, 4 and 5 are all the same at $35,000. Meyer uses the net present value method and has a discount rate of 10%. Will Meyer accept the project?

- A) Meyer accepts the project because the NPV is about $69,455.
- B) Meyer accepts the project because the NPV is about $62,678.
- C) Meyer rejects the project because the NPV is about -$13,382.
- D) Meyer rejects the project because the NPV is less than -$33,021.

Answer: B

Explanation: B) The future after-tax cash inflows are an annuity. Thus, we can use:

NPV = -CF0 + (PMT × . Inserting the given values gives:

NPV = -$70,000 + = -$70,000 + ($35,000 × 3.790787)

= -$70,000 + $132,677.54 = **$62,677.54**. Thus, Meyer accepts the project since it has a positive NPV.

Using the NPV function in Excel yields the same answer.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

16) Aviary, Inc. is considering a five-year project that has initial after-tax outlay or after-tax cost of $170,000. The future after-tax cash inflows from its project for years 1 through 5 are $45,000 for each year. Aviary uses the net present value method and has a discount rate of 11.25%. Will Aviary accept the project?

- A) Aviary accepts the project because the NPV is about $5,455.
- B) Aviary accepts the project because the NPV is about $165,275.
- C) Aviary rejects the project because the NPV is about -$4,725.
- D) Aviary rejects the project because the NPV is about -$154,725.

Answer: C

Explanation: C) The future after-tax cash inflows are an annuity. Thus, we can use:

NPV = -CF0 + . Inserting in the given values gives:

NPV = -$170,000 + = -$170,000 + ($45,000 × 3.672771)

= -$170,000 + $165,274.71 = **-$4,725.29**. Thus, Aviary **rejects** the project since it has a negative NPV.

Using the NPV function in Excel yields the same answer.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

17) Chase, Inc. is considering an eight-year project that has an initial after-tax outlay or after-tax cost of $180,000. The future after-tax cash inflows from its project for years 1 through 8 are the same at $35,000. Chase uses the net present value method and has a discount rate of 12%. Will Chase accept the project?

- A) Chase accepts the project because the NPV is over $10,000.
- B) Chase accepts the project because the NPV is about $6,141.
- C) Chase rejects the project because the NPV is about -$6,133.
- D) Chase rejects the project because the NPV is below -$7,000.

Answer: C

Explanation: C) The future after-tax cash inflows are an annuity. Thus, we can use:

NPV = -CF0 + . Inserting in the given values gives:

NPV = -$180,000 + = -$180,000 + ($35,000 × 4.967640)

= -$180,000 + $173,867.39 = **-$6,132.61**. Thus, Chase **rejects** the project since it has a negative NPV.

Using the NPV function in Excel yields the same answer.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

18) Manhattan, Inc. is considering an eight-year project that has an initial after-tax outlay or after-tax cost of $180,000. The future after-tax cash inflows from its project for years 1 through 8 are the same at $38,000. Manhattan uses the net present value method and has a discount rate of 11.50%. Will Manhattan accept the project?

- A) Manhattan accepts the project because the NPV is about $12,114.
- B) Manhattan accepts the project because the NPV is about $11,114.
- C) Manhattan rejects the project because the NPV is about -$11,114.
- D) Manhattan rejects the project because the NPV is less than -$12,000.

Answer: A

Explanation: A) The future after-tax cash inflows are an annuity. Thus, we can use:

NPV = -CF0 + . Inserting in the given values gives:

NPV = -$180,000 + = -$180,000 + ($38,000 × 5.055637)

= -$180,000 + $192,114.20 = **$12,114.20**. Thus, Manhattan **accepts** the project since it has a positive NPV.

Using the NPV function in Excel yields the same answer.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

19) Allied, Inc. is considering Project A and Project B, which are two mutually exclusive projects with unequal lives. Project A is an eight-year project that has an initial outlay or cost of $180,000. Its future cash inflows for years 1 through 8 are $38,000. Project B is a six-year project that has an initial outlay or cost of $160,000. Its future cash inflows for years 1 through 6 are the same at $36,000. Allied uses the equivalent annual annuity (EAA) method and has a discount rate of 11.50%. Will Allied accept the project?

- A) Allied accepts Project B because it has a more positive EAA.
- B) Allied rejects both projects because both have a negative NPV (and thus negative EAA).
- C) Allied accepts Project A because its EAA is about $2,396 and Project B's EAA is only about $1,097.
- D) Allied accepts Project A because its NPV (and thus EAA) is positive and Project B's NPV (and thus EAA) is negative.

Answer: D

Explanation: D) We will compute the EAA for both projects and choose the one with the greater positive EAA. If both EAAs are negative, then we will reject both projects. If one Project has a negative NPV (and thus negative EAA), then we will choose the project with the positive NPV (and thus positive EAA).

For Project A, the NPV = -CF0 + . Inserting the given values, we have: NPV = -$180,000 + = -$180,000 + ($38,000 × 5.055637)

= -$180,000 + $192,114.20 = $12,114.20. The EAA is the NPV divided by the PVIFA.

We have: EAA (Project A) = = **$2,396.18**.

For Project B, the NPV = -CF0 +

= -$160,000 + = -$160,000 + ($36,000 × 4.170294)

= -$160,000 + $150,130.59 = -$9,869.41. The EAA is the NPV divided by the PVIFA. We have: EAA (Project B) = = **-$2,366.60**. Allied will take Project A, not only because its EAA is positive and superior to Project B's, but because the NPV for Project B is negative. Thus, we can really only consider one project, and that is Project A.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

20) Apple, Inc. is considering Project A and Project B, which are two mutually exclusive projects with unequal lives. Project A is an eight-year project that has an initial outlay or cost of $140,000. Its future cash inflows for years 1 through 8 are the same at $36,500. Project B is a six-year project that has an initial outlay or cost of $160,000. Its future cash inflows for years 1 through 6 are the same at $48,000. Apple uses the equivalent annual annuity (EAA) method and has a discount rate of 13%. Which project(s), if any, will Apple accept?

- A) Apple will take Project B because it has a positive NPV and its EAA is greater than that for Project A.
- B) Apple rejects both projects because both have a negative NPV (and thus negative EAA).
- C) Apple accepts both projects because both have a positive NPV (and thus positive EAA).
- D) Apple accepts Project A because its EAA of about $7,975 is greater than Project B's EAA of about $6,440.

Answer: A

Explanation: A) We will compute the EAA for both projects and choose the one with the greater positive EAA since the projects are mutually exclusive and only one can be taken. If both EAAs are negative then we will reject both projects. If one Project has a negative NPV (and thus negative EAA), then we will choose the project with the positive NPV (and thus positive EAA). For Project A, the NPV = -CF0 + .

Inserting the given values, we have:

NPV = -$140,000 + = -$140,000 + ($36,500 × 4.79877)

= -$140,000 + $175,155.12 = $35,155.12. The EAA is the NPV divided by the PVIFA.

We have: EAA (Project A) = = **$7,325.86**.

For Project B, the NPV = -CF0 +

= -$160,000 + = -$160,000 + ($48,000 × 3.997550)

= -$160,000 + $191,882.39 = $31,882.39. The EAA is the NPV divided by the PVIFA. We have: EAA (Project A) = = **$7,975.4**8. Apple will take **Project B** because it has a positive NPV and its EAA is greater than that for Project A.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

21) The assignment of a discount rate to each project is an integral part of the NPV process.

Answer: TRUE

Diff: 1

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

22) To determine the current value of a project, discount all future cash flows to the present and add up all cash inflow and outflow.

Answer: FALSE

Explanation: To determine the current value of a project, discount all future cash flows to the present, add up all cash inflow, and **SUBTRACT** all cash outflow.

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

23) Finding the equivalent annual annuity (EAA) is a good way to deal with projects with unequal lives and should only be used with mutually exclusive projects.

Answer: TRUE

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

24) To be considered acceptable, a project must have an NPV greater than 1.0.

Answer: FALSE

Explanation: To be considered acceptable, a project must have an NPV greater than $0.0

Diff: 2

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

25) Stanton, Inc. wants to analyze the NPV profile for a five-year project that is considered to be very risky. The project's initial outlay or cost is $80,000 and it has respective cash inflows for years 1, 2, 3, 4 and 5 of $15,000, $25,000, $35,000, $45,000 and $55,000. Stanton wants to know how the NPV will change for the following required rates of returns: 9%, 14%, 19%, 24%, and 29%. From the NPV profile, at about what rate will the NPV be equal to zero?

