Question 1

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.

Accepted Answer

A) True 
 B)False  True

Question 2

project's IRR is independent of the firm's cost of capital In other words, a project's IRR doesn't change with a change in the firm's cost of capital.

Accepted Answer

A) True 
 B)False  True

Question 3

Clifford Company is choosing between two projects The larger project has an initial cost of $100,000, annual cash flows of $30,000 for 5 years, and an IRR of 15.24% The smaller project has an initial cost of $50,000, annual cash flows of $16,000 for 5 years, and an IRR of 16.63% The projects are equally risky Which of the following statements is CORRECT?

Accepted Answer

A)  Since the smaller project has the higher IRR, the two projects' NPV profiles will cross, and the larger project will look better based on the NPV at all positive values of WACC. 
B)  If the company uses the NPV method, it will tend to favor smaller, shorter-term projects over larger, longer-term projects, regardless of how high or low the WACC is. 
C)  Since the smaller project has the higher IRR but the larger project has the higher NPV at a zero discount rate, the two projects' NPV profiles will cross, and the larger project will have the higher NPV if the WACC is less than the crossover rate. 
D)  Since the smaller project has the higher IRR and the larger NPV at a zero discount rate, the two projects' NPV profiles will cross, and the smaller project will look better if the WACC is less than the crossover rate. 
E)  Since the smaller project has the higher IRR, the two projects' NPV profiles cannot cross, and the smaller project's NPV will be higher at all positive values of WACC. 
A)  Since the smaller project has the higher IRR, the two projects' NPV profiles will cross, and the larger project will look better based on the NPV at all positive values of WACC. 
B)  If the company uses the NPV method, it will tend to favor smaller, shorter-term projects over larger, longer-term projects, regardless of how high or low the WACC is. 
C)  Since the smaller project has the higher IRR but the larger project has the higher NPV at a zero discount rate, the two projects' NPV profiles will cross, and the larger project will have the higher NPV if the WACC is less than the crossover rate. 
D)  Since the smaller project has the higher IRR and the larger NPV at a zero discount rate, the two projects' NPV profiles will cross, and the smaller project will look better if the WACC is less than the crossover rate. 
E)  Since the smaller project has the higher IRR, the two projects' NPV profiles cannot cross, and the smaller project's NPV will be higher at all positive values of WACC. C

Question 4

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 5

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.

Accepted Answer

A) True 
 B)False

Question 6

Consider projects S and LBoth have normal cash flows, and the projects have the same risk, hence both are evaluated with the same WACC, 10% However, S has a higher IRR than L Which of the following statements is CORRECT?

Accepted Answer

A)  If Project S has a positive NPV, Project L must also have a positive NPV. 
B)  If the WACC falls, each project's IRR will increase. 
C)  If the WACC increases, each project's IRR will decrease. 
D)  If Projects S and L have the same NPV at the current WACC, 10%, then Project L, the one with the lower IRR, would have a higher NPV if the WACC used to evaluate the projects declined. 
E)  Project S must have a higher NPV than Project L. 
A)  If Project S has a positive NPV, Project L must also have a positive NPV. 
B)  If the WACC falls, each project's IRR will increase. 
C)  If the WACC increases, each project's IRR will decrease. 
D)  If Projects S and L have the same NPV at the current WACC, 10%, then Project L, the one with the lower IRR, would have a higher NPV if the WACC used to evaluate the projects declined. 
E)  Project S must have a higher NPV than Project L.

Question 7

Which of the following statements is CORRECT?

Accepted Answer

A)  The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases. 
B)  An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life. 
C)  An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital. 
D)  We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV. 
E)  An NPV profile graph shows how a project's payback varies as the cost of capital changes. 
A)  The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases. 
B)  An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life. 
C)  An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital. 
D)  We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV. 
E)  An NPV profile graph shows how a project's payback varies as the cost of capital changes.

Question 8

Projects S and L are equally risky, mutually exclusive, and have normal cash flows Project S has an IRR of 15%, while Project L's IRR is 12% The two projects have the same NPV when the WACC is 7% Which of the following statements is CORRECT?

