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Chapter 8 Finance Exam Questions and Answers (FIN701)
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  • FIN701
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  • FIN701

Consider the following cash flows: Year Cash Flow 0 −$5,900 1 2,000 2 2,700 3 1,500 4 900 Required: What is the payback period for the above set of cash flows? - Answer-To calculate the payback period, we need to find the time that the project has recovered its initial investment...

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  • August 23, 2024
  • 8
  • 2024/2025
  • Exam (elaborations)
  • Questions & answers

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  • chapter 8 finance exam questions and answers fin7
  • consider the following cash flows

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  • FIN701
  • FIN701

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Chapter 8 Finance Exam Questions and
Answers (FIN701)
Consider the following cash flows:

Year Cash Flow
0 −$5,900
1 2,000
2 2,700
3 1,500
4 900

Required:
What is the payback period for the above set of cash flows? - Answer-To calculate the
payback period, we need to find the time that the project has recovered its initial
investment. After two years, the project has created:

$2,000 + 2,700 = $4,700

in cash flows. The project still needs to create another:

$5,900 - 4,700 = $1,200

in cash flows. During the third year, the cash flows from the project will be $1,500. So,
the payback period will be 2 years, plus what we still need to make divided by what we
will make during the third year. The payback period is:

Payback = 2 + ($1,200 / $1,500)
Payback = 2.80 years

You're trying to determine whether or not to expand your business by building a new
manufacturing plant. The plant has an installation cost of $14 million, which will be
depreciated straight-line to zero over its four-year life.

Required:
If the plant has projected net income of $1,253,000, $1,935,000, $1,738,000, and
$1,310,000 over these four years, what is the project's average accounting return
(AAR)? - Answer-Our definition of AAR is the average net income divided by the
average book value. The average net income for this project is:

Average net income = ($1,253,000 + 1,935,000 + 1,738,000 + 1,310,000) / 4
Average net income = $1,559,000

And the average book value is:

, Average book value = ($14,000,000 + 0) / 2
Average book value = $7,000,000

So, the AAR for this project is:

AAR = Average net income / Average book value
AAR = $1,559,000 / $7,000,000
AAR = .2227, or 22.27%

A firm evaluates all of its projects by applying the IRR rule.

Year Cash Flow
0 -$ 153,000
1 78,000
2 67,000
3 49,000

Requirement 1:
What is the project's IRR? - Answer-Since the cash flows are conventional and the IRR
is greater than the required return, we would accept the project.

Calculator Solution:


CFo
-$153,000
C01
$78,000
F01
1
C02
$67,000
F02
1
C03
$49,000
F03
1
IRR CPT
14.02%

For the given cash flows, suppose the firm uses the NPV decision rule.

Year Cash Flow
0 -$ 153,000
1 78,000

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