1m|mP a g e
DISCOUNTED CASH FLOW ANALYSIS EXAM VERSION 1- m m m m m m
4|| WALL STREET PREP ALL QUESTIONS AND CORRECT ANSWERS||
m m m m m m m m m
LATEST AND COMPLETE VERSION 2024 WITH VERIFIED SOLUTION
m m m m m m m
S WITH ANSWERS SHEET AFTER EVERY CHAPTER|| ASSURED PASS
m m m m m m m m
!!!
Question 1: m
2D2-LS03
Which characteristic differentiates the net present value (NPV) and the internal rate of return (
m m m m m m m m m m m m m m
IRR) methods? m
NPVmyieldsmampercentage;mIRR mresultsmin mamdollarmfigure.
NPVmconsidersmtheminitial mcashminvestment;mIRR mexaminesmcashmflowsmaftermtheminitial minvestment.
NPVmexaminesmcashmflowsmaftermtheminitial minvestment;mIRR mconsidersmtheminitialmcashminvestment.
NPVmresultsmin mamdollarmfigure;mIRR myieldsmampercentage.
A major difference is that the end result of net present value is a dollar figure whereas the fina
m m m m m m m m m m m m m m m m m m
l computation for internal rate of return is a percentage. NPV values of individual projects can
m m m m m m m m m m m m m m m m
be added up to estimate the effect on accepting some possible combination of projects. Beca
m m m m m m m m m m m m m m
use IRR yields a percentage, multiple projects cannot be added or averaged to evaluate any c
m m m m m m m m m m m m m m m
ombination of capital investment projects.
m m m m
Question 2: m
2D2-AT04
Under which one of the following conditions is the internal rate of return (IRR) method less reli
m m m m m m m m m m m m m m m m
able than the net present value technique?
m m m m m m
when mthemnetmpresentmvaluemof mthemprojectmismequal mtomzero.
when mbothmbenefitsmandmcostsmaremincluded,mbutmeachmismseparatelymdiscountedmtomthempresent.
when mincomemtaxesmaremconsideredmin mthemanalysis.
when mtheremaremseveral malternatingmperiodsmof mnetmcash minflowsmandmnetmcash moutflows.
If any annual cash flow beyond the initial investment (at t=0) is negative, the project will have
m m m m m m m m m m m m m m m m m
multiple IRR's, all of which will be correct, but none of them will make sense. The calculation
m m m m m m m m m m m m m m m m m
of a unique IRR only works when all of the annual cash flows, except the initial investment, ar
m m m m m m m m m m m m m m m m m
e positive.
m
Question 3: m
2D2-LS20
If the present value of expected cash inflows from a project equals the present value of expec
m m m m m m m m m m m m m m m m
ted cash outflows, the discount rate is the:
m m m m m m m
*Source: mRetired mICMA mCMA mExammQuestions.
,2m|mP a g e
netmpresentmvaluem(NPV)mrate.
paybackmrate.
internal mratemof mreturn m(IRR).
accountingmratemof mreturn.
The IRR estimates the discount rate that makes the present value of net cash inflows equal to
m m m m m m m m m m m m m m m m
mthe initial investment. Stated another way, IRR is a discount rate that will make the net prese
m m m m m m m m m m m m m m m m
nt value (NPV) of an investment zero (if the rate is used as the required rate of return to comp
m m m m m m m m m m m m m m m m m m m
ute NPV).
m
Question 4: m
2D2-LS22
The following methods are used to evaluate capital investment projects.
m m m m m m m m m
— m Internal rate of return m m m
— m Average rate of return m m m
— m Payback
— m Net present value (NPV)
m m m
Which one of the following correctly identifies the methods that utilize discounted cash-
m m m m m m m m m m m m
flow (DCF) techniques?
m m
*Source: mRetired mICMA mCMA mExammQuestions
IRR:mYes;mAveragemRatemof mReturn:mNo;mPaybackmMethod:mNPV:mYes.
IRR:mYes;mAveragemRatemof mReturn:mYes;mPaybackmMethod:mNo;mNPV:mNo.
IRR:mYes;mAveragemRatemof mReturn:mNo;mPaybackmmethod:mYes;mNPV:mNo.
IRR:mNo;mAveragemRatemof mReturn:mNo;mPaybackmMethod:mYes;mNPV:mYes.
The IRR and NPV methods that utilize DCF techniques. Average rate of return and the Payba
m m m m m m m m m m m m m m m
ck methods do not discount the cash flows in their analyses.
m m m m m m m m m m
Question 5: m
2D2-AT18
Which one of the following statements about the payback method of investment analysis is co
m m m m m m m m m m m m m m
rrect? The payback method:
m m m
generallymleadsmtomthemsamemdecisionmasmothermmethodsmformlong-termmprojects.
considersmcash mflowsmaftermthempaybackmhasmbeen mreached.
usesmdiscountedmcash mflow mtechniques.
doesmnotmconsidermthemtimemvaluemof mmoney.