Accepted Answer

A)  If the WACC is 6%, Project S will have the higher NPV. 
B)  If the WACC is 13%, Project S will have the lower NPV. 
C)  If the WACC is 10%, both projects will have a negative NPV. 
D)  Project S's NPV is more sensitive to changes in WACC than Project L's. 
E)  If the WACC is 10%, both projects will have positive NPVs. 
A)  If the WACC is 6%, Project S will have the higher NPV. 
B)  If the WACC is 13%, Project S will have the lower NPV. 
C)  If the WACC is 10%, both projects will have a negative NPV. 
D)  Project S's NPV is more sensitive to changes in WACC than Project L's. 
E)  If the WACC is 10%, both projects will have positive NPVs.

Question 9

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 10

Which of the following statements is CORRECT?

Accepted Answer

A)  One defect of the IRR method is that it does not take account of the time value of money. 
B)  One defect of the IRR method is that it does not take account of the cost of capital. 
C)  One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future. 
D)  One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid. 
E)  One defect of the IRR method is that it does not take account of cash flows over a project's full life. 
A)  One defect of the IRR method is that it does not take account of the time value of money. 
B)  One defect of the IRR method is that it does not take account of the cost of capital. 
C)  One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future. 
D)  One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid. 
E)  One defect of the IRR method is that it does not take account of cash flows over a project's full life.

Question 11

NPV 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 12

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.

Accepted Answer

A) True 
 B)False

Question 13

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 14

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 MIRR is always less than its regular IRR. 
B)  If a project's IRR is greater than its WACC, then the MIRR will be less than the IRR. 
C)  If a project's IRR is greater than its WACC, then the MIRR will be greater than the IRR. 
D)  To find a project's MIRR, we compound cash inflows at the IRR and then discount the terminal value back to t = 0 at the WACC. 
E)  A project's MIRR is always greater than its regular IRR. 
A)  A project's MIRR is always less than its regular IRR. 
B)  If a project's IRR is greater than its WACC, then the MIRR will be less than the IRR. 
C)  If a project's IRR is greater than its WACC, then the MIRR will be greater than the IRR. 
D)  To find a project's MIRR, we compound cash inflows at the IRR and then discount the terminal value back to t = 0 at the WACC. 
E)  A project's MIRR is always greater than its regular IRR.

Question 15

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 NPV.

Accepted Answer

A) True 
 B)False

Question 16

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 17

WACC for two mutually exclusive projects that are being considered is 12% Project K has an IRR of 20% while Project R's IRR is 15%The projects have the same NPV at the 12% current WACC Interest rates are currently highHowever, you believe that 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?

Accepted Answer

A)  You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market. 
B)  You should recommend Project R, because at the new WACC it will have the higher NPV. 
C)  You should recommend Project K, because at the new WACC it will have the higher NPV. 
D)  You should recommend Project R because it will have both a higher IRR and a higher NPV under the new conditions. 
E)  You should reject both projects because they will both have negative NPVs under the new conditions. 
A)  You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market. 
B)  You should recommend Project R, because at the new WACC it will have the higher NPV. 
C)  You should recommend Project K, because at the new WACC it will have the higher NPV. 
D)  You should recommend Project R because it will have both a higher IRR and a higher NPV under the new conditions. 
E)  You should reject both projects because they will both have negative NPVs under the new conditions.

Question 18

are on the staff of O'Hara Inc The CFO believes project acceptance should be based on the NPV, but Andrew O'Hara, the president, insists that no project should be accepted unless its IRR exceeds the project's risk-adjusted WACC Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and -$100,000 at the end of Year 2 The president and the CFO both agree that the appropriate WACC for this project is 10% At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one at 527%, and a MIRR of 11.32% Which of the following statements best describes your optimal recommendation, i.e., the analysis and recommendation that is best for the company and least likely to get you in trouble with either the CFO or the president?

