Exam 10: The basics of capital budgeting: evaluating cash flows

Consider two projects, X and Y.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?

Reed Enterprises is considering a project that has the following cash flow and WACC data.What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.

Kiley Electronics 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 WACC (and even negative), in which case it will be rejected.

Which of the following statements is CORRECT?

Carolina 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.

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.

Worthington Inc.is considering a project that has the following cash flow data.What is the project's payback?

No conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, if the projects' cost of capital exceeds the rate at which the projects' NPV profiles cross.

Assuming that their NPVs based on the firm's cost of capital are equal, the NPV of a project whose cash flows accrue relatively rapidly will be more sensitive to changes in the discount rate than the NPV of a project whose cash flows come in later in its life.

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.

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.

Farmer Co.is considering Projects S and L, whose cash flows are shown below.These projects are mutually exclusive, equally risky, and not repeatable.If the decision is made by choosing the project with the shorter payback, some value may be forgone.How much value will be lost in this instance? Note that under some conditions choosing projects on the basis of the shorter payback will not cause value to be lost.

Craig's Car Wash Inc.is considering a project that has the following cash flow and WACC data.What is the project's discounted payback?

Both the regular and the modified IRR (MIRR)methods have wide appeal to professors, but most business executives prefer the NPV method to either of the IRR methods.

Garner Inc.is considering a project that has the following cash flow data.What is the project's payback?

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.

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 WACC.The Fed's action did not affect the forecasted cash flows.By how much did the change in the WACC affect the project's forecasted NPV? Note that a project's expected NPV can be negative, in which case it should be rejected.

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

Which of the following statements is CORRECT?