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

In theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital.The decision criterion should not be affected by managers' tastes, choice of accounting method, or the profitability of other independent projects.

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

Normal Projects S and L have the same NPV when the discount rate is zero.However, Project S's cash flows come in faster than those of L.Therefore, we know that at any discount rate greater than zero, L will have the higher NPV.

Pet World 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.

Current Design Co.is considering two mutually exclusive, equally risky, and not repeatable projects, S and L.Their cash flows are shown below.The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV.If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1)"true value" is measured by NPV, and (2)under some conditions the choice of IRR vs.NPV will have no effect on the value gained or lost.

Projects S and L, whose cash flows are shown below, are mutually exclusive, equally risky, and not repeatable.Hooper Inc.is considering which of these two projects to undertake.If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV, so no value will be lost if the IRR method is used.

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?

Shannon Co.is considering a project that has the following cash flow and WACC data.What is the project's discounted payback?