Question 1

Levin Company 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 negative, in which case it will be rejected.

Accepted Answer

A)   15.94%
B)   17.71%
C)   19.68%
D)   21.86% D

Question 2

The NPV and IRR methods, when used to evaluate INDEPENDENT AND EQUALLY RISKY
projects, will lead to different accept/reject decisions if their IRRs are greater than the cost of capital.

Accepted Answer

A) True 
 B)False  False

Question 3

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)   If Project A has a higher IRR than Project B, then Project A must have the lower NPV.
B)   If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.
C)   The IRR calculation implicitly assumes that all cash flows are reinvested at the WACC.
D)   If a project has normal cash flows and its IRR exceeds its WACC, then the project's NPV must be positive. D

Question 4

Frye Foods 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 negative, in which case it will be rejected.

Accepted Answer

A)   18.72%
B)   19.65%
C)   20.64%
D)   21.67%

Question 5

Which of the following statements best describes multiple IRRs?

Accepted Answer

A)   For a project to have more than one IRR, both IRRs must be greater than the WACC.
B)   If two projects are mutually exclusive, then they are likely to have multiple IRRs.
C)   If a project is independent, then it cannot have multiple IRRs.
D)   Multiple IRRs can occur only if the signs of the cash flows change more than once.

Question 6

Mills Corp. is considering two mutually exclusive machines. Machine A requires an up-front expenditure at t = 0 of $450,000, has an expected life of two years, and will generate positive after-tax cash flows of $350,000 per year (all cash flows are realized at the end of the year) for two years. At the end of two years, the machine will have zero salvage value, but every two years the company can purchase a replacement machine with the same cost and identical cash inflows. Alternatively, it can choose Machine B, which requires an expenditure of $1 million at t = 0, has an expected life of four years, and will generate positive after-tax cash flows of $350,000 per year (all cash flows are realized at year-end). At the end of four years, Machine B will have an after-tax salvage value of $100,000.
The cost of capital is 10%. What is the NPV (on an extended four-year life) of the better machine?

Accepted Answer

A)   $157,438
B)   $177,754
C)   $287,552
D)   $355,508

Question 7

Yonan Inc. 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.

Accepted Answer

A)   $55.16
B)   $66.42
C)   $78.79
D)   $93.16

Question 8

If a firm is experiencing no capital rationing, it should accept all investment proposals whose accounting rate of return is equal to or greater than the weighted average cost of capital.

Accepted Answer

A) True 
 B)False

Question 9

Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project's life.

Accepted Answer

A) True 
 B)False

Question 10

Projects C and D are mutually exclusive and have normal cash flows. Project C has a higher NPV if the WACC is less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is correct?

Accepted Answer

A)   Project D has a higher IRR.
B)   Project D is probably larger in scale than Project C.
C)   Project C probably has a faster payback.
D)   Project C has a higher IRR.

Question 11

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.

Accepted Answer

A) True 
 B)False

Question 12

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

Accepted Answer

A)   2.34 years
B)   2.60 years
C)   2.89 years
D)   3.21 years

Question 13

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.

Question 14

Choi 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.

Accepted Answer

A)   13.89%
B)   15.43%
C)   17.15%
D)   19.05%

Question 15

Selecting the project that has the highest equivalent annual annuity seems to be the rule for comparing projects with different lives. This rule should apply to both independent and mutually exclusive projects.

Accepted Answer

A) True 
 B)False

Question 16

Westchester Corp. is considering two equally risky, mutually exclusive projects, both of which have normal cash flows. Project A has an IRR of 11%, while Project B's IRR is 14%. When the WACC is 8%, the projects have the same NPV. Given this information, which of the following statements is correct?

Accepted Answer

A)   If the WACC is 13%, Project A's NPV will be higher than Project B's.
B)   If the WACC is 9%, Project A's NPV will be higher than Project B's.
C)   If the WACC is 6%, Project B's NPV will be higher than Project A's.
D)   If the WACC is 9%, Project B's NPV will be higher than Project A's.

Question 17

Because "present value" refers to the value of cash flows that occur at different points in time, a series of present values should not be summed to determine the value of a capital budgeting project.

Accepted Answer

A) True 
 B)False

Question 18

The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects that have different lives are being compared.

Accepted Answer

A) True 
 B)False

Question 19

Pinkerton Truck Rental is considering two mutually exclusive engine development projects. The RPX design has an expected life of four years and projected cash inflows are $3.6 million at the end of each of the first two years and $1.8 million in each of the next two years. The RPB design is more flexible and has an eight-year life. The projected end-of-year flows from the RPB design are $2.4 million in each of the first two years and $2.0 million in each of the next six years. Both projects require an initial investment of $5.4 million, and Pinkerton's cost of capital is 12%. What is the NPV (on an eight-year extended basis) of the project with the most value to the company?

Accepted Answer

A)   $3.976 million
B)   $4.325 million
C)   $5.085 million
D)   $5.211 million

Question 20

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

Accepted Answer

A)   2.12 years
B)   2.35 years
C)   2.59 years
D)   2.85 years

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

Levin Company 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 negative, in which case it will be rejected.

The NPV and IRR methods, when used to evaluate INDEPENDENT AND EQUALLY RISKY projects, will lead to different accept/reject decisions if their IRRs are greater than the cost of capital.

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.

Frye Foods 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 negative, in which case it will be rejected.

Which of the following statements best describes multiple IRRs?

If a firm is experiencing no capital rationing, it should accept all investment proposals whose accounting rate of return is equal to or greater than the weighted average cost of capital.

Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project's life.

Projects C and D are mutually exclusive and have normal cash flows. Project C has a higher NPV if the WACC is less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is correct?

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.

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

Choi 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.

Selecting the project that has the highest equivalent annual annuity seems to be the rule for comparing projects with different lives. This rule should apply to both independent and mutually exclusive projects.

Westchester Corp. is considering two equally risky, mutually exclusive projects, both of which have normal cash flows. Project A has an IRR of 11%, while Project B's IRR is 14%. When the WACC is 8%, the projects have the same NPV. Given this information, which of the following statements is correct?

Because "present value" refers to the value of cash flows that occur at different points in time, a series of present values should not be summed to determine the value of a capital budgeting project.

The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects that have different lives are being compared.

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