Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  One defect of the IRR method is that it does not take account of the time value of money. 
B)  One defect of the IRR method is that it does not take account of the cost of capital. 
C)  One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future. 
D)  One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid. 
E)  One defect of the IRR method is that it does not take account of cash flows over a project's full life. 
A)  One defect of the IRR method is that it does not take account of the time value of money. 
B)  One defect of the IRR method is that it does not take account of the cost of capital. 
C)  One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future. 
D)  One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid. 
E)  One defect of the IRR method is that it does not take account of cash flows over a project's full life.

Question 2

Worthington Inc.is considering a project that has the following cash flow data.What is the project's payback? $$\begin{array} { l c c c c } 
\text { Year } & 0 & 1 & 2 & 3 \
\hline  \text { Cash flows } & - \$ 500 & \$ 150 & \$ 200 & \$ 300
\end{array}$$

Accepted Answer

A)  2.03 years 
B)  2.25 years 
C)  2.50 years 
D)  2.75 years 
E)  3.03 years 
A)  2.03 years 
B)  2.25 years 
C)  2.50 years 
D)  2.75 years 
E)  3.03 years

Question 3

Modern Refurbishing 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 cost of capital (and even negative), in which case it will be rejected. $$\begin{array} { l c c c c c } 
\text { Year } & 0 & 1 & 2 & 3 & 4 \
\hline  \text { Cash flows } & - \$ 850 & \$ 300 & \$ 290 & \$ 280 & \$ 270
\end{array}$$

Accepted Answer

A)  13.13% 
B)  14.44% 
C)  15.89% 
D)  17.48% 
E)  19.22% 
A)  13.13% 
B)  14.44% 
C)  15.89% 
D)  17.48% 
E)  19.22%

Question 4

Normal Projects S and L have the same NPV when the discount rate is zero.However, Project S's cash flows come in faster than those of L.Therefore, we know that at any discount rate greater than zero, L will have the higher NPV.

Accepted Answer

A) True 
 B)False

Question 5

Reed Enterprises 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. $$\begin{array} { l c c c c } 
\text { r: } & 10.00 \% & & & \
\text { Year } & 0 & 1 & 2 & 3 \
\hline  \text { Cash flows } & - \$ 1,050 & \$ 450 & \$ 460 & \$ 470
\end{array}$$

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 6

Hart Corp.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 cost of capital or negative, in both cases it will be rejected. $$\begin{array} { l c c c c } 
\text { Year } & 0 & 1 & 2 & 3 \
\hline  \text { Cash flows } & - \$ 1,000 & \$ 425 & \$ 425 & \$ 425
\end{array}$$

Accepted Answer

A)  12.55% 
B)  13.21% 
C)  13.87% 
D)  14.56% 
E)  15.29% 
A)  12.55% 
B)  13.21% 
C)  13.87% 
D)  14.56% 
E)  15.29%

Question 7

When considering two mutually exclusive projects, the firm should always select the project whose internal rate of return is the highest, provided the projects have the same initial cost.This statement is true regardless of whether the projects can be repeated or not.

Accepted Answer

A) True 
 B)False

Question 8

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)  One drawback of the regular payback for evaluating projects is that this method does not properly account for the time value of money. 
B)  If a project's payback is positive, then the project should be rejected because it must have a negative NPV. 
C)  The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. 
D)  If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time. 
E)  The longer a project's payback period, the more desirable the project is normally considered to be by this criterion. 
A)  One drawback of the regular payback for evaluating projects is that this method does not properly account for the time value of money. 
B)  If a project's payback is positive, then the project should be rejected because it must have a negative NPV. 
C)  The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. 
D)  If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time. 
E)  The longer a project's payback period, the more desirable the project is normally considered to be by this criterion.

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A)  If Project A's IRR exceeds Project B's, then A must have the higher NPV. 
B)  A project's MIRR can never exceed its IRR. 
C)  If a project with normal cash flows has an IRR less than the cost of capital, the project must have a positive NPV. 
D)  If the NPV is negative, the IRR must also be negative. 
E)  If a project with normal cash flows has an IRR greater than the cost of capital, the project must also have a positive NPV. 
A)  If Project A's IRR exceeds Project B's, then A must have the higher NPV. 
B)  A project's MIRR can never exceed its IRR. 
C)  If a project with normal cash flows has an IRR less than the cost of capital, the project must have a positive NPV. 
D)  If the NPV is negative, the IRR must also be negative. 
E)  If a project with normal cash flows has an IRR greater than the cost of capital, the project must also have a positive NPV.

