# general business data bank

Frank Dewey Esquire from the firm of Dewey, Cheatum, and Howe, has been offered an upfront retainer of $30,000 to provide legal services over the next 12 months to Taggart Transcontinental . In return for this upfront payment, Taggart Transcontinental would have access to 8 hours of legal services from Frank for each of the next 12 months. Frank’s normal billable rate is $250 per hour for legal services.

1) Assuming that Dewey’s cost of capital is 12% EAR, then the NPV of his retainer offer is closest to:

A) -$7,500

B) -$7,400

C) $6,000

D) $7,400

2) Assuming that Dewey’s cost of capital is 12% EAR, then the IRR of his retainer offer is closest to:

A) -39.3%

B) -3.3%

C) 20.0%

D) 39.3%

3) Assuming that Dewey’s cost of capital is 12% EAR, then the number of potential IRRs that exist for this problem is equal to:

A) 0

B) 1

C) 2

D) 12

Use the following information to answer the question(s) below.

Rearden Metals is considering opening a strip mining operation to provide some of the raw materials needed in producing Rearden metal. The initial purchase of the land and the associated costs of opening up mining operations will cost $100 million today. The mine is expected to generate $16 million worth of ore per year for the next 12 years. At the end of the 12th year Rearden will need to spend $20 million to restore the land to its original pristine nature appearance.

4) The number of potential IRRs that exist for Rearden’s mining operation is equal to:

A) 0

B) 1

C) 2

D) 12

5) One of the IRR for Rearden’s mining operation is closest to:

A) 0%

B) 10.6%

C) 12.4%

D) 72.0%

6) Which of the following statements is false?

A) The IRR investment rule will identify the correct decision in many, but not all, situations.

B) By setting the NPV equal to zero and solving for r, we find the IRR.

C) If you are unsure of your cost of capital estimate, it is important to determine how sensitive your analysis is to errors in this estimate.

D) The simplest investment rule is the NPV investment rule.

7) Which of the following statements is false?

A) The IRR investment rule states you should turn down any investment opportunity where the IRR is less than the opportunity cost of capital.

B) The IRR investment rule states that you should take any investment opportunity where the IRR exceeds the opportunity cost of capital.

C) Since the IRR rule is based upon the rate at which the NPV equals zero, like the NPV decision rule, the IRR decision rule will always identify the correct investment decisions.

D) There are situations in which multiple IRRs exist.

8) Assume the appropriate discount rate for this project is 15%. The IRR for this project is closest to:

A) 21%

B) 22%

C) 15%

D) 60%

Use the table for the question(s) below.

Consider the following two projects:

Project

Year 0

Cash Flow

Year 1

Cash Flow

Year 2

Cash Flow

Year 3

Cash Flow

Year 4

Cash Flow

Discount Rate

A

-100

40

50

60

N/A

.15

B

-73

30

30

30

30

.15

9) The internal rate of return (IRR) for project A is closest to:

A) 7.7%

B) 21.6%

C) 23.3%

D) 42.9%

10) The internal rate of return (IRR) for project B is closest to:

A) 21.6%

B) 23.3%

C) 42.9%

D) 7.7%

11) Which of the following statements is correct?

A) You should accept project A since its IRR > 15%.

B) You should reject project B since its NPV > 0.

C) Your should accept project A since its NPV < 0.

D) You should accept project B since its IRR 0.

B) You should invest in project Alpha since IRRAlpha > IRRBeta.

C) Your should invest i project Alpha since NPVAlpha 0.

Use the information for the question(s) below.

The Sisyphean Company is planning on investing in a new project. This will involve the purchase of some

new machinery costing $450,000. The Sisyphean Company expects cash inflows from this project as

detailed below:

Year One

Year Two

Year Three

Year Four

$200,000

$225,000

$275,000

$200,000

The appropriate discount rate for this project is 16%.

16) The IRR for this project is closest to:

A) 18.9%

B) 22.7%

C) 34.1%

D) 39.1%

Use the information for the question(s) below.

Larry the Cucumber has been offered $14 million to star in the lead role of the next three Larry Boy adventure movies. If Larry takes this offer, he will have to forgo acting in other Veggie movies that would pay him $5 million at the end of each of the next three years. Assume Larry’s personal cost of capital is 10% per year.

17) The IRR for Larry’s three movie deal offer is closest to:

A) 3.5%

B) 1.6%

C) -3.5%

D) -1.6%

:

18) Larry should

A) reject the offer because the NPV < 0.

B) accept the offer even though the IRR 0.

C) reject the offer because the IRR 0%.

Use the information for the question(s) below.

Boulderado has come up with a new composite snowboard. Development will take Boulderado four years and cost $250,000 per year, with the first of the four equal investments payable today upon acceptance of the project. Once in production the snowboard is expected to produce annual cash flows of $200,000 each year for 10 years. Boulderado’s discount rate is 10%.

19) The IRR for Boulderado’s snowboard project is closest to:

A) 10.4%

B) 10.0%

C) 11.0%

D) 15.1%

20) Calculate the IRR for the snow board project and use it to determine he maximum deviation allowable in the cost of capital estimate that leaves the investment decision unchanged. The maximum deviation allowable is closest to:

A) 11.0%

B) 0.0%

C) 2.5%

D) 1.0%

21) When using the internal rate of return (IRR) investment rule, we compare

A) the average return on the investment opportunity to returns on all other investment opportunities in the market.

B) the average return on the investment opportunity to returns on other alternatives in the market with equivalent risk and maturity.

C) the NPV of the investment opportunity to the average return on the investment opportunity.

D) the average return on the investment opportunity to the risk-free rate of return.

22) The internal rate of return rule can result in the wrong decision if the projects being compared have

A) differences in scale.

B) differences in timing.

C) differences in NPV.

D) A and B are correct.

Use the information for the question(s) below.

Larry the Cucumber has been offered $14 million to star in the lead role of the next three Larry Boy adventure movies. If Larry takes this offer, he will have to forgo acting in other Veggie movies that would pay him $5 million at the end of each of the next three years. Assume Larry’s personal cost of capital is 10% per year.

23) Explain why the NPV decision rule might provide Larry with a different decision outcome than the IRR rule when evaluating Larry’s three movie deal offer.

6.3 The Payback Rule

Use the following information to answer the question(s) below.