Question 7) Mulligan, Inc. is currently considering an eight-year project that

7) Mulligan, 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. Mulligan has a discount rate of 12%. Because there is a shortage of funds to finance all good projects, Mulligan wants to compute the profitability index (PI) for each project. That way Mulligan can get an idea as to which project might be a better choice. What is the PI for Mulligan’s current project?

A) About 1.24

B) About 1.21

C) About 1.19

D) About 1.09

8) Berra, 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. Berra has a discount rate of 11%. Because of capital rationing (shortage of funds for financing), Berra wants to compute the profitability index (PI) for each project. What is the PI for Berra’s current project?

A) About 1.29

B) About 1.31

C) About 1.33

D) About 1.39

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9) Pigeon, 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. Pigeon has a discount rate of 13%. Because of concerns about funds being short to finance all good projects, Pigeon wants to compute the profitability index (PI) for each project. What is the PI for Pigeon’s current project?

A) About 1.50

B) About 1.60

C) About 1.70

D) About 1.80

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.

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

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

.

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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

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

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

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

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

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 the time value of money.

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.

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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.

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

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