Question

Question 1: A project has an initial cost of $91,300, a life of 8 years, and equal annual cash inflows. The required return is 8.7 percent. According to the profitability index decision rule, what is the minimum annual cash flow necessary to accept the project?

Multiple Choice:

• $15,057.32

• $17,795.02

• $11,412.50

• $19,277.93

• $16,312.10

Question 2: A bond that pays interest annually yields a rate of return of 8.50 percent. The inflation rate for the same period is 4 percent. What is the real rate of return on this bond?

Multiple Choice:

• 12.50%

• 4.00%

• 2.13%

• 1.04%

• 4.33%

Answer 1

1. The amount is computed as follows:

= Initial cost / Present value annuity factor of 8.7% of 8 years

Present value annuity factor of 8.7% of 8 years will be as follows:

= [ (1 – 1 / (1 + r)ⁿ) / r ]

= [ (1 - 1 / (1 + 0.087)⁸ ) / 0.087 ]

= 5.597072728

So, the amount will be as follows:

= $ 91,300 /  5.597072728

= $ 16,312.10

2. The rate is computed as follows:

= [ (1 + Rate of return of bond) / (1 + inflation rate) ] - 1

= [ (1 + 0.085) / (1 + 0.04) ] - 1

= [ 1.085 / 1.04 ] - 1

= 4.33%

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