Question 1

A basic rule in capital budgeting is that if a project's NPV exceeds its IRR, then the project should be accepted.

Accepted Answer

A) True 
 B)False

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

Thorley Inc. 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. $\begin{array}{c}
\begin{array}{lll}
 \text {Year}\
\text {Cash flows}
\end{array}
\begin{array}{lll}
 0 \
\hline -\$1,250
\end{array}
\begin{array}{lll}
1 \
\hline \$325
\end{array}
\begin{array}{lll}
2 \
\hline \$325
\end{array}
\begin{array}{lll}
3 \
\hline \$325
\end{array}
\begin{array}{lll}
4 \
\hline \$325
\end{array}
\begin{array}{lll}
5 \
\hline \$325
\end{array}
\end{array}$

a. $9.43 \%$
b. $9.91 \%$
c. $10.40 \%$
d. $10.92 \%$
e. $11.47 \%$

Accepted Answer

The answer of Thorley Inc. is considering a project that...

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)  An NPV profile graph shows how a project's payback varies as the cost of capital changes. 
B)  The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases. 
C)  An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life. 
D)  An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital. 
E)  We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV. 
A)  An NPV profile graph shows how a project's payback varies as the cost of capital changes. 
B)  The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases. 
C)  An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life. 
D)  An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital. 
E)  We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV.

Question 5

Small businesses make less use of DCF capital budgeting techniques than large businesses. This may reflect a lack of knowledge on the part of small firms' managers, but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for very small firms.

Accepted Answer

A) True 
 B)False

Question 6

Which of the following statements is CORRECT?

Accepted Answer

A)  The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR. 
B)  The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR. 
C)  The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate. 
D)  The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period. 
E)  The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period. 
A)  The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR. 
B)  The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR. 
C)  The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate. 
D)  The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period. 
E)  The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period.

Question 7

Four of the following statements are truly disadvantages of the regular payback method, but one is not a disadvantage of this method. Which one is NOT a disadvantage of the payback method?

Accepted Answer

A)  Lacks an objective, market-determined benchmark for making decisions. 
B)  Ignores cash flows beyond the payback period. 
C)  Does not directly account for the time value of money. 
D)  Does not provide any indication regarding a project's liquidity or risk. 
E)  Does not take account of differences in size among projects. 
A)  Lacks an objective, market-determined benchmark for making decisions. 
B)  Ignores cash flows beyond the payback period. 
C)  Does not directly account for the time value of money. 
D)  Does not provide any indication regarding a project's liquidity or risk. 
E)  Does not take account of differences in size among projects.

Question 8

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 payback criterion 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 payback criterion 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 9

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 10

Kosovski Company is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and are not repeatable. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under some conditions choosing projects on the basis of the IRR will cause $0.00 value to be lost. WACC:$\quad $$7.75 \%$

$\begin{array}{c}
\begin{array}{lll}
 \text {Year}\
 \text {CF}_{S} \
 \text {CF}_{L} 
\end{array}
\begin{array}{c}
 0 \
\hline -\$1,050\
-\$1,050
\end{array}
\begin{array}{c}
1 \
\hline \$675\
360
\end{array}
\begin{array}{c}
2 \
\hline \$650\
\$360
\end{array}
\begin{array}{c}
3 \
\hline \
\$360
\end{array}
\begin{array}{c}
4 \
\hline \
\$360
\end{array}
\end{array}$

a. $\$ 11.45$
b. $\$ 12.72$
c. $\$ 14.63$
d. $\$ 16.82$
e. $\$ 19.35$

Accepted Answer

The answer of Kosovski Company is considering Projects S and...

Question 11

Projects S and L both have normal cash flows, and the projects have the same risk, hence both are evaluated with the same WACC, 10%. However, S has a higher IRR than L. Which of the following statements is CORRECT?

Accepted Answer

A)  Project S must have a higher NPV than Project L. 
B)  If Project S has a positive NPV, Project L must also have a positive NPV. 
C)  If the WACC falls, each project's IRR will increase. 
D)  If the WACC increases, each project's IRR will decrease. 
E)  If Projects S and L have the same NPV at the current WACC, 10%, then Project L, the one with the lower IRR, would have a higher NPV if the WACC used to evaluate the projects declined. 
A)  Project S must have a higher NPV than Project L. 
B)  If Project S has a positive NPV, Project L must also have a positive NPV. 
C)  If the WACC falls, each project's IRR will increase. 
D)  If the WACC increases, each project's IRR will decrease. 
E)  If Projects S and L have the same NPV at the current WACC, 10%, then Project L, the one with the lower IRR, would have a higher NPV if the WACC used to evaluate the projects declined.

Question 12

Ehrmann Data Systems is considering a project that has the following cash flow and WACC data. What is the project's MIRR? Note that a project's projected MIRR can be less than the WACC (and even negative), in which case it will be rejected. WACC: $\quad 10.00 \%$
$\begin{array}{c}
\begin{array}{lll}
 \text {Year}\
\text {Cash flows}
\end{array}
\begin{array}{c}
 0 \
\hline -\$1,000
\end{array}
\begin{array}{c}
1 \
\hline \$450
\end{array}
\begin{array}{c}
2 \
\hline \$450
\end{array}
\begin{array}{c}
3 \
\hline \$450
\end{array}
\end{array}$

a. $9.32 \%$
b. $10.35 \%$
c. $11.50 \%$
d. $12.78 \%$
e. $14.20 \%$

Accepted Answer

The answer of Ehrmann Data Systems is considering a project...