Answer: Let us first compute the NPV for 9%. We have:

NPV = -CF0 + + + + +

= -$80,000 + + + + +

= -$80,000 + $13,761.47 + $21,042.00 + $27,026.42 + $31,879.13 + $35,746.23

= -$80,000 + $129,455.25 = **$49,455.25**.

In a similar fashion, for 14%, 19%, 24% and 29%, we get respective NPVs of **$31,227.48, $16,516.53, $4,507.67**, and **-$5,398.55**. Thus, we can see the rate of return where the NPV is zero will be between 24% and 29%. Using an Excel spreadsheet, one can compute a break-even rate of return (called IRR in the next section) of about **26.16%** (26.159675%, which will give a zero negative present value to two decimal points). Beginning with a rate of 24%, the rule of thumb when trying various rates is to increase the rate of return until the NPV becomes zero. If it becomes negative, then one decreases the rate.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

26) Ace, Inc. is considering Project A and Project B, which are two mutually exclusive projects with unequal lives. Project A is an eight-year project that has an initial outlay or cost of $18,000. Its future cash inflows for years 1 through 8 are the same at $3,800. Project B is a six-year project that has an initial outlay or cost of $16,000. Its future cash inflows for years 1 through 6 are the same at $3,600. Ace uses the equivalent annual annuity (EAA) method and has a discount rate of 11.50%. Which, if any, project will Ace accept?

Answer: We will compute the EAA for both projects and choose the one with the greater positive EAA. If both EAAs are negative, we will then reject both projects. If one Project has a negative NPV (and thus negative EAA), we will then choose the project with the positive NPV (and thus positive EAA). For Project A, the NPV = -CF0 + . Inserting the given values, we have: NPV = -$18,000 + = -$18,000 + ($3,800 × 5.055637)

= -$18,000 + $19,211.42 = $1,211.42. The EAA is the NPV divided by the PVIFA.

We have: EAA (Project A) = = **$239.62**.

For Project B, the NPV = -CF0 + = -$16,000 +

= -$16,000 + ($3,600 × 4.170294) = -$16,000 + $15,013.06 = -$986.94. The EAA is the NPV divided by the PVIFA. We have: EAA (Project A) = = **-$236.66**. Ace will take Project A not only because its EAA is positive and superior to Project B's, but because the NPV for Project B is negative. Thus, we can really only consider one project and that is Project A.

Diff: 3

Topic: 9.3 Net Present Value

AACSB: 3 Analytical Thinking

9.4 Internal Rate of Return

1) The most popular alternative to NPV for capital budgeting decisions is the ________ method.

- A) internal rate of return (IRR)
- B) payback period
- C) discounted payback period
- D) profitability index

Answer: A

Diff: 1

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

LO: 9.4 Calculate the most popular capital budgeting alternative to the NPV, the internal rate of return (IRR); explain how the modified internal rate of return (MIRR) model attempts to address the IRR's problems.

2) The IRR is the discount rate that produces a zero NPV or the specific discount rate at which the present value of the cost equals ________.

- A) the future value of the present cash outflows
- B) the present value of the future benefits or cash inflows
- C) the present value of the cash outflow
- D) the investment

Answer: B

Explanation: B) The IRR is defined as the discount rate that produces a zero NPV or the specific discount rate at which the present value of the cost (the investment or cash outflows) equals the present value of the future benefits.

Diff: 1

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

LO: 9.4 Calculate the most popular capital budgeting alternative to the NPV, the internal rate of return (IRR); explain how the modified internal rate of return (MIRR) model attempts to address the IRR's problems.

3) Without a computer and special calculator, ________.

- A) computing the payback period is much more difficult than computing the IRR
- B) finding the IRR will typically be a very easy process
- C) finding the IRR may be a very tedious process only if the NPV is negative
- D) finding the IRR may be a very tedious process since it is an iterative process

Answer: D

Explanation: D) Computing an IRR without a computer or special calculator is typically much more difficult than computing the payback period or the NPV.

Diff: 1

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

LO: 9.4 Calculate the most popular capital budgeting alternative to the NPV, the internal rate of return (IRR); explain how the modified internal rate of return (MIRR) model attempts to address the IRR's problems.

4) Which of the statements below describes the IRR decision criterion?

- A) The decision criterion is to accept a project if the IRR falls below the desired or required return rate.
- B) The decision criterion is to reject a project if the IRR exceeds the desired or required return rate.
- C) The decision criterion is to accept a project if the IRR exceeds the desired or required return rate.
- D) The decision criterion is to accept a project if the NPV is positive.

Answer: C

Diff: 2

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

5) The hurdle rate should be set so that it reflects the proper risk level for the project. If we have to choose between two projects with similar risk and therefore similar hurdle rates, we would select the project that ________.

- A) has a higher internal rate of return
- B) has a lower internal rate of return
- C) has a hurdle rate that is consistent with the payback period method
- D) has a hurdle rate that is consistent with the discounted payback period model

Answer: A

Diff: 1

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

6) Which of the statements below is TRUE?

- A) The hurdle rate is the cost of debt needed to fund a project.
- B) If the IRR exceeds a project's hurdle rate, the project should be rejected.
- C) If the IRR clears the hurdle rate, the project is rejected.
- D) The hurdle rate should be set so that it reflects the proper risk level for the project.

Answer: D

Explanation: D) The hurdle rate is the COST OF CAPITAL needed to fund a project. If the IRR exceeds a project's hurdle rate, the project CAN BE ACCEPTED (assuming the NPV method renders the same decision). If the IRR CANNOT CLEAR the hurdle rate, the project is rejected.

Diff: 2

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

7) Flynn, Inc. is considering a four-year project that has an initial outlay or cost of $80,000. The future cash inflows from its project are $40,000, $40,000, $30,000, and $30,000 for years 1, 2, 3 and 4, respectively. Flynn uses the internal rate of return method to evaluate projects. What is the approximate IRR for this project?

- A) The IRR is less than 12%.
- B) The IRR is between 12% and 20%.
- C) The IRR is about 24.55%.
- D) The IRR is about 28.89%.

Answer: D

Explanation: D) Using a financial calculator or software program like Excel or trial and error, we get IRR = **28.89%** if we round our answer to two decimal places.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

8) Washington Industries Inc. is considering a project that has an initial after-tax outlay or after-tax cost of $350,000. The respective future cash inflows from its five-year project for years 1 through 5 are $75,000 each year. Washington expects an additional cash flow of $50,000 in the fifth year. The firm uses the IRR method and has a hurdle rate of 10%. Will Washington accept the project?

- A) Washington accepts the project because it has an IRR greater than 10%.
- B) Washington rejects the project because it has an IRR less than 10%.
- C) Washington accepts the project because it has an IRR greater than 5%.
- D) There is not enough information to answer this question.

Answer: B

Explanation: B) Using a financial calculator or software program like Excel or trial and error (and rounding our answer to two decimal places), we get IRR = **6.32%**. Thus, Washington will reject the project as its IRR is less than its hurdle rate.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

9) Rogue River, Inc. is considering a project that has an initial outlay or cost of $220,000. The respective future cash inflows from its four-year project for years 1 through 4 are: $50,000, $60,000, $70,000, and $80,000, respectively. Rogue River uses the internal rate of return method to evaluate projects. Will Rogue River accept the project if its hurdle rate is 10%?

- A) Rogue River will not accept this project because its IRR is about 9.70%.
- B) Rogue River will not accept this project because its IRR is about 8.70%.
- C) Rogue River will not accept this project because its IRR is about 6.50%.
- D) Rogue River will not accept this project because its IRR is about 4.60%.

Answer: C

Explanation: C) Using a financial calculator or software program like Excel or trial and error (and rounding our answer to two decimal places), we get IRR = **6.50%**. Thus, Rogue River will reject the project as its IRR is less than its hurdle rate.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

10) Simpson, Inc. is considering a five-year project that has an initial outlay or cost of $80,000. The respective future cash inflows from its project for years 1, 2, 3, 4 and 5 are: $15,000, $25,000, $35,000, $45,000, and $55,000. Simpson uses the internal rate of return method to evaluate projects. What is the project's IRR?

