# Choosing Investments and Projects

1. Determine which of the two investment projects a manager should choose if the discount rate of the firm is 10 percent. The first project promises a profit of $100,000 in each of the next four years, while the second project promises a profit of $75,000 in each of the next six years.

2. Determine which of two investment projects of problem 1 the manager should choose if the discount rate of the firm is 20 percent. (Use the wealth or value of the firm for question #2 ( theory of the firm).

3. A woman managing photocopying establishment for $25,000 per year decides to open her own duplicating place. Her revenue during the first year of operation is $120,000, and her expenses are as follows:

Salaries to hired help $45,000

Supplies 15,000

Rent 10,000

Utilities 1,000

Interest on bank loan 10,000

Calculate (a) the explicit costs, (b) the implicit costs, (c) the business profit (d) the economic profit, and (e) the normal return on investment in this business

4. Given the following total-revenue function:

TR=9Q- Q2

Derive the total-revenue schedules from Q=0 to Q=6 by 1s.

5.

1. Given the following total-cost schedule:

___Q________0_____1_____2_____3_____4_____

TC 1 12 14 15 20

( a) Derive the average- and marginal-cost schedules.

(b) Derive the total-revenue, average-revenue, and marginal-revenue schedules from Q = 0 to Q = 4 by 1s.

Average revenue (AR) = total revenue (TR) / Q

Marginal revenue (MR) = change in total revenue / change in Q

For example Q TR AR MR

2 14 7

3 18 6 4

Revised problem: With the total-revenue schedule of Problem 4 and the total-cost schedule of Problem 5, show how the firm determines the profit-maximizing level of output.

6. What effect would each of the following have on the value of the firm? (a) A new advertising campaign increases the sales of the firm substantially. (b) A new competitor enters the market. (c) The production department achieves a technological breakthrough that reduces production costs. (d) The firm is required to install pollution-control equipment. (e) The workforce votes to unionize. (f) The rate of interest rises. (g) The rate of inflation changes.

7. How does the danger and fear of terrorism affect managerial decisions?

8. According to Milton Friedman, Business has only on social responsibility---to make profit (as long as it stays within the legal and moral rules of the game established by society). Few trends could so thoroughly undermine the very foundations of our society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible. Explain why you agree or disagree with such a statement.

9. How does the value of a businesspersons time effect his or her decision to fly or drive on a business trip? (b) How much time should a consumer spend on shopping (searching) for lower prices? (c) For which type of good would you expect consumers to spend more time on comparative shopping, or shopping for lower prices?

10. What evidence is there that companies governance failed in the United States at the beginning of this decade? (b) How can public trust in the American financial markets be reestablished?

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#### Solution Summary

Excel and Word documents to answer these 10 questions ranging from choosing investments to fear of terrorism in business to implicit vs explicit costs.

Problem set-Multiple Choice Questions on Capital Budgeting

2. The term mutually exclusive investments mean:

a. Choose only the best investments.

b. Selection of one investment precludes the selection of an alternative.

c. The elite investment opportunities will get chosen.

d. There are no investment options available.

ABC Company is considering two investments both of which cost $10,000. The cash flows are as follows:

Year Project A Project B

1 $6,000 $5,000

2 4,000 3,000

3 3,000 8,000

3. Based on the payback method, which of the two projects should be chosen?

a. Project A which has a payback period of 2.0 years.

b. Project A which has a payback period of 2.25 years.

c. Project B which has a payback period of 2.0 years.

d. Project B which has a payback period of 2.25 years.

4. Based on the net present value method, assuming a cost of capital of 10%, which of the two projects should be chosen?

a. Project A which has a net present value of $11,011.

b. Project A which has a net present value of $1,011.

c. Project B which has a net present value of $13,031

d. Project B which has a net present value of $3,031.

5. Which method provides more confidence, the payback method or the net present value method?

a. Payback because it provides a good timetable.

b. Payback because it tells you when you break even.

c. Net present value because it considers all inflows and outflows and the time value of money.

d. Net present value because it does not need to use cost of capital.

The Pan American Bottling Co. is considering the purchase of a new machine that would increase the speed of bottling and save money. The net cost of this machine is $45,000. The annual cash flows have the following projections.

Year Cash Flow

1 $15,000

2 20,000

3 25,000

4 10,000

5 5,000

6. What is the net present value of selecting the new machine, assuming cost of capital of 10%?

a. $11,883

b. $13,883

c. $15,883

d. $17,883

7. What is the internal rate of return?

a. About 7%

b. About 10%

c. About 23%

d. About 27%

8. Should Pan American buy the machine?

a. Yes. NPV is positive and IRR exceeds cost of capital.

b. Yes. NPV is positive and IRR is less than cost of capital.

c. No. NPV does not provide enough information.

d. No. IRR is higher than the cost of capital.

Big Sky Construction Company is considering two new investments. Project E calls for the purchase of earth-moving equipment. Project H represents the investment in a hydraulic lift. Big Sky wishes to use a new present value profile in comparing the projects. The investment and cash flow patterns are as follows:

Project E

($20,000 investment) Project H

($20,000 investment)

Year Cash Flow

1 $ 5,000

2 6,000

3 7,000

4 10,000 Year Cash Flow

1 $16,000

2 5,000

3 4,000

9. What is the NPV of both projects using zero discount rate?

a. $8,000 for project E and $5,000 for project H

b. $8,000 for project H and $5,000 for project E

c. $28,000 for project E and $25,000 for project H

d. $20,000 for both projects.

10. What is the NPV of both projects using 9% discount rate?

a. $22,121 for project E and $21,970 for project H

b. $20,000 for both projects.

c. $2,121 for project E and $1,970 for project H

d. $8,000 for project E and $5,000 for project H

11. The IRR of project E is _______

a. About 9%

b. About 13%

c. About 16%

d. About 20%

12. If the two projects are mutually exclusive, which project would you accept using NPV, assuming cost of capital of 18%.

a. Project E

b. Project H

c. Both

d. Neither

13. Risk-averse managers will generally require _____ return from risky investments.

a. Lower

b. Zero

c. Higher

d. Negative

14. The concept of risk can be incorporated into the capital budgeting process by using higher discount rates for riskier investments.

a. True

b. False

15. If risk is to be analyzed in a qualitative way, which is the least risky?

a. New equipment

b. New market

c. Repair of old machinery

d. New product in a foreign market

Best Technology Corp. is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given.

Possible

Market Reaction Sales

in Units

Probabilities

Low response 20 .10

Moderate response 40 .20

High response 65 .40

Very high response

80 .30

16. What is the expected value of unit sales for new product?

a. 20

b. 30

c. 45

d. 60

17. What is the standard deviation of unit sales?

a. 370

b. 160

c. 19.2

d. 5.8

18. Project A has an expected return of $1,000 and a standard deviation of $590. Project B has expected return of $3,000 and a standard deviation of $750. Using coefficient of variation, which has a lower risk?

a. Project A, because coefficient of variation is higher.

b. Project A, because coefficient of variation is lower.

c. Project B, because coefficient of variation is higher.

d. Project B, because coefficient of variation is lower.

19. A company with a beta of 1.50 is considered to have lower level of risk than the stock market in general.

a. True

b. False

20. A company is considering the purchase one of two companies. Both of these companies have an expected return of 15% with the same standard deviation of returns. Company 1 has a positive correlation of returns with the acquiring company, while company 2 has a negative correlation. Which company should the acquiring company purchase if it must purchase one of them?

a. Company 1 because it reduces risk

b. Company 1 because it increases return

c. Company 2 because it reduces risk

d. Company 2 because it increases return