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

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 outflow followed by a series of inflows.

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.

Which of the following statements is CORRECT?

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.

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.

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?

Which of the following statements is CORRECT?

A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC).

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.

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?

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.

Other things held constant,an increase in the cost of capital will result in a decrease in a project's IRR.

Clifford Company is choosing between two projects.The larger project has an initial cost of $100,000,annual cash flows of $30,000 for 5 years,and an IRR of 15.24%.The smaller project has an initial cost of $50,000,annual cash flows of $16,000 for 5 years,and an IRR of 16.63%.The projects are equally risky.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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.

The NPV method is based on the assumption that projects' cash flows are reinvested at the project's risk-adjusted cost of capital.

Projects S and L are both normal projects with 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 cost of capital of 10%,the two projects have identical NPVs.Which project's NPV is more sensitive to changes in the cost of capital?

The NPV method's assumption that cash inflows are reinvested at the cost of capital is generally more reasonable than the IRR's assumption that cash flows are reinvested at the IRR.This is an important reason why the NPV method is generally preferred over the IRR method.