Exam 10: Capital Budgeting

Barry Company 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.

Ehrmann Data Systems is considering a project that has the following cash flow and WACC data.What is the project's MIRR? Note that a project's MIRR can be less than the WACC (and even negative), in which case it will be rejected.

Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method ranks the other one first.In theory, such conflicts should be resolved in favor of the project with the higher positive IRR.

Which of the following statements is CORRECT?

Assume that the economy is enjoying a strong boom, and as a result interest rates and money costs generally are relatively high.The WACC for two mutually exclusive projects that are being considered is 12%.Project S has an IRR of 20% while Project L's IRR is 15%.The projects have the same NPV at the 12% current WACC.However, you believe that the economy will soon fall into a mild recession, and money costs and thus your WACC will soon decline.You also think that the projects will not be funded until the WACC has decreased, and their cash flows will not be affected by the change in economic conditions.Under these conditions, which of the following statements is CORRECT?

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?

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.

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 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. Old WACC: 8.00\% New WACC: 8.50\% Year 0 1 2 3 Cash flows -\ 1,000 \ 410 \ 410 \ 410

internal rate of return is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows.

NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, will lead to different accept/reject decisions and thus capital budgets if the cost of capital at which the projects' NPV profiles cross is less than the projects' 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.

evaluating mutually exclusive projects, the modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method, regardless of the relative lives or sizes of the projects being evaluated.

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.

Assume that the economy is in a mild recession, and as a result interest rates and money costs generally are relatively low.The WACC for two mutually exclusive projects that are being considered is 8%.Project S has an IRR of 20% while Project L's IRR is 15%.The projects have the same NPV at the 8% current WACC.However, you believe that the economy is about to recover, and money costs and thus your WACC will also increase.You also think that the projects will not be funded until the WACC has increased, and their cash flows will not be affected by the change in economic conditions.Under these conditions, which of the following statements is CORRECT?

Tesar Chemicals is considering Projects S and L, whose cash flows are shown below.These projects are mutually exclusive, equally risky, and not repeatable.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. WACC: 7.50% Year 0 1 2 3 4 CFS -$1,100 $550 $600 $100 $100 CFL -$2,700 $650 $725 $800 $1,400

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.

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

regular payback method is deficient in that it does not take account of cash flows beyond the payback period.The discounted payback method corrects this fault.

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.

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?