- A) The IRR is less than 22.50%.
- B) The IRR is about 24.16%.
- C) The IRR is about 26.16%.
- D) The IRR is over 26.50%.

Answer: C

Explanation: C) Using a financial calculator or software program like Excel or trial and error (and rounding off to two digits), we get IRR = **26.16%**.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

11) Meyer, Inc. is considering a very risky five-year project that has an initial outlay or cost of $70,000. The future cash inflows from its project for years 1, 2, 3, 4, and 5 are all the same at $35,000. Meyer uses the internal rate of return method to evaluate projects. Will Meyer accept the project if its hurdle rate is 41.00%?

- A) Meyer will probably reject this project because its IRR is about 39.74%, which is slightly below its hurdle rate.
- B) Meyer will probably accept this project because its IRR is about 41.04%, which is slightly above its hurdle rate.
- C) Meyer will accept this project because its IRR is about 41.50%.
- D) Meyer will accept this project because its IRR is over 45.50%.

Answer: B

Explanation: B) Using a financial calculator or software program like Excel or trial and error (and rounding our answer to two decimal places), we get IRR = 41.04%. Thus, it appears that Meyer will accept this project since Meyer's hurdle rate of 41.00% is slightly less than the project's IRR of 41.04%.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

12) The Internal Rate of Return (IRR) Model suffers from three problems. Which of the below is NOT one of these problems?

- A) Comparing mutually exclusive projects
- B) Cumbersome computations not resolvable by the latest technology
- C) Incorporates the IRR as the reinvestment rate for the future cash flows
- D) Multiple IRRs

Answer: B

Diff: 2

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

13) Which of the following in NOT a potential problem suffered by the IRR method of capital budgeting?

- A) Multiple IRRs
- B) Disagreement with the NPV as to whether a project with ordinary cash flows is profitable or not
- C) Incorporates the IRR as the reinvestment rate for the future cash flows
- D) Comparing mutually exclusive projects

Answer: B

Diff: 2

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

14) Two projects intersect, in terms of NPV, at a discount rate labeled the ________.

- A) crossover rate
- B) internal rate of return
- C) discount rate
- D) yield to maturity

Answer: A

Diff: 1

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

15) The crossover rate is the discount rate where both projects have the same ________.

- A) IRR
- B) PI
- C) NPV
- D) length to completion

Answer: C

Diff: 1

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

16) Which of the statements below is FALSE?

- A) Project A has a higher y-axis intercept for its NPV profile than mutually exclusive Project B. As long as the profile of Project A is above the profile of Project B, Project A will have a higher NPV value for that particular discount rate.
- B) Project A and Project B are mutually exclusive. The two projects intersect in terms of NPV at a discount rate labeled the crossover rate.
- C) Project A has a higher y-axis intercept for its NPV profile than mutually exclusive Project B. As we proceed past the crossover rate to the right on the x-axis, Project B's profile will be above Project A's profile.
- D) Project A has a higher y-axis intercept for its NPV profile than mutually exclusive Project B. This means that Project A has a lower NPV than Project B when the discount rate is zero.

Answer: D

Explanation: D) Project A has a higher y-axis intercept for its NPV profile than mutually exclusive Project B. This means that Project A has a HIGHER NPV than Project B when the discount rate is zero.

Diff: 2

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

17) Which of the statements below is TRUE?

- A) One problem with IRR as a decision rule is that if the cash flow is not standard, there is a possibility of multiple IRRs for a single project.
- B) When we talk about standard cash flow for a project, we assume an initial cash outflow at the beginning of the project and negative cash flows in the future.
- C) When we apply IRR to standard cash flow, we have the potential for more than one IRR solution.
- D) For every period that the cash flow has a change of sign (negative to positive or positive to negative), the NPV profile could cross the y-axis, generating a MIRR.

Answer: A

Explanation: A) When we talk about standard cash flow for a project, we assume an initial cash outflow at the beginning of the project and POSITIVE cash flows in the future. When we apply IRR to NONSTANDARD cash flow we have the potential for more than one IRR solution. For every period that the cash flow has a change of sign (negative to positive or positive to negative), the NPV profile could cross the **X**-AXIS GENERATING AN **IRR**.

Diff: 2

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

18) Suppose you have an investment that costs $80,000 at the beginning of the project, and it generates $30,000 a year for four years in positive cash flows. The cost of capital is 12%. The IRR of the project is 18.45% and the NPV is about $11,120. The IRR model assumes that at the end of the first year you can invest the $30,000 at ________.

- A) 18.45%
- B) 12.00%
- C) a rate less than the cost of capital
- D) a rate greater than the IRR

Answer: A

Diff: 2

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

19) Find the Modified Internal Rate of Return (MIRR) for the following series of future cash flows, given a discount rate of 11%: Year 0: -$22,000; Year 1: $5,000; Year 2: $6,000; Year 3: $7,000; Year 4: $7,500; and, Year 5: $8,000.

- A) About 12.13%
- B) About 12.88%
- C) About 13.04%
- D) About 13.12%

Answer: D

Explanation: D) **Step One**. Find the future values of all the cash inflows by reinvesting the cash inflows at the appropriate cost of capital. FV = $5,000 × (1.11)4 + $6,000 × (1.11)3 + $7,000 × (1.11)2 + $7,500 × (1.11)1 + $8,000 × (1.11)0 = $7,590.35 + $8,205.79 + $8,624.70 + $8,325.00 + $8,000.00. Summing these we get: **FV =** **$40,745.84**.

**Step Two**. Find the present value of the cash outflow by discounting at the appropriate cost of capital. This is the initial cash outflow of $22,000 because all investment is made at the start of the project. Expressing the cash outflow in absolute terms: **PV = $22,000**.

**Step Three**. Find the interest rate that equates the present value of the cash outflow with the future value of the cash inflow given as: MIRR = (FV/PV)1/n - 1 = ($40,745.84/$22,000)1/5 - 1 = (1.852084)1/5 - 1 = 1.131181 - 1 = 0.131181, or about **13.12%**.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

20) Find the Modified Internal Rate of Return (MIRR) for the following annual series of cash flows, given a discount rate of 10.50%: Year 0: -$75,000; Year 1: $15,000; Year 2: $16,000; Year 3: $17,000; Year 4: $17,500; and, Year 5: $18,000.

- A) About 6.35%
- B) About 6.88%
- C) About 7.35%
- D) About 7.88%

Answer: A

Explanation: A) **Step One**. Find the future values of all the cash inflow by reinvesting the cash inflow at the appropriate cost of capital. FV = $15,000 × (1.1050)4 + $16,000 × (1.1050)3 + $17,000 × (1.1050)2 + $17,500 × (1.1050)1 + $18,000 × (1.1050)0 = $22,363.53 + $21,587.72 + $20,757.43 + $19,337.50 + $18,000.00. Summing these we get: **FV =** **$102,046.18**.

**Step Two**. Find the present value of the cash outflow by discounting at the appropriate cost of capital. This is the initial cash outflow of $75,000 because all investment is made at the start of the project. Expressing the cash outflow in absolute terms: **PV= $75,000**.

**Step Three**. Find the interest rate that equates the present value of the cash outflow with the future value of the cash inflow given as: MIRR = (FV / PV)n - 1 = ($102,046.18 / $75,000)1/5 - 1 = (1.360616)1/5 - 1 = 1.063524 - 1 = 0.063524 or about **6.35%**.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

21) Corbett and Sullivan Enterprises (CSE) use the Modified Internal Rate of Return (MIRR) when evaluating projects. CSE's cost of capital is 9.5%. What is the MIRR of a project if the initial costs are $10,200,000 and the project lasts seven years, with each year producing the same after-tax cash inflows of $1,900,000?

- A) About 7.95%
- B) About 8.01%
- C) About 8.24%
- D) About 8.88%

Answer: C

Explanation: C) **Step One**. Find the future values of all the cash inflow by reinvesting the cash inflow at the appropriate cost of capital. We can use the future value annuity formula, given that the cash inflow stream is identical. We have: FV = $1,900,000 × = $1,900,000 × = $1,900,000 × 9.342648. Thus, **FV =** **$17,751,032**.

