Question 1

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.

Accepted Answer

A) True 
 B)False

Question 2

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

Question 3

Which of the following statements is CORRECT?

Accepted Answer

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

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)  The discounted payback method recognizes all cash flows over a project's life, and it also adjusts these cash flows to account for the time value of money. 
B)  The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today. 
C)  The regular payback is useful as an indicator of a project's liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project. 
D)  The regular payback does not consider cash flows beyond the payback year, but the discounted payback overcomes this defect. 
E)  The regular payback method recognizes all cash flows over a project's life.

Question 5

Markman & Sons is considering Projects S and L.These projects are mutually exclusive, equally risky, and not repeatable and their cash flows are shown below.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, i.e., no conflict will exist. $$\begin{array} { c c c c c c } 
 { \mathrm { r } : 10.00 \% } & & & \
\text { Y ear } & 0 & 1 & 2 & 3 & 4 \
\hline  \mathrm { CF } _ { \mathrm { S } } & - \$ 1,025 & \$ 650 & \$ 450 & \$ 250 & \$ 50 \
\mathrm { CF } _ { \mathrm { L } } & - \$ 1,025 & \$ 100 & \$ 300 & \$ 500 & \$ 700
\end{array}$$

Accepted Answer

A)  $5.47 
B)  $6.02 
C)  $6.62 
D)  $7.29 
E)  $7.82

Question 6

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 regular IRR is found by discounting the cash inflows at the cost of capital to find the present value (PV), then compounding this PV to find the IRR. 
B)  If a project's IRR is greater than the WACC, then its NPV must be negative. 
C)  To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs. 
D)  To find a project's IRR, we must find a discount rate that is equal to the cost of capital. 
E)  A project's regular IRR is found by compounding the cash inflows at the cost of capital to find the terminal value (TV), then discounting this TV at the cost of capital.

Question 7

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

Accepted Answer

A) True 
 B)False

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

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.

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.

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.

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