Question 13

Which of the following statements is CORRECT?

Accepted Answer

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

Question 14

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.

Accepted Answer

A) True 
 B)False

Question 15

Datta Computer Systems 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 (and even negative), in which case it will be rejected. $\begin{array}{c}
\begin{array}{lll}
 \text {Year}\
\text {Cash flows}
\end{array}
\begin{array}{lll}
 0 \
\hline -\$1,100
\end{array}
\begin{array}{lll}
1 \
\hline \$450
\end{array}
\begin{array}{lll}
2 \
\hline \$470
\end{array}
\begin{array}{lll}
3 \
\hline \$490
\end{array}
\end{array}$

a. $9.70 \%$
b. $10.78 \%$
c. $11.98 \%$
d. $13.31 \%$
e. $14.64 \%$

Accepted Answer

The answer of Datta Computer Systems is considering a project...

Question 16

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 17

Assume that the economy is enjoying a strong boom, and as a result interest rates and money costs generally are relatively high. The WACC for two mutually exclusive projects that are being considered is 12%. Project S has an IRR of 20% while Project L's IRR is 15%. The projects have the same NPV at the 12% current WACC. However, you believe that the economy will soon fall into a mild recession, and money costs and thus your WACC will soon decline. You also think that the projects will not be funded until the WACC 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?

Accepted Answer

A)  You should reject both projects because they will both have negative NPVs under the new conditions. 
B)  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. 
C)  You should recommend Project L, because at the new WACC it will have the higher NPV. 
D)  You should recommend Project S, because at the new WACC it will have the higher NPV. 
E)  You should recommend Project L because it will have both a higher IRR and a higher NPV under the new conditions. 
A)  You should reject both projects because they will both have negative NPVs under the new conditions. 
B)  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. 
C)  You should recommend Project L, because at the new WACC it will have the higher NPV. 
D)  You should recommend Project S, because at the new WACC it will have the higher NPV. 
E)  You should recommend Project L because it will have both a higher IRR and a higher NPV under the new conditions.

Question 18

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 NPV is generally found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting the TV at the IRR to find its PV. 
B)  The higher the WACC used to calculate the NPV, the lower the calculated NPV will be. 
C)  If a project's NPV is greater than zero, then its IRR must be less than the WACC. 
D)  If a project's NPV is greater than zero, then its IRR must be less than zero. 
E)  The NPVs of relatively risky projects should be found using relatively low WACCs. 
A)  A project's NPV is generally found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting the TV at the IRR to find its PV. 
B)  The higher the WACC used to calculate the NPV, the lower the calculated NPV will be. 
C)  If a project's NPV is greater than zero, then its IRR must be less than the WACC. 
D)  If a project's NPV is greater than zero, then its IRR must be less than zero. 
E)  The NPVs of relatively risky projects should be found using relatively low WACCs.

Question 19

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 projected NPV can be negative, in which case it will be rejected. WACC:$\quad $$14.00 \%$ 
$\begin{array}{c}
\begin{array}{lll}
 \text {Year}\
\text {Cash flows}
\end{array}
\begin{array}{lll}
 0 \
\hline -\$1,200 
\end{array}
\begin{array}{lll}
1 \
\hline \$400
\end{array}
\begin{array}{lll}
2 \
\hline \$425
\end{array}
\begin{array}{lll}
3 \
\hline \$450
\end{array}
\begin{array}{lll}
4 \
\hline \$475
\end{array}
\end{array}$

a $\$ 41.25$
b. $\$ 45.84$
c. $\$ 50.93$
d. $\$ 56.59$
e. $\$ 62.88$

Accepted Answer

The answer of Jazz World Inc. is considering a project...

Question 20

If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital, the payback method and NPV method would always lead to the same decision on which project to undertake.

Accepted Answer

A) True 
 B)False

A basic rule in capital budgeting is that if a project's NPV exceeds its IRR, then the project should be accepted.

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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Four of the following statements are truly disadvantages of the regular payback method, but one is not a disadvantage of this method. Which one is NOT a disadvantage of the payback method?

Which of the following statements is CORRECT?

Projects S and L both have normal cash flows, and the projects have the same risk, hence both are evaluated with the same WACC, 10%. However, S has a higher IRR than L. Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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.

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.

If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital, the payback method and NPV method would always lead to the same decision on which project to undertake.

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

The Value of Money

Interest Rates

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

Cash Flow Estimation and Risk Analysis

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Multinational Financial Management

Financial and Operating Leverage: Analysis and Calculation

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Exam 11: The Basics of Capital Budgeting

A basic rule in capital budgeting is that if a project's NPV exceeds its IRR, then the project should be accepted.

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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Four of the following statements are truly disadvantages of the regular payback method, but one is not a disadvantage of this method. Which one is NOT a disadvantage of the payback method?

Which of the following statements is CORRECT?

Projects S and L both have normal cash flows, and the projects have the same risk, hence both are evaluated with the same WACC, 10%. However, S has a higher IRR than L. Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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.

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.

If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital, the payback method and NPV method would always lead to the same decision on which project to undertake.

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

The Value of Money

Interest Rates

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

Cash Flow Estimation and Risk Analysis

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Multinational Financial Management

Financial and Operating Leverage: Analysis and Calculation

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