,3m|mP a g e
The payback method merely looks at the length of time it takes to recover the initial investme
m m m m m m m m m m m m m m m m
nt. It does not consider the life of the project nor does it consider the time value of money.
m m m m m m m m m m m m m m m m m m
Question 6: m
2D2-CQ32
Jenson Copying Company is planning to buy a copying machine costing $25,310. The net pre
m m m m m m m m m m m m m m
sent values (NPV) of this investment, at various discount rates, are:
m m m m m m m m m m
Jenson's approximate internal rate of return (IRR) on this investment is:
m m m m m m m m m m
10%.
8%.
6%.
9%.
The IRR is the discount rate at which the NPV is equal to zero.
m m m m m m m m m m m m m
For the copy machine, the IRR, by interpolation = 8% + [(60)/(60 +40)](2%)
m m m m m m m m m m m m
IRR, copy machine = 8% + 2%[(460)/(460 +440)] = 8% + 2%(0.51) = 8% + 1% = 9%.
m m m m m m m m m m m m m m m m m
Question 7: m
2D2-CQ28
Wilcox Corporation won a settlement in a law suit and was offered four different payment alter
m m m m m m m m m m m m m m m
natives by the defendant's insurance company. A review of interest rates indicates that 8% is
m m m m m m m m m m m m m m m
appropriate for analyzing this situation. Ignoring any tax considerations, which one of the follo
m m m m m m m m m m m m m
wing four alternatives should the controller recommend to Wilcox management?
m m m m m m m m m
$5,000mnow mandm$5,000mpermyearmatmthemendmof meach mof mthemnextmninemyears,mplusmamlump-
summpaymentmof m$200,000matmthemendmof mthemtenth myear.
$5,000mnow mandm$20,000mpermyearmatmthemendmof meach mof mthemnextmten myears.
$135,000mnow.
$40,000mpermyearmatmthemendmof meach mof mthemnextmfourmyears.
Wilcox would select the alternative with the highest net present value (NPV) computed at 8%.
m m m m m m m m m m m m m m
, 4m|mP a g e
NPV($135,000 now) = $135,000 m m m
NPV($40,000/year for 4 years) = ($40,000)(3.312 PV of annuity i=8, n=4) = $132,480
m m m m m m m m m m m m
NPV($5,000 now, $5,000/year for 9 years, $200,000 at 10th year)= $5,000 + ($5,000)(6.247 P
m m m m m m m m m m m m m
V annuity i=8, n=9) + ($200,000)(0.463 PV lumpsum i=8, n=10)
m m m m m m m m m
NPV($5,000 now, $5,000/year for 9 years, $200,000 at 10th year)= $5,000 + $31,235 + $92,6
m m m m m m m m m m m m m m
00 = $128,835 m m
NPV($5,000 now, $20,000/year for 10 years) = $5,000 + ($20,000)(6.71 PV of annuity i=8, n=
m m m m m m m m m m m m m m
10)
NPV($5,000 now, $20,000/year for 10 years) = $5,000 + $134,200 = $139,200
m m m m m m m m m m m
This option has the highest NPV, and would therefore be selected.
m m m m m m m m m m
Question 8: m
2D2-LS11
A company wants to evaluate the purchase of a new machine.
m m m m m m m m m m
• The machine costs $48,000 plus $2,000 in shipping and installation charges.
m m m m m m m m m m
• Purchase of the machine would require an increase in net working capital of $5,000.
m m m m m m m m m m m m m
• The company depreciates this asset according to a Modified Acceleration Cost Reco
m m m m m m m m m m m
very System (MACRS) depreciation schedule for a five-
m m m m m m m
year asset (Year 1 = 0.20, Year 2 = 0.32, Year 3 = 0.19, Year 4 = 0.12, Year 5 = 0.1
m m m m m m m m m m m m m m m m m m m m m
1, and Year 6 = 0.06).
m m m m m
• The company expects that the computer would increase its before-
m m m m m m m m m
tax revenues by $30,000 a year, but would also increase operating costs by $10,000
m m m m m m m m m m m m m
ma year.
m
• The company expects to sell the machine after five years for $8,000.
m m m m m m m m m m m
• The firm's marginal tax rate is 40%.
m m m m m m
What is the initiation cash flow in Year 0 for the capital budgeting project?
m m m m m m m m m m m m m
($48,000).
($50,000).
($55,000).
($53,000).
