Exam 12: Capital Budgeting: Decision Criteria

A company just paid $10 million for a feasibility study. If the company goes ahead with the project, it must immediately spend another $100 million now, and then spend $20 million in one year. In two years it will receive $80 million, and in three years it will receive $90 million. If the cost of capital for the project is 11 percent, what are the project's NPV and IRR?

If a project's NPV exceeds the project's IRR, then the project should be accepted.

Normal projects C and D are mutually exclusive. Project C has a higher net present value if the WACC is less than 12 percent, whereas Project D has a higher net present value if the WACC exceeds 12 percent. Both projects have a positive NPV if the WACC is 12 percent. Which of the following statements is most correct?

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

Michigan Mattress Company is considering the purchase of land and the construction of a new plant. The land, which would be bought immediately (at t = 0), has a cost of $100,000 and the building, which would be erected at the end of the first year (t = 1), would cost $500,000. It is estimated that the firm's after-tax cash flow will be increased by $100,000 starting at the end of the second year, and that this incremental flow would increase at a 10 percent rate annually over the next 10 years. What is the approximate payback period?

Your assistant has just completed an analysis of two mutually exclusive projects. You must now take her report to a board of directors meeting and present the alternatives for the board's consideration. To help you with your presentation, your assistant also constructed a graph with NPV profiles for the two projects. However, she forgot to label the profiles, so you do not know which line applies to which project. Of the following statements regarding the profiles, which one is most reasonable?

Project A has an IRR of 15 percent. Project B has an IRR of 18 percent. Both projects have the same risk. Which of the following statements is most correct?

When considering two mutually exclusive projects, the financial manager should always select that project whose internal rate of return is the highest provided the projects have the same initial cost.

Which of the following statements is correct?

Which of the following statements is most correct?

Projects L and S each have an initial cost of $10,000, followed by a series of positive cash inflows. Project L has total, undiscounted cash inflows of $16,000, while S has total undiscounted inflows of $15,000. Further, at a discount rate of 10 percent, the two projects have identical NPVs. Which project's NPV will be more sensitive to changes in the discount rate? (Hint: Projects with steeper NPV profiles are more sensitive to discount rate changes.)

Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large cash flows late in its life. At the current cost of capital, normal Projects S and L have identical NPVs. Now suppose interest rates and money costs generally decline. Other things held constant, this change will cause L to become preferred to S.

Which of the following statements is most correct? The modified IRR (MIRR) method:

You are considering the purchase of an investment that would pay you $5,000 per year for Years 1-5, $3,000 per year for Years 6-8, and $2,000 per year for Years 9 and 10. If you require a 14 percent rate of return, and the cash flows occur at the end of each year, then how much should you be willing to pay for this investment?

Houston Inc. is considering a project which involves building a new refrigerated warehouse which will cost $7,000,000 at t = 0 and which is expected to have operating cash flows of $500,000 at the end of each of the next 20 years. However, repairs which will cost $1,000,000 must be incurred at the end of the 10th year. Thus, at the end of Year 10 there will be a $500,000 operating cash inflow and an outflow of -$1,000,000 for repairs. If Houston's cost of capital is 12 percent, what is the project's MIRR? (Hint: Think carefully about the MIRR equation and the treatment of cash outflows.)

Which of the following statements is most correct?

Which of the following statements is incorrect?

Project X has an internal rate of return of 20 percent. Project Y has an internal rate of return of 15 percent. Both projects have a positive net present value. Which of the following statements is most correct?

The main reason that the NPV method is regarded as being conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist.

Which of the following statements is most correct?