**Step Two**. Find the present value of the cash outflow by discounting at the appropriate cost of capital. This is the initial cash outflow of $10,200,000 because all investment is made at the start of the project. Expressing the cash outflow in absolute terms: **PV**=** $10,200,000**.

**Step Three**. Find the interest rate that equates the present value of the cash outflow with the future value of the cash inflow given as: MIRR = (FV / PV)n - 1 = ($17,751,032 / $10,200,000)1/ 7 - 1 = (1.740297)1/ 7 - 1 = 1.082368 - 1 = 0.082368, or about **8.24%**.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

22) The IRR decision criterion is to accept a project if the IRR exceeds the desired or required return rate and to reject the project if the IRR is less than the desired or required rate of return.

Answer: TRUE

Diff: 1

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

23) The IRR is an unpopular capital budgeting decision model because even with the advent of calculators and spreadsheets, the cumbersome calculation remains.

Answer: FALSE

Explanation: The IRR is very popular because with the advent of calculators and spreadsheets the cumbersome calculation is a thing of the past. [NOTE: It can also be argued that the IRR is popular because lenders understand the IRR and know that a firm with an IRR greater than the cost of borrowing is a good investment.]

Diff: 2

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

24) One problem with the decision criterion of IRR is that if cash flow is not standard, there is a possibility of multiple IRRs for a single project.

Answer: TRUE

Diff: 1

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

25) One of the underlying assumptions of the IRR model is that all cash inflow can be reinvested at the individual project's internal rate of return (IRR) over the remaining life of the project.

Answer: TRUE

Diff: 2

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

26) Pandora, Inc. is considering a five-year project that has an initial outlay or cost of $70,000. The cash inflows from its project for years 1, 2, 3, 4 and 5 are all the same at $14,000. The borrowing costs are 10%. What is the IRR? Should Pandora use the IRR method to evaluate this project? Explain.

Answer: Using a financial calculator or software program like Excel or trial and error, we get an IRR that is **exactly equal to zero percen**t (this is because the undiscounted sum of all future inflows equals the initial outlay, e.g., $14,000 × 5 = $70,000). It does not appear that Pandora will accept this project since its borrowing costs of 10% will be greater than 0%. Thus, Pandora can use the IRR method if it likes because it does indicate the project should not be accepted. Pandora can verify its rejection decision of the project by computing its NPV, which is about -$16,929.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

27) Spotify, Inc. is considering a five-year project that has an initial outlay or cost of $22,000. The future cash inflows from its project for years 1, 2, 3, 4 and 5 are $15,000, $15,000, $15,000, $15,000 and -$41,000, respectively. Compute both IRRs. Given these IRRs, compute the two NPVs. If Spotify's true cost of borrowing for this project is 10%, would Spotify choose the project?

Answer: Using a financial calculator or software program like Excel or trial and error (and rounding off to two digits), we can get two IRRs: **24.88%** and **9.34%**. If using Excel, you can get 24.88% by typing in a percentage near 24.88% (like 20%) and you can get 9.34% by typing in a percentage near 9.34% (like 10%). If we use these two values to compute the Net Present Value, you would get **$0 for each IRR used.** If the true cost of capital for this project is 10%, then the NPV would be **$90.21** and Spotify would **accept** the project.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

28) Wyatt and Zachary Enterprises (WZE) uses the Modified Internal Rate of Return (MIRR) when evaluating projects. WZE's cost of capital is 9.75%. What is the MIRR of a project if the initial cost is $1,200,000 and the project will last seven years, with each year producing cash inflows of $290,000? Should WZE accept this project according to the MIRR method? Explain.

Answer:

**Step One**. Find the future values of all the cash inflow by reinvesting the cash inflow at the appropriate cost of capital. We can use the future value annuity formula, given that the cash inflow stream is identical. We have: FV = $290,000 × = $290,000 × = $290,000 × 9.414619. Thus, **FV =** **$2,730,240**.

**Step Two**. Find the present value of the cash outflow by discounting at the appropriate cost of capital. This is the initial cash outflow of -$1,200,000 because all investment is made at the start of the project. Expressing the cash outflow in absolute terms: **PV**=** $1,200,000**.

**Step Three**. Find the interest rate that equates the present value of the cash outflow with the future value of the cash inflow given as: MIRR = (FV / PV)n - 1 = ($2,730,240 / $1,200,000)7 - 1 = (2.2751996)7 - 1 = 1.124612 - 1 = 0.124612 or about **12.46%**. Since the MIRR is greater than the cost of capital (e.g., 12.46% > 9.75%), WZE should **accept** the project. To verify this, WZE can compute the NPV; in doing this, they would find out that it is positive, e.g., NPV = $223,537.95.

Diff: 3

Topic: 9.4 Internal Rate of Return

AACSB: 3 Analytical Thinking

9.5 Profitability Index

1) Which method is designed to give the dollar amount of return for every $1.00 invested in the project in terms of current dollars?

- A) Profitability Index Method
- B) Internal Rate of Return Method
- C) Net Present Value Method
- D) Discounted Payback Period Method

Answer: A

Diff: 1

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

2) ________ is a modification of NPV to produce the ratio of the present value of the benefits (future cash inflow) to the present value of the costs (initial investment).

- A) Modified Internal Rate of Return Method
- B) Profitability Index (PI)
- C) Payback Period Method
- D) Discounted Cash Flow Method

Answer: B

Diff: 1

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

3) The ________ method of capital budgeting is a ratio of the present value of cash inflows divided by the initial investment.

- A) payback period
- B) net present value
- C) internal rate of return
- D) profitability index

Answer: D

Diff: 1

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

4) Which of the statements below is FALSE?

- A) The profitability index (PI) decision criterion states: if PI > 1.0, accept the project.
- B) The profitability index (PI) decision criterion states: if PI < 1.0, reject the project.
- C) The profitability index (PI) method multiplies the Present Value of Benefits by Present Value of Costs.
- D) If the PI is greater than one, the benefits exceed the costs.

Answer: C

Explanation: C) The profitability index method DIVIDES the Present Value of Benefits by Present Value of Costs.

Diff: 1

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

5) Which of the statements below is TRUE?

- A) According to the profitability index (PI) decision criterion when the PI is greater than 1, the costs exceed the benefits.
- B) If we realize that NPV is the present value of the benefits minus the present value of the costs, then we simply need to subtract the costs from the NPV to get the present value of the benefits.
- C) There are two acceptable projects, but we can only take one due to a shortage of funds. The PI for these two projects are: Project A: 2.25; Project B: 1.89. We would take Project B.
- D) A PI of 1.50 can be interpreted as meaning that for every $1.00 invested today the firm gets back $1.50 in current dollars.

Answer: D

Explanation: D) According to the profitability index (PI) decision criterion, when the PI is greater than 1, the BENEFITS exceed the COSTS. If we realize that NPV is the present value of the benefits minus the present value of the costs, then we simply need to ADD BACK the costs to the NPV to get the present value of the benefits. There are two acceptable projects, but we can only take one due to a shortage of funds. The PI for these two projects are: Project A: 2.25; Project B: 1.89. **We would take Project A** because it gives back $2.25 for every dollar invested, while Project B only gives back $1.89 for every dollar invested.

Diff: 2

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

6) Dakota, Inc. is currently considering an eight-year project that has an initial outlay or cost of $140,000. The cash inflows from its project for years 1 through 8 are the same at $35,000. Dakota has a discount rate of 12%. Because there is a shortage of funds to finance all good projects, Dakota wants to compute the profitability index (PI) for each project. That way Dakota can get an idea as to which project might be a better choice. What is the PI for Dakota's current project?

- A) About 1.24
- B) About 1.21
- C) About 1.19
- D) About 1.09

Answer: A

Explanation: A) The PI is (NPV plus the absolute value of the costs) divided by the absolute value of the costs. The future after-tax cash inflows are an annuity. Thus, we can use:

NPV = -CF0 + . Inserting the given values gives:

NPV = -$140,000 + = -$140,000 + ($35,000 × 4.967640)

= -$140,000 + $173,867.39 = $33,867.39. We can now compute the PI.

We have: PI = = = 1.2419, or about **1.24**.