Question 10

Last month, Standard Systems analyzed the project whose cash flows are shown below.However, before the decision to accept or reject the project took place, the Federal Reserve changed interest rates and therefore the firm's cost of capital (r).The Fed's action did not affect the forecasted cash flows.By how much did the change in the r affect the project's forecasted NPV? Note that a project's expected NPV can be negative, in which case it should be rejected. $$\begin{array} { l c c c c } 
\text { Old r: } & 10.00 \% & \text { New r: } & 11.25 \% \
\text { Year } & 0 & 1 & 2 & 3 \
\hline  \text { Cash flows } & - \$ 1,000 & \$ 410 & \$ 410 & \$ 410
\end{array}$$

Accepted Answer

A)  ?$18.89 
B)  ?$19.88 
C)  ?$20.93 
D)  ?$22.03 
E)  ?$23.13 
A)  ?$18.89 
B)  ?$19.88 
C)  ?$20.93 
D)  ?$22.03 
E)  ?$23.13

Question 11

Suppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4-year payback regardless of economic conditions.Other things held constant, which of the following statements is most likely to be true?

Accepted Answer

A)  It will accept too many long-term projects and reject too many short-term projects (as judged by the NPV). 
B)  The firm will accept too many projects in all economic states because a 4-year payback is too low. 
C)  The firm will accept too few projects in all economic states because a 4-year payback is too high. 
D)  If the 4-year payback results in accepting just the right set of projects under average economic conditions, then this payback will result in too few long-term projects when the economy is weak. 
E)  It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV). 
A)  It will accept too many long-term projects and reject too many short-term projects (as judged by the NPV). 
B)  The firm will accept too many projects in all economic states because a 4-year payback is too low. 
C)  The firm will accept too few projects in all economic states because a 4-year payback is too high. 
D)  If the 4-year payback results in accepting just the right set of projects under average economic conditions, then this payback will result in too few long-term projects when the economy is weak. 
E)  It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV).

Question 12

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

Question 13

The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects that have different lives are compared to one another.

Accepted Answer

A) True 
 B)False

Question 14

The NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, will lead to different accept/reject decisions and thus capital budgets if the cost of capital at which the projects' NPV profiles cross is less than the projects' cost of capital.

Accepted Answer

A) True 
 B)False

Question 15

Which of the following statements is CORRECT?

Accepted Answer

A)  To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the cost of capital to find the PV. 
B)  The NPV and IRR methods both assume that cash flows can be reinvested at the cost of capital.However, the MIRR method assumes reinvestment at the MIRR itself. 
C)  If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the higher IRR probably has more of its cash flows coming in the later years. 
D)  If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years. 
E)  For a project with normal cash flows, any change in the cost of capital will change both the NPV and the IRR. 
A)  To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the cost of capital to find the PV. 
B)  The NPV and IRR methods both assume that cash flows can be reinvested at the cost of capital.However, the MIRR method assumes reinvestment at the MIRR itself. 
C)  If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the higher IRR probably has more of its cash flows coming in the later years. 
D)  If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years. 
E)  For a project with normal cash flows, any change in the cost of capital will change both the NPV and the IRR.

Question 16

The cost of capital for two mutually exclusive projects that are being considered is 8%.Project K has an IRR of 20% while Project R's IRR is 15%.The projects have the same NPV at the 8% current cost of capital.However, you believe that money costs and thus your cost of capital will also increase.You also think that the projects will not be funded until the cost of capital has increased, and their cash flows will not be affected by the change in economic conditions.Under these conditions, which of the following statements is CORRECT?

Accepted Answer

A)  You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market. 
B)  You should recommend Project R, because at the new cost of capital it will have the higher NPV. 
C)  You should recommend Project K, because at the new cost of capital it will have the higher NPV. 
D)  You should recommend Project K because it has the higher IRR and will continue to have the higher IRR even at the new cost of capital. 
E)  You should reject both projects because they will both have negative NPVs under the new conditions. 
A)  You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market. 
B)  You should recommend Project R, because at the new cost of capital it will have the higher NPV. 
C)  You should recommend Project K, because at the new cost of capital it will have the higher NPV. 
D)  You should recommend Project K because it has the higher IRR and will continue to have the higher IRR even at the new cost of capital. 
E)  You should reject both projects because they will both have negative NPVs under the new conditions.

