Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project's full life whereas IRR does not. 
B)  One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV assumption is generally more appropriate. 
C)  One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project's full life whereas MIRR does not. 
D)  One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows. 
E)  Since cash flows under the IRR and MIRR are both discounted at the same rate (the WAC
C) , these two methods always rank mutually exclusive projects in the same order. 
A)  One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project's full life whereas IRR does not. 
B)  One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV assumption is generally more appropriate. 
C)  One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project's full life whereas MIRR does not. 
D)  One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows. 
E)  Since cash flows under the IRR and MIRR are both discounted at the same rate (the WAC
C) , these two methods always rank mutually exclusive projects in the same order.

Question 2

An increase in the firm's WACC will decrease projects' NPVs, which could change the accept/reject decision for any potential project. However, such a change would have no impact on projects' IRRs. Therefore, the accept/reject decision under the IRR method is independent of the cost of capital.

Accepted Answer

A) True 
 B)False

Question 3

Jazz World Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.

Accepted Answer

A)  $41.25 
B)  $45.84 
C)  $50.93 
D)  $56.59 
E)  $62.88 
A)  $41.25 
B)  $45.84 
C)  $50.93 
D)  $56.59 
E)  $62.88

Question 4

No conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, if the projects' cost of capital exceeds the rate at which the projects' NPV profiles cross.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A)  The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount, which the NPV method provides. 
B)  The discounted payback method eliminates all of the problems associated with the payback method. 
C)  When evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a project's acceptability. 
D)  To find the MIRR, we discount the TV at the IRR. 
E)  A project's NPV profile must intersect the X-axis at the project's WACC. 
A)  The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount, which the NPV method provides. 
B)  The discounted payback method eliminates all of the problems associated with the payback method. 
C)  When evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a project's acceptability. 
D)  To find the MIRR, we discount the TV at the IRR. 
E)  A project's NPV profile must intersect the X-axis at the project's WACC.

Question 6

Anderson Systems is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's expected NPV is negative, it should be rejected.

Accepted Answer

A)  $265.65 
B)  $278.93 
C)  $292.88 
D)  $307.52 
E)  $322.90 
A)  $265.65 
B)  $278.93 
C)  $292.88 
D)  $307.52 
E)  $322.90

Question 7

The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zero. Also, the NPV of X is greater than the NPV of Y at the cost of capital. If the two projects are mutually exclusive, Project X should definitely be selected, and the investment made, provided we have confidence in the data. Put another way, it is impossible to draw NPV profiles that would suggest not accepting Project X.

Accepted Answer

A) True 
 B)False

Question 8

Tesar Chemicals is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or lost.

Accepted Answer

A)  $138.10 
B)  $149.21 
C)  $160.31 
D)  $171.42 
E)  $182.52 
A)  $138.10 
B)  $149.21 
C)  $160.31 
D)  $171.42 
E)  $182.52

Question 9

When evaluating mutually exclusive projects, the modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method, regardless of the relative lives or sizes of the projects being evaluated.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

Accepted Answer

A)  A project's MIRR is always greater than its regular IRR. 
B)  A project's MIRR is always less than its regular IRR. 
C)  If a project's IRR is greater than its WACC, then the MIRR will be less than the IRR. 
D)  If a project's IRR is greater than its WACC, then the MIRR will be greater than the IRR. 
E)  To find a project's MIRR, we compound cash inflows at the IRR and then discount the terminal value back to t = 0 at the WACC. 
A)  A project's MIRR is always greater than its regular IRR. 
B)  A project's MIRR is always less than its regular IRR. 
C)  If a project's IRR is greater than its WACC, then the MIRR will be less than the IRR. 
D)  If a project's IRR is greater than its WACC, then the MIRR will be greater than the IRR. 
E)  To find a project's MIRR, we compound cash inflows at the IRR and then discount the terminal value back to t = 0 at the WACC.