Diff: 3

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

7) Project A has an NPV of $20,000 and a PI of 1.2. Project B has an NPV of $10,000 and a PI of 1.3. Both projects have equal lives. Which project should be preferred if we are NOT concerned with capital rationing (that is, we are NOT concerned with being short of funds)?

- A) We should prefer Project B since it has a higher PI.
- B) We should compute the EAA before we make any decision.
- C) We should prefer Project A since it has a higher NPV.
- D) We should prefer Project B if it has a higher IRR.

Answer: C

Explanation: C) We should NOT prefer Project B even though it has a higher PI; this is because it has a lower NPV and we are not facing capital constraints. Computing the EAA is typically used if we have mutually exclusive projects with unequal lives; we do not know if such is the case for this situation since we are not told if the projects are mutually exclusive (we are only asked which one we would prefer, i.e., which one adds more value to the company). Even if Project B has a higher IRR, this would not tell us to prefer it because it has a lower NPV.

Diff: 2

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

8) Hollister, Inc. is currently considering an eight-year project that has an initial outlay or cost of $120,000. The future cash inflows from its project for years 1 through 8 are the same at $30,000. Hollister has a discount rate of 11%. Because of capital rationing (shortage of funds for financing), Hollister wants to compute the profitability index (PI) for each project. What is the PI for Hollister's current project?

- A) About 1.29
- B) About 1.31
- C) About 1.33
- D) About 1.39

Answer: A

Explanation: A) The PI is (NPV plus the absolute value of the costs) divided by the absolute value of the costs (or the present value of all future cash flows divided by the cost). The future after-tax cash inflows are an annuity. Thus, we can use:

NPV = -CF0 + . Inserting the given values gives:

NPV = -$120,000 + = -$120,000 + ($30,000 × 5.146123)

= -$120,000 + $154,383.68 = $34,383.68. We can now compute the PI.

We have: PI = = = 1.2865 or about **1.29**.

Diff: 3

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

9) Birdman, Inc. is currently considering an eight-year project that has an initial outlay or cost of $80,000. The future cash inflows from its project for years 1 through 8 are the same at $30,000. Birdman has a discount rate of 13%. Because of concerns about funds being short to finance all good projects, Birdman wants to compute the profitability index (PI) for each project. What is the PI for Birdman's current project?

- A) About 1.50
- B) About 1.60
- C) About 1.70
- D) About 1.80

Answer: D

Explanation: D) The PI is (NPV plus the absolute value of the costs) divided by the absolute value of the costs (or the present value of all future cash flows divided by the cost). The future after-tax cash inflows are an annuity. Thus, we can use:

NPV = -CF0 + . Inserting in the given values gives:

NPV = -$80,000 + = -$80,000 + ($30,000 × 4.798770)

= -$80,000 + $143,963.11 = $63,963.11. We can now compute the PI.

We have: PI = = = **1.7995,** or about **1.80**.

Diff: 3

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

10) The present value of the benefits and costs needed to calculate Profitability Index (PI) is the same information one finds when computing the NPV.

Answer: TRUE

Diff: 1

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

11) When the Profitability Index (PI) is greater than 1, the benefits exceed the costs.

Answer: TRUE

Explanation: Ranking projects by PI with different costs levels CAN STILL LEAD to selection problems.

Diff: 2

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

12) A firm is considering four projects with the following PIs, NPVs, and Costs. Project A: PI of 1.3, NPV of $3,600, and cost of $12,000; Project B: PI of 1.4, NPV of $5,600, and cost of $14,000; Project C: PI of 1.5, NPV of $5,000, and cost of $10,000; Project D: PI of 2.1, NPV of $8,800, and cost of $8,000. Rank the projects from best to worst in terms of their NPVs. Now rank the projects from best to worst in terms of their PIs.

Answer: Ranking by NPV, we get D: $8,000; B: $5,600; C: $5,000; and A: $3,600.

Ranking by PI, we get D: 2.1; C: 1.5; B: 1.4; and A: 1.3.

Explanation: If we could only spend, say, $20,000, then Project D looks great since it has the highest PI (the biggest bang for our limited bucks), and yet costs only $8,000. Our next pick would then be Project C, based on the PI. Although it would add another $10,000 to our costs to boost the total to $18,000, we would still be within our limit. Then, we would use the PI to look at Project B, but we would reject it since its cost of $14,000 would push us over our limit. We would then look at Project A, and we would also reject it since its cost of $12,000 would also push us over the limit. The PI is simply a guide that tells us which projects to look at in what order when you have a capital budgeting cost limit.

Diff: 3

Topic: 9.5 Profitability Index

AACSB: 3 Analytical Thinking

LO: 9.5 Understand the profitability index (PI) as a modification of the NPV model.

9.6 Overview of Six Decision Models

1) The ________ method is simple and fast but economically unsound as it ignores all cash flow after the cutoff date and ignores the time-value of money.

- A) Payback Period
- B) MIRR
- C) Net Present Value
- D) IRR

Answer: A

Diff: 1

Topic: 9.6 Overview of the Six Decision Models

AACSB: 3 Analytical Thinking

LO: 9.6 Compare and contrast the strengths and weaknesses of each decision model in a holistic way.

2) The ________ model incorporates the time-value of money but still ignores cash flows after the cutoff date.

- A) Payback Period
- B) Discounted Payback Period
- C) IRR
- D) Modified Internal Rate of Return

Answer: B

Diff: 1

Topic: 9.6 Overview of the Six Decision Models

AACSB: 3 Analytical Thinking

LO: 9.6 Compare and contrast the strengths and weaknesses of each decision model in a holistic way.

3) The ________ method is economically sound and properly ranks projects across various sizes, time horizons, and levels of risk, without exception for all independent projects.

- A) NPV
- B) Discounted Payback Period
- C) Profitability Index
- D) Modified IRR

Answer: A

Diff: 1

Topic: 9.6 Overview of the Six Decision Models

AACSB: 3 Analytical Thinking

LO: 9.6 Compare and contrast the strengths and weaknesses of each decision model in a holistic way.

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

4) The ________ model provides a single measure (return) but must apply risk outside the model, thus allowing for errors in rankings of projects.

- A) Payback Period
- B) IRR
- C) Net Present Value
- D) Profitability Index

Answer: B

Diff: 1

Topic: 9.6 Overview of the Six Decision Models

AACSB: 3 Analytical Thinking

LO: 9.6 Compare and contrast the strengths and weaknesses of each decision model in a holistic way.

5) ________ corrects for most, but not all, of the problems of IRR and gives the solution in terms of a return.

- A) Profitability Index
- B) Discounted Payback Period
- C) Net Present Value
- D) MIRR

Answer: D

Diff: 1

Topic: 9.6 Overview of the Six Decision Models

AACSB: 3 Analytical Thinking

LO: 9.6 Compare and contrast the strengths and weaknesses of each decision model in a holistic way.

6) The discounted payback method, net present value method (NPV), internal rate of return (IRR), modified internal rate of return (MIRR), and profitability index (PI) are all consistent with the time value of money.

Answer: TRUE

Explanation: The IRR method is used by 75.61% of the respondents while the NPV method is used by 74.93% of the respondents. The payback method came in third at 56.74%. From these results one may conclude that some corporations use more than one method to evaluate their projects.

Diff: 2

Topic: 9.6 Overview of the Six Decision Models

AACSB: 3 Analytical Thinking

LO: 9.6 Compare and contrast the strengths and weaknesses of each decision model in a holistic way.

7) Calculating IRR, NPV, or MIRR is easy and efficient using a spreadsheet once you know the relevant cash flow, the timing of the cash flow, the cost of capital, and the reinvestment rate.

Answer: TRUE

Diff: 1

Topic: 9.6 Overview of the Six Decision Models

AACSB: 3 Analytical Thinking

LO: 9.6 Compare and contrast the strengths and weaknesses of each decision model in a holistic way.

8) According to an academic survey of large and small U.S. businesses, the IRR method of capital budgeting is slightly preferred over NPV by the survey respondents.

Answer: TRUE

Diff: 1

Topic: 9.6 Overview of the Six Decision Models

AACSB: 1 Written and Oral Communication

LO: 9.6 Compare and contrast the strengths and weaknesses of each decision model in a holistic way.

9) Describe **three** of the six decision models used in capital budgeting decision-making and briefly evaluate their effectiveness.