Question 17

The NPV and IRR methods, when used to evaluate two independent and equally risky projects, will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their cost of capital.

Accepted Answer

A) True 
 B)False

Question 18

Corner Jewelers, Inc.recently analyzed the project whose cash flows are shown below.However, before the company decided to accept or reject the project, the Federal Reserve changed interest rates and therefore the firm's cost of capital (r).The Fed's action did not affect the forecasted cash flows.By how much did the change in the r affect the project's forecasted NPV? Note that a project's expected NPV can be negative, in which case it should be rejected. $$\begin{array} { l c c c c } 
\text { Old r: } & 8.00 \% & \text { New r: } & 11.25 \% \
\text { Year } & 0 & 1 & 2 & 3 \
\hline  \text { Cash flows } & - \$ 1,000 & \$ 410 & \$ 410 & \$ 410
\end{array}$$

Accepted Answer

A)  ?$59.03 
B)  ?$56.08 
C)  ?$53.27 
D)  ?$50.61 
E)  ?$48.08 
A)  ?$59.03 
B)  ?$56.08 
C)  ?$53.27 
D)  ?$50.61 
E)  ?$48.08

Question 19

Under certain conditions, a project may have more than one IRR.One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project's life.

Accepted Answer

A) True 
 B)False

Question 20

Craig's Car Wash Inc.is considering a project that has the following cash flow and cost of capital (r) data.What is the project's discounted payback? $$\begin{array} { l c c c c } 
& r = 10.00 \% & & & \
\text { Year } & 0 & 1 & 2 & 3 \
\hline  \text { Cash flows } & - \$ 900 & \$ 500 & \$ 500 & \$ 500
\end{array}$$

Accepted Answer

A)  1.88 years 
B)  2.09 years 
C)  2.29 years 
D)  2.52 years 
E)  2.78 years 
A)  1.88 years 
B)  2.09 years 
C)  2.29 years 
D)  2.52 years 
E)  2.78 years

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

Which of the following statements is CORRECT?

Worthington Inc.is considering a project that has the following cash flow data.What is the project's payback? Year 0 1 2 3 Cash flows -\ 500 \ 150 \ 200 \ 300

Modern Refurbishing 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 cost of capital (and even negative), in which case it will be rejected. Year 0 1 2 3 4 Cash flows -\ 850 \ 300 \ 290 \ 280 \ 270

Normal Projects S and L have the same NPV when the discount rate is zero.However, Project S's cash flows come in faster than those of L.Therefore, we know that at any discount rate greater than zero, L will have the higher NPV.

Reed Enterprises 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 -\ 1,050 \ 450 \ 460 \ 470

Hart Corp.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 cost of capital or negative, in both cases it will be rejected. Year 0 1 2 3 Cash flows -\ 1,000 \ 425 \ 425 \ 425

When considering two mutually exclusive projects, the firm should always select the project whose internal rate of return is the highest, provided the projects have the same initial cost.This statement is true regardless of whether the projects can be repeated or not.

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?

Suppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4-year payback regardless of economic conditions.Other things held constant, which of the following statements is most likely to be true?

The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects that have different lives are compared to one another.

The NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, will lead to different accept/reject decisions and thus capital budgets if the cost of capital at which the projects' NPV profiles cross is less than the projects' cost of capital.

Which of the following statements is CORRECT?

The NPV and IRR methods, when used to evaluate two independent and equally risky projects, will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their cost of capital.

Under certain conditions, a project may have more than one IRR.One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project's life.

Craig's Car Wash Inc.is considering a project that has the following cash flow and cost of capital (r) data.What is the project's discounted payback? r=10.00\% Year 0 1 2 3 Cash flows -\ 900 \ 500 \ 500 \ 500

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risk and Return

Corporate Valuation and Stock Valuation

Financial Options and Applications in Corporate Finance

The Cost of Capital

Cash Flow Estimation and Risk Analysis

Corporate Valuation and Financial Planning

Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Dynamic Capital Structures and Corporate Valuation

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, Reorganization, and Liquidation

Portfolio Theory and Asset Pricing Models

Real Options

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not-For-Profit Businesses

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