Question 11

Projects A and B have identical expected lives and identical initial cash outflows (costs). However, most of one project's cash flows come in the early years, while most of the other project's cash flows occur in the later years. The two NPV profiles are given below:Which of the following statements is CORRECT?

Accepted Answer

A)  More of Project A's cash flows occur in the later years. 
B)  More of Project B's cash flows occur in the later years. 
C)  We must have information on the cost of capital in order to determine which project has the larger early cash flows. 
D)  The NPV profile graph is inconsistent with the statement made in the problem. 
E)  The crossover rate, i.e., the rate at which Projects A and B have the same NPV, is greater than either project's IRR. 
A)  More of Project A's cash flows occur in the later years. 
B)  More of Project B's cash flows occur in the later years. 
C)  We must have information on the cost of capital in order to determine which project has the larger early cash flows. 
D)  The NPV profile graph is inconsistent with the statement made in the problem. 
E)  The crossover rate, i.e., the rate at which Projects A and B have the same NPV, is greater than either project's IRR.

Question 12

Projects S and L both have an initial cost of $10,000, followed by a series of positive cash inflows. Project S's undiscounted net cash flows total $20,000, while L's total undiscounted flows are $30,000. At a WACC of 10%, the two projects have identical NPVs. Which project's NPV is more sensitive to changes in the WACC?

Accepted Answer

A)  Project S. 
B)  Project L. 
C)  Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital. 
D)  Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal. 
E)  The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs. 
A)  Project S. 
B)  Project L. 
C)  Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital. 
D)  Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal. 
E)  The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs.

Question 13

Which of the following statements is CORRECT?

Accepted Answer

A)  If a project has "normal" cash flows, then its IRR must be positive. 
B)  If a project has "normal" cash flows, then its MIRR must be positive. 
C)  If a project has "normal" cash flows, then it will have exactly two real IRRs. 
D)  The definition of "normal" cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project's life. 
E)  If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR. 
A)  If a project has "normal" cash flows, then its IRR must be positive. 
B)  If a project has "normal" cash flows, then its MIRR must be positive. 
C)  If a project has "normal" cash flows, then it will have exactly two real IRRs. 
D)  The definition of "normal" cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project's life. 
E)  If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR.

Question 14

Cornell Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.

Accepted Answer

A)  $ 92.37 
B)  $ 96.99 
C)  $101.84 
D)  $106.93 
E)  $112.28 
A)  $ 92.37 
B)  $ 96.99 
C)  $101.84 
D)  $106.93 
E)  $112.28

Question 15

The IRR method is based on the assumption that projects' cash flows are reinvested at the project's risk-adjusted cost of capital.

Accepted Answer

A) True 
 B)False

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A)  The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion. 
B)  One drawback of the regular payback is that this method does not take account of cash flows beyond the payback period. 
C)  If a project's payback is positive, then the project should be accepted because it must have a positive NPV. 
D)  The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. 
E)  One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback. 
A)  The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion. 
B)  One drawback of the regular payback is that this method does not take account of cash flows beyond the payback period. 
C)  If a project's payback is positive, then the project should be accepted because it must have a positive NPV. 
D)  The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. 
E)  One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback.

Question 17

Projects A and B are mutually exclusive and have normal cash flows. Project A has an IRR of 15% and B's IRR is 20%. The company's WACC is 12%, and at that rate Project A has the higher NPV. Which of the following statements is CORRECT?

Accepted Answer

A)  The crossover rate for the two projects must be less than 12%. 
B)  Assuming the timing pattern of the two projects' cash flows is the same, Project B probably has a higher cost (and larger scale). 
C)  Assuming the two projects have the same scale, Project B probably has a faster payback than Project A. 
D)  The crossover rate for the two projects must be 12%. 
E)  Since B has the higher IRR, then it must also have the higher NPV if the crossover rate is less than the WACC of 12%. 
A)  The crossover rate for the two projects must be less than 12%. 
B)  Assuming the timing pattern of the two projects' cash flows is the same, Project B probably has a higher cost (and larger scale). 
C)  Assuming the two projects have the same scale, Project B probably has a faster payback than Project A. 
D)  The crossover rate for the two projects must be 12%. 
E)  Since B has the higher IRR, then it must also have the higher NPV if the crossover rate is less than the WACC of 12%.