Answer:

**Payback Period** is simple and fast but economically unsound. It ignores all cash flow after the cutoff date and it ignores the time value of money.

**Discounted Payback Period** incorporates the time value of money but still ignores cash flow after the cutoff date.

**Net Present Value** is economically sound and properly ranks projects across various sizes, time horizons, and levels of risk, without exception for all independent projects.

**IRR** provides a single measure (return) but has the potential for errors in ranking projects. It also can lead to incorrect selection of two mutually exclusive projects or incorrect acceptance or rejection of a project with more than a single IRR.

**Modified Internal Rate of Return**, in general, corrects for most of, but not all, the problems of IRR and gives the solution in terms of a return.

**Profitability Index** incorporates risk and return, but the benefits-to-cost ratio is actually just another way of expressing the NPV.

Diff: 2

Topic: 9.6 Overview of the Six Decision Models

AACSB: 3 Analytical Thinking

LO: 9.6 Compare and contrast the strengths and weaknesses of each decision model in a holistic way.

-----

Key Contents: **Financial Management and Corporate Finance**

------**Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University****Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business, University of Western Ontario****Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown****International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick, Columbia University****------****Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University****Corporate Finance: The Core, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University****Excel Modeling in Corporate Finance, 5th Edition, 2015, Craig W. Holden, Indiana University****Fundamentals of Corporate Finance, 3rd Edition, 2015, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University, Jarrad Harford, University of Washington**

-----

**Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017****Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016****Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University****Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown, Virginia Polytechnic Instit. and State University****Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin****Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter**

------

Part 1: Fundamental Concepts and Basic Tools of Finance

1. Financial Management

2. Financial Statements

3. The Time Value of Money (Part 1)

4. The Time Value of Money (Part 2)

5. Interest Rates

Part 2: Valuing Stocks and Bonds and Understanding Risk and Return

6. Financial Management Bonds and Bond Valuation

7. Stocks and Stock Valuation

8. Risk and Return

Part 3: Capital Budgeting

9: Capital Budgeting Decision Models

10: Cash Flow Estimation

11: The Cost of Capital

Part 4: Financial Planning and Evaluating Performance

12. Forecasting and Short-Term Financial Planning

13. Working Capital Management

14. Financial Ratios and Firm Performance

Part 5: Other Selected Finance Topics

15. Raising Capital

16. Capital Structure

17. Dividends, Dividend Policy, and Stock Splits

18. International Financial Management

Appendix 1 Future Value Interest Factors

Appendix 2 Present Value Interest Factors

Appendix 3 Future Value Interest Factors of an Annuity

Appendix 4 Present Value Interest Factors of an Annuity

Appendix 5 Answers to Prepping for Exam Questions

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1. Overview of Financial Management

