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

Projects C and D both have normal cash flows and are mutually exclusive.Project C has a higher NPV if the cost of capital is less than 12%, whereas Project D has a higher NPV if the cost of capital exceeds 12%.Which of the following statements is CORRECT?

Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method ranks the other one first.In theory, such conflicts should be resolved in favor of the project with the higher positive IRR.

You are on the staff of O'Hara Inc.The CFO believes project acceptance should be based on the NPV, but Andrew O'Hara, the president, insists that no project should be accepted unless its IRR exceeds the project's risk-adjusted cost of capital.Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and −$100,000 at the end of Year 2.The president and the CFO both agree that the appropriate cost of capital for this project is 10%.At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one at 527%, and a MIRR of 11.32%.Which of the following statements best describes your optimal recommendation, i.e., the analysis and recommendation that is best for the company and least likely to get you in trouble with either the CFO or the president?

In theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital.The decision criterion should not be affected by managers' tastes, choice of accounting method, or the profitability of other independent projects.

Computer Consultants Inc.is considering a project that has the following cash flow and cost of capital (r) data.What is the project's MIRR? Note that a project's MIRR can be less than the cost of capital (and even negative), in which case it will be rejected. =10.00\% Year 0 1 2 3 Cash flows -\ 1,000 \ 450 \ 450 \ 450

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.

Langton Inc.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 MIRR.If the decision is made by choosing the project with the higher IRR rather than the one with the higher MIRR, how much, if any, value will be forgone.In other words, what's the NPV of the chosen project versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs.MIRR will have no effect on the value lost. =7.00\% Year 0 1 2 3 4 -\ 1,100 \ 550 \ 600 \ 100 \ 100 -\ 2,750 \ 725 \ 725 \ 800 \ 1,400

Because "present value" refers to the value of cash flows that occur at different points in time, a series of present values of cash flows should not be summed to determine the value of a capital budgeting project.

Consider two projects, X and Y.Project X's IRR is 19% and Project Y's IRR is 17%.The projects have the same risk and the same lives, and each has constant cash flows during each year of their lives.If the cost of capital is 10%, Project Y has a higher NPV than X.Given this information, which of the following statements is CORRECT?

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 cash outflow at t = 0 followed by a series of positive cash flows.

Westwood Painting Co.is considering a project that has the following cash flow and cost of capital (r) data.What is the project's MIRR? Note that a project's MIRR can be less than the cost of capital (and even negative), in which case it will be rejected. r=12.25\% Year 0 1 2 3 4 Cash flows -\ 850 \ 300 \ 320 \ 340 \ 360

Patterson Co.is considering a project that has the following cash flow and cost of capital (r) data.What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected. r: 10.00\% Year 0 1 2 3 Cash flows -\ 950 \ 500 \ 400 \ 300

A project's IRR is independent of the firm's cost of capital.In other words, a project's IRR doesn't change with a change in the firm's cost of capital.

The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows.

The cost of capital for two mutually exclusive projects that are being considered is 12%.Project K has an IRR of 20% while Project R's IRR is 15%.The projects have the same NPV at the 12% current cost of capital.Interest rates are currently high.However, you believe that money costs and thus your cost of capital will soon decline.You also think that the projects will not be funded until the cost of capital has decreased, and their cash flows will not be affected by the change in economic conditions.Under these conditions, 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 cost of capital is 12%, and at that rate Project A has the higher NPV.Which of the following statements is CORRECT?

Dickson Co.is considering a project that has the following cash flow and cost of capital (r) data.What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected. r: 12.00\% Year 0 1 2 3 4 5 Cash flows -\ 1,100 \ 400 \ 390 \ 380 \ 370 \ 360

Which of the following statements is CORRECT?

Projects S and L are equally risky, mutually exclusive, and have normal cash flows.Project S has an IRR of 15%, while Project L's IRR is 12%.The two projects have the same NPV when the cost of capital is 7%.Which of the following statements is CORRECT?