Question 18

McCall Manufacturing has a WACC of 10%. The firm is considering two normal, equally risky, mutually exclusive, but not repeatable projects. The two projects have the same investment costs, but Project A has an IRR of 15%, while Project B has an IRR of 20%. Assuming the projects' NPV profiles cross in the upper right quadrant, which of the following statements is CORRECT?

Accepted Answer

A)  Each project must have a negative NPV. 
B)  Since the projects are mutually exclusive, the firm should always select Project B. 
C)  If the crossover rate is 8%, Project B will have the higher NPV. 
D)  Only one project has a positive NPV. 
E)  If the crossover rate is 8%, Project A will have the higher NPV. 
A)  Each project must have a negative NPV. 
B)  Since the projects are mutually exclusive, the firm should always select Project B. 
C)  If the crossover rate is 8%, Project B will have the higher NPV. 
D)  Only one project has a positive NPV. 
E)  If the crossover rate is 8%, Project A will have the higher NPV.

Question 19

Thorley Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC or negative, in both cases it will be rejected.

Accepted Answer

A)  9.43% 
B)  9.91% 
C)  10.40% 
D)  10.92% 
E)  11.47% 
A)  9.43% 
B)  9.91% 
C)  10.40% 
D)  10.92% 
E)  11.47%

Question 20

Masulis Inc. is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?

Accepted Answer

A)  1.61 years 
B)  1.79 years 
C)  1.99 years 
D)  2.22 years 
E)  2.44 years 
A)  1.61 years 
B)  1.79 years 
C)  1.99 years 
D)  2.22 years 
E)  2.44 years

Exam 10: The Basics of Capital Budgeting: Evaluating Cash Flows

Which of the following statements is CORRECT?

An increase in the firm's WACC will decrease projects' NPVs, which could change the accept/reject decision for any potential project. However, such a change would have no impact on projects' IRRs. Therefore, the accept/reject decision under the IRR method is independent of the cost of capital.

Jazz World Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.

No conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, if the projects' cost of capital exceeds the rate at which the projects' NPV profiles cross.

Which of the following statements is CORRECT?

Anderson Systems is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's expected NPV is negative, it should be rejected.

When evaluating mutually exclusive projects, the modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method, regardless of the relative lives or sizes of the projects being evaluated.

Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

Which of the following statements is CORRECT?

Cornell Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.

The IRR method is based on the assumption that projects' cash flows are reinvested at the project's risk-adjusted cost of capital.

Which of the following statements is CORRECT?

Projects A and B are mutually exclusive and have normal cash flows. Project A has an IRR of 15% and B's IRR is 20%. The company's WACC is 12%, and at that rate Project A has the higher NPV. Which of the following statements is CORRECT?

Thorley Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC or negative, in both cases it will be rejected.

Masulis Inc. is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements Part 2 Fixed Income Securities

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risk, Return, and the Capital Asset Pricing Model

Stocks, Stock Valuation, and Stock Market Equilibrium

Financial Options and Applications in Corporate Finance

The Cost of Capital

Cash Flow Estimation and Risk Analysis

Financial Planning and Forecasting Financial Statements

Corporate Valuation, Value-Based Management and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Working Capital Management

Multinational Financial Management

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Initial Public Offerings, Investment Banking, and Financial Restructuring

Mergers, Lbos, Divestitures, and Holding Companies

Bankruptcy, Reorganization, and Liquidation

Derivatives and Risk Management

Portfolio Theory, Asset Pricing Models, and Behavioral Finance

Real Options

Analysis of Capital Structure Theory

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