2. Sizing Up a Business: A Non-Financial Perspective

3. Understanding Financial Statements

4. Measuring Financial Performance

5. Managing Day-To-Day Cash Flow

6. Projecting Financial Requirements and Managing Growth

7. Time Value of Money Basics and Applications

8. Making Investment Decisions

9. Overview of Capital Markets: Long-Term Financing Instruments

10. Assessing the Cost of Capital: What Investors Require

11. Understanding Financing and Payout Decisions

12. Designing an Optimal Capital Structure

13. Measuring and Creating Value

14. Comprehensive Case Study: Wal-Mart Stores, Inc.

1. Overview of Financial Management

• 1.1: Financial Management and the Cash Flow Cycle

• 1.2: The Role of Financial Managers

• 1.3: A Non-Financial Perspective of Financial Management

• 1.4: Financial Management’s Relationship with Accounting and Other Disciplines

• 1.5: Types of Firms

• 1.6: A Financial Management Framework

• 1.7: Relevance for Managers

• 1.8: Summary

• 1.9: Additional Readings

• 1.10: End of Chapter Problems

2. Sizing Up a Business: A Non-Financial Perspective

• 2.1: Sizing Up The Overall Economy

o 2.1.1: GDP Components

o 2.1.2: Sector-Related Fluctuations

o 2.1.3: Inflation and Interest Rates

o 2.1.4: Capital Markets

o 2.1.5: Economic Size-Up Checklist

• 2.2: Sizing Up the Industry

o 2.2.1: Industry Life Cycles

o 2.2.2: The Competitive Environment

o 2.2.3: Opportunities and Risks

o 2.2.4: Industry Size-up Checklist

• 2.3: Sizing Up Operations Management and Supply Risk

• 2.4: Sizing Up Marketing Management and Demand Risk

• 2.5: Sizing Up Human Resource Management and Strategy

• 2.6: Sizing Up Home Depot: An Example

• 2.7: Relevance for Managers

• 2.8 Summary

• 2.9: Additional Readings and Information

• 2.10: End of Chapter Problems

3. Understanding Financial Statements

• 3.1: Understanding Balance Sheets

o 3.1.1: Understanding Assets

o 3.1.2: Understanding Liabilities

o 3.1.3: Understanding Equity

• 3.2: Understanding Income Statements

o 3.2.1: Understanding Revenues, Costs, Expenses, and Profits

o 3.2.2: Connecting a Firm’s Income Statement and Balance Sheet

• 3.3: Understanding Cash Flow Statements

o 3.3.1: Cash Flows Related to Operating Activities

o 3.3.2: Cash Flows from Investing Activities

o 3.3.3: Cash Flows from Financing Activities

• 3.4: Relevance for Managers

• 3.5: Summary

• 3.6: Additional Readings and Sources of Information

• 3.7: End of Chapter Problems

4. Measuring Financial Performance

• 4.1: Performance Measures

o 4.1.1: Return on Equity

o 4.1.2: Profitability Measures

o 4.1.3: Resource Management Measures

o 4.1.4: Liquidity Measures

o 4.1.5: Leverage Measures

o 4.1.6: Application: Home Depot

• 4.2: Reading Annual Reports

• 4.3: Relevance for Managers

• 4.4: Summary

• 4.5: Additional Readings and Sources of Information

• 4.6: End of Chapter Problems

5. Managing Day-To-Day Cash Flow

• 5.1: Cash Flow Cycles

• 5.2: Working Capital Management

o 5.2.1: Managing Inventory

o 5.2.2: Managing Accounts Receivable

o 5.2.3: Managing Accounts Payable

o 5.2.4: Application: Home Depot

• 5.2.4.1: Orange Computers and Little Orange Computers

• 5.2.4.2: Home Depot

• 5.3: Short-Term Financing

o 5.3.1: Bank Loans

o 5.3.2: Commercial Paper

o 5.3.3: Banker’s Acceptance

• 5.4: Relevance for Managers

• 5.5: Summary

• 5.6: Additional Readings

• 5.7: End of Chapter Problems

6. Projecting Financial Requirements and Managing Growth

• 6.1: Generating Pro Forma Income Statements

o 6.1.1: Establishing the Cost of Goods Sold and Gross Profit

o 6.1.2: Establishing Expenses

o 6.1.3: Establishing Earnings

• 6.2: Generating Pro Forma Balance Sheets

o 6.2.1: Establishing Assets

o 6.2.2: Establishing Liabilities and Equity

• 6.3: Generating Pro Forma Cash Budgets

o 6.3.1: Establishing Cash Inflows

o 6.3.2: Establishing Cash Outflows

o 6.3.3: Establishing Net Cash Flows

• 6.4: Performing Sensitivity Analysis

o 6.4.1: Sales Sensitivity

o 6.4.1: Interest Rate Sensitivity

o 6.4.3: Working Capital Sensitivity

• 6.5: Understanding Sustainable Growth and Managing Growth

• 6.6: Relevance for Managers

• 6.7: Summary

• 6.8: Additional Readings and Resources

• 6.9: Problems

7. Time Value of Money Basics and Applications

• 7.1: Exploring Time Value of Money Concepts

o 7.1.1: Future Values

o 7.1.2: Present Values

o 7.1.3: Annuities

o 7.1.4: Perpetuities

• 7.2: Applying Time Value of Money Concepts to Financial Securities

o 7.2.1: Bonds

o 7.2.2: Preferred Shares

o 7.2.3: Common Equity

• 7.3: Relevance for Managers

• 7.4: Summary

• 7.5: Additional Readings

• 7.6: End of Chapter Problems

8. Making Investment Decisions

• 8.1: Understanding the Decision-Making Process

• 8.2: Capital Budgeting Techniques

o 8.2.1: Payback

• 8.2.1.1: Strengths and Weaknesses of the Payback Method

o 8.2.2: Net Present Value

• 8.2.2.1: Strengths and Weaknesses of the Net Present Value Method

o 8.2.3: Internal Rate of Return

• 8.2.3.1: Strengths and Weaknesses of the Internal Rate of Return Method

• 8.2.3.2: Modified Internal Rate of Return

• 8.3: Capital Budgeting Extensions

o 8.3.1: Profitability Index

o 8.3.2: Equivalent Annual Cost and Project Lengths

o 8.3.3: Mutually Exclusive Projects and Capital Rationing

• 8.4: Relevance for Managers

• 8.5: Summary

• 8.6: Additional Readings

• 8.7: End of Chapter Problems

9. Overview of Capital Markets: Long-Term Financing Instruments

• 9.1: Bonds

o 9.1.1: Changing Bond Yields

o 9.1.2: Bond Features

o 9.1.3: Bond Ratings

• 9.2: Preferred Shares

• 9.3: Common Shares

o 9.3.1: Historical Returns

• 9.4: Capital Markets Overview

o 9.4.1: Private versus Public Markets

o 9.4.2: Venture Capital and Private Equity

o 9.4.3: Initial Offerings versus Seasoned Issues

o 9.4.4: Organized Exchanges versus Over-The-Counter Markets

o 9.4.5: Role of Intermediaries

• 9.5: Market Efficiency

o 9.5.1: Weak Form

o 9.5.2: Semi-strong Form

o 9.5.3: Strong Form

o 9.5.4: U.S. Stock Market Efficiency

• 9.6: Relevance for Managers

• Appendix: Understanding Bond and Stock Investment Information

• 9.7: Summary

• 9.8: Additional Readings

• 9.9: End of Chapter Problems

10. Assessing the Cost of Capital: What Investors Require

• 10.1: Understanding the Cost of Capital: An Example

• 10.2: Understanding the Implications of the Cost of Capital

• 10.3: Defining Risk

• 10.4: Estimating the Cost of Debt

• 10.5: Estimating the Cost of Preferred Shares

• 10.6: Estimating the Cost of Equity

o 10.6.1: Dividend Model Approach

o 10.6.2: Capital Asset Pricing Model

• 10.6.2.1: Risk-Free Rate

• 10.6.2.2: Market Risk Premium

• 10.6.2.3: Beta

• 10.7: Estimating Component Weights

• 10.8: Home Depot Application

• 10.9: Hurdle Rates

• 10.10: Relevance for Managers

• 10.11: Summary

• 10.12: Additional Readings

• 10.13: Problems

11. Understanding Financing and Payout Decisions

• 11.1: Capital Structure Overview

• 11.2: Understanding the Modigliani-Miller Argument: Why Capital Structure Does Not Matter

• 11.3: Relaxing the Assumptions: Why Capital Structure Does Matter

o 11.3.1: Understanding the Impact of Corporate Taxes

o 11.3.2: Understanding the Impact of Financial Distress

o 11.3.3: Combining Corporate Taxes and Financial Distress Costs

o 11.3.4: Impact of Asymmetric Information

• 11.4: Understanding Payout Policies

o 11.4.1: Paying Dividends

o 11.4.2: Repurchasing Shares

o 11.4.3: Do Dividend Policies Matter?

• 11.5: Relevance for Managers

• 11.6: Summary

• 11.7: Additional Resources

• 11.8: End of Chapter Problems

• Appendix: Why Dividend Policy Doesn’t Matter: Example

12. Designing an Optimal Capital Structure

• 12.1: Factor Affecting Financing Decisions: The FIRST Approach

o 12.1.1: Maximizing Flexibility

o 12.1.2: Impact on EPS: Minimizing Cost

• 12.1.2.1: A Simple Valuation Model

• 12.1.2.2: Earnings before Interest and Taxes Break-Even: What Leverage Really Means

• 12.1.2.3: Does Issuing Equity Dilute the Value of Existing Shares?

o 12.1.3: Minimizing Risk

o 12.1.4: Maintaining Shareholder Control

o 12.1.5: Optimal Training

• 12.2: Tradeoff Assessment: Evaluating FIRST Criteria

• 12.3: Relevance for Managers

• 12.4: Summary

• 12.5: Additional Resource

• 12.6: End of Chapter Problems

13. Measuring and Creating Value

• 13.1: An Overview of Measuring and Creating Value

• 13.2: Measuring Value: The Book Value Plus Adjustments Method

o 13.2.1: Pros and Cons of the Book Value of Equity Plus Adjustments Method

• 13.3: Measuring Value: The Discount Cash Flow Analysis Method

o 13.3.1: Estimating Free Cash Flows

o 13.3.2: Estimating the Cost of Capital

o 13.3.3: Estimating the Present Value of Free Cash Flows

o 13.3.4: Estimating the Terminal Value

o 13.3.5: Estimating the Value of Equity

o 13.3.6: Pros and Cons of the Free Cash Flow to the Firm Approach

• 13.4: Measuring Value: Relative Valuations and Comparable Analysis

o 13.4.1: The Price-Earnings Method

• 13.4.1.1: Pros and Cons of the Price-Earnings Approach

o 13.4.2: The Enterprise Value-to-EBITDA Method

• 13.4.2.1: Pros and Cons of the EV/EBITDA Approach

• 13.5: Creating Value and Value-Based Management

• 13.6: Valuing Mergers and Acquisitions

o 13.6.1: Valuing Comparable M&A Transactions

• 13.7: Relevance for Managers

• 13.8: Summary

• 13.9: Additional Readings

• 13.10: End of Chapter Problems

14. Comprehensive Case Study: Wal-Mart Stores, Inc.

• 14.1: Sizing Up Wal-Mart

o 14.1.1: Analyzing the Economy

o 14.1.2: Analyzing the Industry

o 14.1.3: Analyzing Walmart’s Strengths and Weaknesses in Operations, Marketing, Management, and Strategy

• 14.1.3.1: Analyzing Walmart’s Operations

• 14.1.3.2: Analyzing Walmart’s Marketing

• 14.1.3.3: Analyzing Walmart’s Management and Strategy

o 14.1.4: Analyzing Walmart’s Financial Health

• 14.2: Projecting Walmart’s Future Performance

o 14.2.1: Projecting Walmart’s Income Statement

o 14.2.2: Projecting Walmart’s Balance Sheet

o 14.2.3: Examining Alternate Scenarios

• 14.3: Assessing Walmart’s Long-Term Investing and Financing

o 14.3.1: Assessing Walmart’s Investments

o 14.3.2: Assessing Walmart’s Capital Raising and the Cost of Capital

• 14.4: Valuing Walmart

o 14.4.1: Measuring Walmart’s Economic Value Added

o 14.4.2: Estimating Walmart’s Intrinsic Value: The DCF Approach

o 14.4.3: Estimating Walmart’s Intrinsic Value: Comparable Analysis

o 14.4.4: Creating Value and Overall Assessment of Walmart

• 14.5: Relevance for Managers and Final Comments

• 14.6: Additional Readings and Sources of Information

• 14.7: End of Chapter Problems

------

Part 1: Introduction to Financial Management

Chapter 1: Getting Started - Principles of Finance

Chapter 2: Firms and the Financial Market

Chapter 3: Understanding Financial Statements, Taxes, and Cash Flows

Chapter 4: Financial Analysis - Sizing Up Firm Performance

Part 2: Valuation of Financial Assets

Chapter 5: Time Value of Money - The Basics

Chapter 6: The Time Value of Money - Annuities and Other Topics

Chapter 7: An Introduction to Risk and Return - History of Financial Market Returns

