Question 1

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

Accepted Answer

A) True 
 B)False

Question 2

The primary reason that the NPV method is conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist, and when that happens, we don't know which IRR is relevant.

Accepted Answer

A) True 
 B)False

Question 3

Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows and are equally risky.

Accepted Answer

A)  If a project's IRR is equal to its WACC, then, under all reasonable conditions, the project's NPV must be negative. 
B)  If a project's IRR is equal to its WACC, then under all reasonable conditions, the project's IRR must be negative. 
C)  If a project's IRR is equal to its WACC, then under all reasonable conditions the project's NPV must be zero. 
D)  There is no necessary relationship between a project's IRR, its WACC, and its NPV. 
E)  When evaluating mutually exclusive projects, those projects with relatively long lives will tend to have relatively high NPVs when the cost of capital is relatively high.

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)  One defect of the IRR method versus the NPV is that the IRR does not take account of cash flows over a project's full life. 
B)  One defect of the IRR method versus the NPV is that the IRR does not take account of the time value of money. 
C)  One defect of the IRR method versus the NPV is that the IRR does not take account of the cost of capital. 
D)  One defect of the IRR method versus the NPV is that the IRR values a dollar received today the same as a dollar that will not be received until sometime in the future. 
E)  One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects.

Question 5

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.

Accepted Answer

A) True 
 B)False

Question 6

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

Accepted Answer

A) True 
 B)False

Question 7

Lasik Vision Inc. recently analyzed the project whose cash flows are shown below. However, before Lasik decided to accept or reject the project, the Federal Reserve took actions that 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 projected NPV can be negative, in which case it should be rejected. $\begin{array} { l l l l } \text { Old WACC: } & 8.00 \% & \text { New WACC: } & 11.25 \% \end{array}$

$\begin{array}{c}
\begin{array}{lll}
 \text {Year}\
\text {Cash flows}
\end{array}
\begin{array}{c}
 0 \
\hline -\$1,00
\end{array}
\begin{array}{c}
1 \
\hline \$41
\end{array}
\begin{array}{c}
2 \
\hline \$410
\end{array}
\begin{array}{c}
3 \
\hline \$410
\end{array}
\end{array}$

a. $- \$ 59.03$
b. $- \$ 56.08$
c. $- \$ 53.27$
d. $- \$ 50.61$
e. $- \$ 48.08$

Accepted Answer

The answer of Lasik Vision Inc. recently analyzed the project...

Question 8

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)  The IRR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business. 
E)  If a project has normal cash flows and its IRR exceeds its WACC, then the project's NPV must be positive.

Question 9

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.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)  For a project to have more than one IRR, then 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 only occur if the signs of the cash flows change more than once. 
E)  If a project has two IRRs, then the smaller one is the one that is most relevant, and it should be accepted and relied upon.

Question 11

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

Question 12

Maxwell Feed & Seed 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. $\begin{array}{c}
\begin{array}{lll}
 \text {Year}\
\text {Cash flows}
\end{array}
\begin{array}{c}
 0 \
\hline -\$9,500
\end{array}
\begin{array}{c}
1 \
\hline \$2,000
\end{array}
\begin{array}{c}
2 \
\hline \$2,025
\end{array}
\begin{array}{c}
3 \
\hline \$2,050
\end{array}
\begin{array}{c}
4 \
\hline \$2,075
\end{array}
\begin{array}{c}
5 \
\hline \$32,100
\end{array}
\end{array}$

a $2.08 \%$
b. $2.31 \%$
c. $2.57 \%$
d. $2.82 \%$
e. $3.10 \%$

Accepted Answer

The answer of Maxwell Feed & Seed is considering a...

Question 13

Projects A and B have identical expected lives and identical initial cash outflows (costs). However, most of one project's cash flows come in the early years, while most of the other project's cash flows occur in the later years. The two NPV profiles are given below:  Which of the following statements is CORRECT?

Accepted Answer

A)  More of Project A's cash flows occur in the later years. 
B)  More of Project B's cash flows occur in the later years. 
C)  We must have information on the cost of capital in order to determine which project has the larger early cash flows. 
D)  The NPV profile graph is inconsistent with the statement made in the problem. 
E)  The crossover rate, i.e., the rate at which Projects A and B have the same NPV, is greater than either project's IRR.

Question 14

Last month, Lloyd's Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project, the Federal Reserve took actions that 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 projected NPV can be negative, in which case it should be rejected. $\begin{array} { l c c c c c } 
\text { Old WACC: } & 10.00 \% & { \text { New WACC: } 11.25 \% } \end{array}$

$\begin{array}{c}
\begin{array}{lll}
 \text {Year}\
\text {Cash flows}
\end{array}
\begin{array}{c}
 0 \
\hline -\$1,100
\end{array}
\begin{array}{c}
1 \
\hline \$410
\end{array}
\begin{array}{c}
2 \
\hline \$410
\end{array}
\begin{array}{c}
3 \
\hline \$410
\end{array}
\end{array}$

$\begin{array} { l c c c c c } \text { Old NPV } =  \$ 19.61 & & & & \
\text { New NPV } = - \$ 2.42 & & & & \
\hline \text { Change } = - \$ 22.03 & & & &\end{array}$

Accepted Answer

The answer of Last month, Lloyd's Systems analyzed the project...

Exam 11: The Basics of Capital Budgeting

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

The primary reason that the NPV method is conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist, and when that happens, we don't know which IRR is relevant.

Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows and are equally risky.

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.

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

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.

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.