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

ZumBahlen Inc. is considering the following mutually exclusive projects: At what cost of capital will the NPV of the two projects be the same? (That is, what is the "crossover" rate?)

Walker & Campsey wants to invest in a new computer system, and management has narrowed the choice to Systems A and B. System A requires an up-front cost of $100,000, after which it generates positive after-tax cash flows of $60,000 at the end of each of the next two years. System B also requires an up-front cost of $100,000, after which it generates positive after-tax cash flows of $48,000 at the end of each of the next three years. The company's cost of capital is 11%. Based on the equivalent annual annuity, which system will be chosen?

Which of the following statements is correct?

Humboldt Inc. 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 projected NPV is negative, it should be rejected.

Financing pressure or liquidity can explains the popular use of payback period in project appraisals for small firms.

The Bank of Canada recently shifted its monetary policy, causing Lasik Vision's WACC to change. Lasik had recently analyzed the project whose cash flows are shown below. However, the CFO wants to reconsider this and all other proposed projects in view of the Bank of Canada's action. How much did the changed WACC cause the forecasted NPV to change? Assume that the Bank of Canada's action does not affect the cash flows, and note that a project's projected NPV can be negative, in which case it should be rejected.

Aubey Inc. is considering two projects that have the following cash flows: At what cost of capital would the two projects have the same NPV?

You are on the staff of Camden Inc. The CFO believes project acceptance should be based on the NPV, but Steve Camden, the president, insists that no project can be accepted unless its IRR exceeds the project's risk-adjusted WACC. 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 WACC 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 5.27%, 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?

Tucker Corp. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be negative, in which case it will be rejected.

When considering two mutually exclusive projects, the firm should always select that project whose IRR 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.

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 WACC is 10%, Project Y has a higher NPV than X. Given this information, which of the following statements is correct?

Which of the following statements is correct?

The MIRR method has wide appeal for professors, but most business executives prefer the NPV method to either the regular or MIRR.

Steve Hawke is a football star who has been offered contracts by two different teams. The payments (in millions of dollars) under the two contracts are shown below: Steve plans to accept the contract that provides him with the highest NPV. At what discount rate would he be indifferent between the two contracts?

Assume a project has normal cash flows. All else being equal, which of the following statements is correct?

When evaluating mutually exclusive projects, the 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.

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%. Which of the following statements is correct?

The regular payback method has a number of disadvantages, some of which are listed below. Which of these items is NOT a disadvantage of this method?

Which of the following statements is correct? Assume that all projects being considered have normal cash flows and are equally risky.

A small manufacturer is considering two alternative machines. Machine A costs $1.0 million, has an expected life of 5 years, and generates after-tax cash flows of $350,000 per year. At the end of 5 years, the salvage value of the machine is zero, but the company will be able to purchase another Machine A at a cost of $1.2 million. The second Machine A will generate after-tax cash flows of $375,000 a year for another 5 years, at which time its salvage value will again be zero. Alternatively, the company can buy Machine B at a cost of $1.5 million today. Machine B will produce after-tax cash flows of $400,000 a year for 10 years, after which it will have an after-tax salvage value of $100,000. Assume that the cost of capital is 12%. Based on the equivalent annual annuity, if the company chooses the machine that adds the most value to the firm, by how much will the company's value increase per year?