The calculation of the incremental cash flows at initiation is
m m m m m m m m m
• Direct effect for the cost of the new asset ($48,000)
m m m m m m m m m
• Additional capitalized expenditures ($2,000)
m m m
• Increase in net working capital ($5,000)
m m m m m
• Initiation cash flow ($55,000)
m m m
DISCOUNTED CASH FLOW ANALYSIS EXAM VERSION 1- m m m m m m
4|| WALL STREET PREP ALL QUESTIONS AND CORRECT ANSWERS||
m m m m m m m m m
LATEST AND COMPLETE VERSION 2024 WITH VERIFIED SOLUTION
m m m m m m m
S WITH ANSWERS SHEET AFTER EVERY CHAPTER|| ASSURED PASS
m m m m m m m m
!!!
Question 1: m
2D2-LS03
Which characteristic differentiates the net present value (NPV) and the internal rate of return (
m m m m m m m m m m m m m m
IRR) methods? m
NPVmyieldsmampercentage;mIRR mresultsmin mamdollarmfigure.
NPVmconsidersmtheminitial mcashminvestment;mIRR mexaminesmcashmflowsmaftermtheminitial minvestment.
NPVmexaminesmcashmflowsmaftermtheminitial minvestment;mIRR mconsidersmtheminitialmcashminvestment.
NPVmresultsmin mamdollarmfigure;mIRR myieldsmampercentage.
A major difference is that the end result of net present value is a dollar figure whereas the fina
m m m m m m m m m m m m m m m m m m
l computation for internal rate of return is a percentage. NPV values of individual projects can
m m m m m m m m m m m m m m m m
be added up to estimate the effect on accepting some possible combination of projects. Beca
m m m m m m m m m m m m m m
use IRR yields a percentage, multiple projects cannot be added or averaged to evaluate any c
m m m m m m m m m m m m m m m
ombination of capital investment projects.
m m m m
Question 2: m
2D2-AT04
Under which one of the following conditions is the internal rate of return (IRR) method less reli
m m m m m m m m m m m m m m m m
able than the net present value technique?
m m m m m m
when mthemnetmpresentmvaluemof mthemprojectmismequal mtomzero.
when mbothmbenefitsmandmcostsmaremincluded,mbutmeachmismseparatelymdiscountedmtomthempresent.
when mincomemtaxesmaremconsideredmin mthemanalysis.
when mtheremaremseveral malternatingmperiodsmof mnetmcash minflowsmandmnetmcash moutflows.
If any annual cash flow beyond the initial investment (at t=0) is negative, the project will have
m m m m m m m m m m m m m m m m m
multiple IRR's, all of which will be correct, but none of them will make sense. The calculation
m m m m m m m m m m m m m m m m m
of a unique IRR only works when all of the annual cash flows, except the initial investment, ar
m m m m m m m m m m m m m m m m m
e positive.
m
Question 3: m
2D2-LS20
If the present value of expected cash inflows from a project equals the present value of expec
m m m m m m m m m m m m m m m m
ted cash outflows, the discount rate is the:
m m m m m m m
*Source: mRetired mICMA mCMA mExammQuestions.
,2m|mP a g e
netmpresentmvaluem(NPV)mrate.
paybackmrate.
internal mratemof mreturn m(IRR).
accountingmratemof mreturn.
The IRR estimates the discount rate that makes the present value of net cash inflows equal to
m m m m m m m m m m m m m m m m
mthe initial investment. Stated another way, IRR is a discount rate that will make the net prese
m m m m m m m m m m m m m m m m
nt value (NPV) of an investment zero (if the rate is used as the required rate of return to comp
m m m m m m m m m m m m m m m m m m m
ute NPV).
m
Question 4: m
2D2-LS22
The following methods are used to evaluate capital investment projects.
m m m m m m m m m
— m Internal rate of return m m m
— m Average rate of return m m m
— m Payback
— m Net present value (NPV)
m m m
Which one of the following correctly identifies the methods that utilize discounted cash-
m m m m m m m m m m m m
flow (DCF) techniques?
m m
*Source: mRetired mICMA mCMA mExammQuestions
IRR:mYes;mAveragemRatemof mReturn:mNo;mPaybackmMethod:mNPV:mYes.
IRR:mYes;mAveragemRatemof mReturn:mYes;mPaybackmMethod:mNo;mNPV:mNo.
IRR:mYes;mAveragemRatemof mReturn:mNo;mPaybackmmethod:mYes;mNPV:mNo.
IRR:mNo;mAveragemRatemof mReturn:mNo;mPaybackmMethod:mYes;mNPV:mYes.
The IRR and NPV methods that utilize DCF techniques. Average rate of return and the Payba
m m m m m m m m m m m m m m m
ck methods do not discount the cash flows in their analyses.
m m m m m m m m m m
Question 5: m
2D2-AT18
Which one of the following statements about the payback method of investment analysis is co
m m m m m m m m m m m m m m
rrect? The payback method:
m m m
generallymleadsmtomthemsamemdecisionmasmothermmethodsmformlong-termmprojects.
considersmcash mflowsmaftermthempaybackmhasmbeen mreached.
usesmdiscountedmcash mflow mtechniques.
doesmnotmconsidermthemtimemvaluemof mmoney.
