Exam 11: The Basics of Capital Budgeting

If the IRR of normal Project X is greater than the IRR of mutually exclusive (and also normal) Project Y, we can conclude that the firm should always select X rather than Y if X has NPV > 0.

You are considering two mutually exclusive, equally risky, projects. Both have IRRs that exceed the WACC. Which of the following statements is CORRECT? Assume that the projects have normal cash flows, with one outflow followed by a series of inflows.

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?

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

One advantage of the payback method for evaluating potential investments is that it provides information about a project's liquidity and risk.

Which of the following statements is CORRECT?

Warnock 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 projected NPV can be negative, in which case it will be rejected. WACC: $\quad 10.00 \%$ Year Cash flows 0 - \9 50 1 \5 00 2 \4 00 3 \3 00 a $\$ 54.62$ b. $\$ 57.49$ c. $\$ 60.52$ d. $\$ 63.54$ e. $\$ 66.72$

For a project with one initial cash outflow followed by a series of positive cash inflows, the modified IRR (MIRR) method involves compounding the cash inflows out to the end of the project's life, summing those compounded cash flows to form a terminal value (TV), and then finding the discount rate that causes the PV of the TV to equal the project's cost.

Mansi Inc. is considering a project that has the following cash flow data. What is the project's payback? Year Cash flows 0 - \7 50 1 \3 00 2 \3 25 3 \3 50 a $1.91$ years b. $2.12$ years c. $2.36$ years d. $2.59$ years e. $2.85$ years

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?

Simms 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 less than the WACC or negative, in both cases it will be rejected. Year Cash flows 0 - \1 ,000 1 \4 25 2 \4 25 3 \4 25 a. $12.55 \%$ b. $13.21 \%$ c. $13.87 \%$ d. $14.56 \%$ e. $15.29 \%$

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 costs of capital.

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.

Resnick Inc. is considering a project that has the following cash flow data. What is the project's payback? Year Cash flows 0 - \3 50 1 \2 00 2 \2 00 3 \2 00 a. $1.42$ years b. $1.58$ years c. $1.75$ years d. $1.93$ years e. $2.12$ years

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.

Assume that the economy is in a mild recession, and as a result interest rates and money costs generally are relatively low. The WACC for two mutually exclusive projects that are being considered is 8%. Project S has an IRR of 20% while Project L's IRR is 15%. The projects have the same NPV at the 8% current WACC. However, you believe that the economy is about to recover, and money costs and thus your WACC will also increase. You also think that the projects will not be funded until the WACC 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?

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

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 should 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 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?

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.