12.3

a) Kensington, Inc. is considering an investment in new equipment that will produce equal annual cash flows of $90,000 for 6 years.The equipment's net present value is $31,950, its cost is $360,000, its useful life is 6 years, and its annual depreciation expense (no salvage value) is $60,000.What is the profitability index of this project?

• A
• :
• 3.6
• B
• :
• 4.0
• C
• :
• 1.1
• D
• :
• 2.8

b) Industrial Products Inc. is trying to decide whether to build a new manufacturing plant or a new warehouse. Both facilities require the same initial investment and are expected to generate the same annual cash flows and intangible benefits. However, when calculating the NPVs of the projects, Industrial uses a lower discount rate for the warehouse than for the manufacturing plant. This tells us that

• A
• :
• the warehouse will have a higher NPV than the plant, because Industrial believes the warehouse presents a higher degree of risk.
• B
• :
• the warehouse will have a lower NPV than the plant, because Industrial believes the warehouse presents a higher degree of risk.
• C
• :
• the warehouse will have a lower NPV than the plant, because Industrial believes the warehouse presents a lower degree of risk.
• D
• :
• the warehouse will have a higher NPV than the plant, because Industrial believes the warehouse presents a lower degree of risk.

c) Fleming Enterprises is thinking about building a new manufacturing facility in either California or Nevada. Both facilities require the same initial investment and are expected to generate the same intangible benefits and annual net cash flows, but the estimated NPV for the California facility is tens of thousands of dollars lower than that for the Nevada facility. What is the most likely reason for this difference in NPV?

• A
• :
• Fleming is using a lower discount rate when calculating the NPV of the California facility because it believes that construction of this facility involves a greater degree of risk.
• B
• :
• Fleming is using a lower discount rate when calculating the NPV of the California facility because it believes that construction of this facility involves a lower degree of risk.
• C
• :
• Fleming is using a higher discount rate when calculating the NPV of the California facility because it believes that construction of this facility involves a greater degree of risk.
• D
• :
• Fleming is using a higher discount rate when calculating the NPV of the California facility because it believes that construction of this facility involves a lower degree of risk.

d) Two years ago, Green Industries decided to undertake a new construction project because it estimated the project's NPV was $95,000. Now, during its post-audit of the project, Green estimates that the project's actual NPV is closer to $48,000. What is the most likely reason why this new NPV is lower than the previous one?

• A
• :
• Green calculated the new NPV using a shorter project lifespan.
• B
• :
• Green calculated the new NPV using a lower discount rate.
• C
• :
• Green calculated the new NPV using actual dollar amounts instead of estimated dollar amounts.
• D
• :
• Green calculated the new NPV using different evaluation techniques.