,3m|mP a g e
The payback method merely looks at the length of time it takes to recover the initial investme
m m m m m m m m m m m m m m m m
nt. It does not consider the life of the project nor does it consider the time value of money.
m m m m m m m m m m m m m m m m m m
Question 6: m
2D2-CQ32
Jenson Copying Company is planning to buy a copying machine costing $25,310. The net pre
m m m m m m m m m m m m m m
sent values (NPV) of this investment, at various discount rates, are:
m m m m m m m m m m
Jenson's approximate internal rate of return (IRR) on this investment is:
m m m m m m m m m m
10%.
8%.
6%.
9%.
The IRR is the discount rate at which the NPV is equal to zero.
m m m m m m m m m m m m m
For the copy machine, the IRR, by interpolation = 8% + [(60)/(60 +40)](2%)
m m m m m m m m m m m m
IRR, copy machine = 8% + 2%[(460)/(460 +440)] = 8% + 2%(0.51) = 8% + 1% = 9%.
m m m m m m m m m m m m m m m m m
Question 7: m
2D2-CQ28
Wilcox Corporation won a settlement in a law suit and was offered four different payment alter
m m m m m m m m m m m m m m m
natives by the defendant's insurance company. A review of interest rates indicates that 8% is
m m m m m m m m m m m m m m m
appropriate for analyzing this situation. Ignoring any tax considerations, which one of the follo
m m m m m m m m m m m m m
wing four alternatives should the controller recommend to Wilcox management?
m m m m m m m m m
$5,000mnow mandm$5,000mpermyearmatmthemendmof meach mof mthemnextmninemyears,mplusmamlump-
summpaymentmof m$200,000matmthemendmof mthemtenth myear.
$5,000mnow mandm$20,000mpermyearmatmthemendmof meach mof mthemnextmten myears.
$135,000mnow.
$40,000mpermyearmatmthemendmof meach mof mthemnextmfourmyears.
Wilcox would select the alternative with the highest net present value (NPV) computed at 8%.
m m m m m m m m m m m m m m
, 4m|mP a g e
NPV($135,000 now) = $135,000 m m m
NPV($40,000/year for 4 years) = ($40,000)(3.312 PV of annuity i=8, n=4) = $132,480
m m m m m m m m m m m m
NPV($5,000 now, $5,000/year for 9 years, $200,000 at 10th year)= $5,000 + ($5,000)(6.247 P
m m m m m m m m m m m m m
V annuity i=8, n=9) + ($200,000)(0.463 PV lumpsum i=8, n=10)
m m m m m m m m m
NPV($5,000 now, $5,000/year for 9 years, $200,000 at 10th year)= $5,000 + $31,235 + $92,6
m m m m m m m m m m m m m m
00 = $128,835 m m
NPV($5,000 now, $20,000/year for 10 years) = $5,000 + ($20,000)(6.71 PV of annuity i=8, n=
m m m m m m m m m m m m m m
10)
NPV($5,000 now, $20,000/year for 10 years) = $5,000 + $134,200 = $139,200
m m m m m m m m m m m
This option has the highest NPV, and would therefore be selected.
m m m m m m m m m m
Question 8: m
2D2-LS11
A company wants to evaluate the purchase of a new machine.
m m m m m m m m m m
• The machine costs $48,000 plus $2,000 in shipping and installation charges.
m m m m m m m m m m
• Purchase of the machine would require an increase in net working capital of $5,000.
m m m m m m m m m m m m m
• The company depreciates this asset according to a Modified Acceleration Cost Reco
m m m m m m m m m m m
very System (MACRS) depreciation schedule for a five-
m m m m m m m
year asset (Year 1 = 0.20, Year 2 = 0.32, Year 3 = 0.19, Year 4 = 0.12, Year 5 = 0.1
m m m m m m m m m m m m m m m m m m m m m
1, and Year 6 = 0.06).
m m m m m
• The company expects that the computer would increase its before-
m m m m m m m m m
tax revenues by $30,000 a year, but would also increase operating costs by $10,000
m m m m m m m m m m m m m
ma year.
m
• The company expects to sell the machine after five years for $8,000.
m m m m m m m m m m m
• The firm's marginal tax rate is 40%.
m m m m m m
What is the initiation cash flow in Year 0 for the capital budgeting project?
m m m m m m m m m m m m m
($48,000).
($50,000).
($55,000).
($53,000).
The calculation of the incremental cash flows at initiation is
m m m m m m m m m
• Direct effect for the cost of the new asset ($48,000)
m m m m m m m m m
• Additional capitalized expenditures ($2,000)
m m m
• Increase in net working capital ($5,000)
m m m m m
• Initiation cash flow ($55,000)
m m m