Chapter 8: Risk and Return - Capital Market Theory

Chapter 9: Debt Valuation and Interest Rates

Chapter 10: Stock Valuation

Part 3: Capital Budgeting

Chapter 11: Investment Decision Criteria

Chapter 12: Analyzing Project Cash Flows

Chapter 13: Risk Analysis and Project Evaluation

Chapter 14: The Cost of Capital

Part 4: Capital Structure & Dividend Policy

Chapter 15: Capital Structure Policy

Chapter 16: Dividend Policy

Part 5: Liquidity Management & Special Topics in Finance

Chapter 17: Financial Forecasting and Planning

Chapter 18: Working Capital Management

Chapter 19: International Business Finance

Chapter 20: Corporate Risk Management

------

PART I: INTRODUCTION TO FOREIGN EXCHANGE MARKETS AND RISKS

Chapter 1: Globalization and the Multinational Corporation

Chapter 2: The Foreign Exchange Market

Chapter 3: Forward Markets and Transaction Exchange Risk

Chapter 4: The Balance of Payments

Chapter 5: Exchange Rate Systems

PART II: INTERNATIONAL PARITY CONDITIONS AND EXCHANGE RATE DETERMINATION

Chapter 6: Interest Rate Parity

Chapter 7: Speculation and Risk in the Foreign Exchange Market

Chapter 8: Purchasing Power Parity and Real Exchange Rates

Chapter 9: Measuring and Managing Real Exchange Risk

Chapter 10: Exchange Rate Determination and Forecasting

PART III: INTERNATIONAL CAPITAL MARKETS

Chapter 11: International Debt Financing

Chapter 12: International Equity Financing

Chapter 13: International Capital Market Equilibrium

Chapter 14: Political and Country Risk

PART IV: INTERNATIONAL CORPORATE FINANCE

Chapter 15: International Capital Budgeting

Chapter 16: Additional Topics in International Capital Budgeting

Chapter 17: Risk Management and the Foreign Currency Hedging Decision

Chapter 18: Financing International Trade

Chapter 19: Managing Net Working Capital

PART V: FOREIGN CURRENCY DERIVATIVES

Chapter 20: Foreign Currency Futures and Options

Chapter 21: Interest Rate and Foreign Currency Swaps

------

PART 1: INTRODUCTION

1. The Corporation

2. Introduction to Financial Statement Analysis

3. Financial Decision Making and the Law of One Price

PART 2: TIME, MONEY, AND INTEREST RATES

4. The Time Value of Money

5. Interest Rates

6. Valuing Bonds

PART 3: VALUING PROJECTS AND FIRMS

7. Investment Decision Rules

8. Fundamentals of Capital Budgeting

9. Valuing Stocks

PART 4: RISK AND RETURN

10. Capital Markets and the Pricing of Risk

11. Optimal Portfolio Choice and the Capital Asset Pricing Model

12. Estimating the Cost of Capital

13. Investor Behavior and Capital Market Efficiency

PART 5: CAPITAL STRUCTURE

14. Capital Structure in a Perfect Market

15. Debt and Taxes

16. Financial Distress, Managerial Incentives, and Information

17. Payout Policy

PART 6: ADVANCED VALUATION

18. Capital Budgeting and Valuation with Leverage

19. Valuation and Financial Modeling: A Case Study

PART 7: OPTIONS

20. Financial Options

21. Option Valuation

22. Real Options

PART 8: LONG-TERM FINANCING

23. Raising Equity Capital

24. Debt Financing

25. Leasing

PART 9: SHORT-TERM FINANCING

26. Working Capital Management

27. Short-Term Financial Planning

PART 10: SPECIAL TOPICS

28. Mergers and Acquisitions

29. Corporate Governance

30. Risk Management

31. International Corporate Finance

------

PART 1: INTRODUCTION

1. The Corporation

2. Introduction to Financial Statement Analysis

3. Financial Decision Making and the Law of One Price

PART 2: TIME, MONEY, AND INTEREST RATES

4. The Time Value of Money

5. Interest Rates

6. Valuing Bonds

PART 3: VALUING PROJECTS AND FIRMS

7. Investment Decision Rules

8. Fundamentals of Capital Budgeting

9. Valuing Stocks

PART 4: RISK AND RETURN

10. Capital Markets and the Pricing of Risk

11. Optimal Portfolio Choice and the Capital Asset Pricing Model

12. Estimating the Cost of Capital

13. Investor Behavior and Capital Market Efficiency

PART 5: CAPITAL STRUCTURE

14. Capital Structure in a Perfect Market

15. Debt and Taxes

16. Financial Distress, Managerial Incentives, and Information

17. Payout Policy

PART 6: ADVANCED VALUATION

18. Capital Budgeting and Valuation with Leverage

19. Valuation and Financial Modeling: A Case Study

------

------

PART 1 INTRODUCTION

Chapter 1 Corporate Finance and the Financial Manager

Chapter 2 Introduction to Financial Statement Analysis

PART 2 INTEREST RATES AND VALUING CASH FLOWS

Chapter 3 Time Value of Money: An Introduction

Chapter 4 Time Value of Money: Valuing Cash Flow Streams

Chapter 5 Interest Rates

Chapter 6 Bonds

Chapter 7 Stock Valuation

PART 3 VALUATION AND THE FIRM

Chapter 8 Investment Decision Rules

Chapter 9 Fundamentals of Capital Budgeting

Chapter 10 Stock Valuation: A Second Look

PART 4 RISK AND RETURN

Chapter 11 Risk and Return in Capital Markets

Chapter 12 Systematic Risk and the Equity Risk Premium

Chapter 13 The Cost of Capital

PART 5 LONG-TERM FINANCING

Chapter 14 Raising Equity Capital

Chapter 15 Debt Financing

PART 6 CAPITAL STRUCTURE AND PAYOUT POLICY

Chapter 16 Capital Structure

Chapter 17 Payout Policy

PART 7 FINANCIAL PLANNING AND FORECASTING

Chapter 18 Financial Modeling and Pro Forma Analysis

Chapter 19 Working Capital Management

Chapter 20 Short-Term Financial Planning

PART 8 Special Topics

Chapter 21 Option Applications and Corporate Finance

Chapter 22 Mergers and Acquisitions

Chapter 23 International Corporate Finance

------

**FINANCIAL MANAGEMENT AND CORPORATE FINANCE - COLLECTION 2017 (FREE DOWNLOAD)**

**Financial Management: Core Concepts, 3rd Edition, 2016,** Raymond Brooks, Oregon State University

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**Financial Management: Concepts and Applications, 2015,** Stephen Foerster, Richard Ivey School of Business

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**International Financial Management, 2nd Edition, 2012,** Geert J Bekaert, Columbia University, Robert J. Hodrick

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**Corporate Finance, 4th Edition, 2017,** Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University

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**Excel Modeling in Corporate Finance, 5th Edition, 2015,** Craig W. Holden, Indiana University**Fundamentals of Corporate Finance, 3rd Edition, 2015**, Jonathan Berk, Stanford University, Peter DeMarzo, **Financial Management: Principles and Applications, 12th Edition, 2015,** Sheridan Titman, Arthur J. Keown

**Fundamentals of Investing, 13th Edition,** Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017

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**Multinational Business Finance, 14th Edition,** David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016

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**Personal Finance: Turning Money into Wealth, 7th Edition,** 2016, Arthur J. Keown,

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**Foundations of Finance, 9th Edition, 2017,** Arthur J. Keown, John H. Martin

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**Principles of Managerial Finance, 14th Edition,** 2015, Lawrence J. Gitman, Chad J. Zutter

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**Financial Management: Core Concepts, 3rd Edition, 2016,** Raymond Brooks, Oregon State University **- Test bank**

**International Financial Management, 2nd Edition, 2012,** Geert J Bekaert, Columbia University, Robert J. Hodrick **- Test bank**

**Financial Management: Principles and Applications, 12th Edition, 2015,** Sheridan Titman, Arthur J. Keown **- Test bank**

**Corporate Finance: The Core, 4th Edition,** 2017, Jonathan Berk, Stanford University, Peter DeMarzo **- Test bank**

**Fundamentals of Investing, 13th Edition,** Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017 **- Test bank**

**Multinational Business Finance, 14th Edition,** David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016 **- Test bank**

**Personal Finance, 6th Edition**, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University **- Test bank**

**Personal Finance: Turning Money into Wealth, 7th Edition,** 2016, Arthur J. Keown **- Test bank**

**Foundations of Finance, 9th Edition,** 2017, Arthur J. Keown, John H. Martin **- Test bank**

**Principles of Managerial Finance, 14th Edition,** 2015, Lawrence J. Gitman, Chad J. Zutter **- Test bank**

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