Accepted Answer

A)  You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC. 
B)  You should recommend that the project be accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that the firm's value will increase if the project is accepted. 
C)  You should recommend that the project be rejected. Although its NPV is positive it has two IRRs, one of which is less than the WACC, which indicates that the firm's value will decline if the project is accepted. 
D)  You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm's value will decline if it is accepted. 
E)  You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC. 
A)  You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC. 
B)  You should recommend that the project be accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that the firm's value will increase if the project is accepted. 
C)  You should recommend that the project be rejected. Although its NPV is positive it has two IRRs, one of which is less than the WACC, which indicates that the firm's value will decline if the project is accepted. 
D)  You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm's value will decline if it is accepted. 
E)  You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.

Question 19

Projects S and L are both normal projects with 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 L. 
B)  Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital. 
C)  Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal. 
D)  The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs. 
E)  Project S. 
A)  Project L. 
B)  Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital. 
C)  Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal. 
D)  The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs. 
E)  Project S.

Question 20

WACC for two mutually exclusive projects that are being considered is 8% Project K has an IRR of 20% while Project R's IRR is 15%The projects have the same NPV at the 8% current WACC However, you believe that 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?

Accepted Answer

A)  You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market. 
B)  You should recommend Project R, because at the new WACC it will have the higher NPV. 
C)  You should recommend Project K, because at the new WACC it will have the higher NPV. 
D)  You should recommend Project K because it has the higher IRR and will continue to have the higher IRR even at the new WACC. 
E)  You should reject both projects because they will both have negative NPVs under the new conditions. 
A)  You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market. 
B)  You should recommend Project R, because at the new WACC it will have the higher NPV. 
C)  You should recommend Project K, because at the new WACC it will have the higher NPV. 
D)  You should recommend Project K because it has the higher IRR and will continue to have the higher IRR even at the new WACC. 
E)  You should reject both projects because they will both have negative NPVs under the new conditions.

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.

project's IRR is independent of the firm's cost of capital In other words, a project's IRR doesn't change with a change in the firm's cost of capital.

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.

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.

Consider projects S and LBoth have normal cash flows, and the projects have the same risk, hence both are evaluated with the same WACC, 10% However, S has a higher IRR than L Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Projects S and L are equally risky, mutually exclusive, and have normal cash flows Project S has an IRR of 15%, while Project L's IRR is 12% The two projects have the same NPV when the WACC is 7% Which of the following statements is CORRECT?

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

Which of the following statements is CORRECT?

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

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.

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.

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.

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 NPV.

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

Overview

Risk and Return: Part I

Risk and Return: Part II

Bonds

Stocks

Financial Options

Financial Analysis

Forecasting

Cost of Capital

Corporate Valuation

Cash Flows and Risk

Real Options

Cap Structure

Cap Structure II

Dividends

Ipos, Invsmt Banking

Leasing

Hybrids

Working Capital

Derivatives

Bankruptcy, Reorganization, and Liquidation

Mergers

Filters

Exam 12: Capital Budgeting

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.

project's IRR is independent of the firm's cost of capital In other words, a project's IRR doesn't change with a change in the firm's cost of capital.

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.

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.

Consider projects S and LBoth have normal cash flows, and the projects have the same risk, hence both are evaluated with the same WACC, 10% However, S has a higher IRR than L Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Projects S and L are equally risky, mutually exclusive, and have normal cash flows Project S has an IRR of 15%, while Project L's IRR is 12% The two projects have the same NPV when the WACC is 7% Which of the following statements is CORRECT?

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

Which of the following statements is CORRECT?

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

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.

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.

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.

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 NPV.

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

Overview

Risk and Return: Part I

Risk and Return: Part II

Bonds

Stocks

Financial Options

Financial Analysis

Forecasting

Cost of Capital

Corporate Valuation

Cash Flows and Risk

Real Options

Cap Structure

Cap Structure II

Dividends

Ipos, Invsmt Banking

Leasing

Hybrids

Working Capital

Derivatives

Bankruptcy, Reorganization, and Liquidation

Mergers

Filters