Question 1

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

Accepted Answer

A) 	1.88 years 
B) 	2.09 years 
C) 	2.29 years 
D) 	2.52 years 
E) 	2.78 years 
A) 	1.88 years 
B) 	2.09 years 
C) 	2.29 years 
D) 	2.52 years 
E) 	2.78 years

Question 2

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 occur only 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. 
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 occur only 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 3

Four of the following statements are truly disadvantages of the regular payback method, but one is not a disadvantage of this method. Which one is NOT a disadvantage of the payback method?

Accepted Answer

A)  Lacks an objective, market-determined benchmark for making decisions. 
B)  Ignores cash flows beyond the payback period. 
C)  Does not directly account for the time value of money. 
D)  Does not provide any indication regarding a project's liquidity or risk. 
E)  Does not take account of differences in size among projects. 
A)  Lacks an objective, market-determined benchmark for making decisions. 
B)  Ignores cash flows beyond the payback period. 
C)  Does not directly account for the time value of money. 
D)  Does not provide any indication regarding a project's liquidity or risk. 
E)  Does not take account of differences in size among projects.

Question 4

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 5

Which of the following statements is CORRECT?

Accepted Answer

A)  One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project's full life whereas IRR does not. 
B)  One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV assumption is generally more appropriate. 
C)  One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project's full life whereas MIRR does not. 
D)  One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows. 
E)  Since cash flows under the IRR and MIRR are both discounted at the same rate (the WAC
C) , these two methods always rank mutually exclusive projects in the same order. 
A)  One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project's full life whereas IRR does not. 
B)  One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV assumption is generally more appropriate. 
C)  One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project's full life whereas MIRR does not. 
D)  One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows. 
E)  Since cash flows under the IRR and MIRR are both discounted at the same rate (the WAC
C) , these two methods always rank mutually exclusive projects in the same order.

Question 6

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?

Accepted Answer

A)  You should reject both projects because they will both have negative NPVs under the new conditions. 
B)  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. 
C)  You should recommend Project L, because at the new WACC it will have the higher NPV. 
D)  You should recommend Project S, because at the new WACC it will have the higher NPV. 
E)  You should recommend Project L because it will have both a higher IRR and a higher NPV under the new conditions. 
A)  You should reject both projects because they will both have negative NPVs under the new conditions. 
B)  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. 
C)  You should recommend Project L, because at the new WACC it will have the higher NPV. 
D)  You should recommend Project S, because at the new WACC it will have the higher NPV. 
E)  You should recommend Project L because it will have both a higher IRR and a higher NPV under the new conditions.

Question 7

The 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

Question 8

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 IRR can be less than the WACC (and even negative), in which case it will be rejected.

Accepted Answer

A)  2.08% 
B)  2.31% 
C)  2.57% 
D)  2.82% 
E)  3.10% 
A)  2.08% 
B)  2.31% 
C)  2.57% 
D)  2.82% 
E)  3.10%

Question 9

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

Accepted Answer

A)  1.86 years 
B)  2.07 years 
C)  2.30 years 
D)  2.53 years 
E)  2.78 years 
A)  1.86 years 
B)  2.07 years 
C)  2.30 years 
D)  2.53 years 
E)  2.78 years

Question 10

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. Neither has negative cash flows after Year 0, and at the current cost of capital, the two projects have identical NPVs. Now suppose interest rates and money costs decline. Other things held constant, this change will cause L to become preferred to S.

Accepted Answer

A) True 
 B)False

Question 11

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?

Accepted Answer

A) 	You should reject both projects because they will both have negative NPVs under the new conditions. 
B) 	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. 
C) 	You should recommend Project L, because at the new WACC it will have the higher NPV. 
D) 	You should recommend Project S, because at the new WACC it will have the higher NPV. 
E) 	You should recommend Project S because it has the higher IRR and will continue to have the higher IRR even at the new WACC. 
A) 	You should reject both projects because they will both have negative NPVs under the new conditions. 
B) 	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. 
C) 	You should recommend Project L, because at the new WACC it will have the higher NPV. 
D) 	You should recommend Project S, because at the new WACC it will have the higher NPV. 
E) 	You should recommend Project S because it has the higher IRR and will continue to have the higher IRR even at the new WACC.

Question 12

Tuttle Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's expected NPV is negative, it should be rejected.

Accepted Answer

A)  $77.49 
B)  $81.56 
C)  $85.86 
D)  $90.15 
E)  $94.66 
A)  $77.49 
B)  $81.56 
C)  $85.86 
D)  $90.15 
E)  $94.66

Question 13

Warnock Inc. 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.

Accepted Answer

A)  $54.62 
B)  $57.49 
C)  $60.52 
D)  $63.54 
E)  $66.72 
A)  $54.62 
B)  $57.49 
C)  $60.52 
D)  $63.54 
E)  $66.72

Question 14

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.

Accepted Answer

A)  -$59.03 
B)  -$56.08 
C)  -$53.27 
D)  -$50.61 
E)  -$48.08 
A)  -$59.03 
B)  -$56.08 
C)  -$53.27 
D)  -$50.61 
E)  -$48.08

Question 15

The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zero. Also, the NPV of X is greater than the NPV of Y at the cost of capital. If the two projects are mutually exclusive, Project X should definitely be selected, and the investment made, provided we have confidence in the data. Put another way, it is impossible to draw NPV profiles that would suggest not accepting Project X.

Accepted Answer

A) True 
 B)False

Question 16

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. 
E)  The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs. 
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. 
E)  The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs.

Question 17

You are on the staff of Camden Inc. The CFO believes project acceptance should be based on the NPV, but Steve Camden, 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 its NPV is negative and its IRR is less than the WACC. 
B) 	You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC. 
C) 	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. 
D) 	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. 
E) 	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. 
A) 	You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC. 
B) 	You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC. 
C) 	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. 
D) 	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. 
E) 	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.

Question 18

Which of the following statements is CORRECT?

Accepted Answer

A)  The MIRR and NPV decision criteria can never conflict. 
B)  The IRR method can never be subject to the multiple IRR problem, while the MIRR method can be. 
C)  One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption. 
D)  The higher the WACC, the shorter the discounted payback period. 
E)  The MIRR method assumes that cash flows are reinvested at the crossover rate. 
A)  The MIRR and NPV decision criteria can never conflict. 
B)  The IRR method can never be subject to the multiple IRR problem, while the MIRR method can be. 
C)  One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption. 
D)  The higher the WACC, the shorter the discounted payback period. 
E)  The MIRR method assumes that cash flows are reinvested at the crossover rate.

Question 19

The 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.

Accepted Answer

A) True 
 B)False

Question 20

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 greater than 14%, Project A's IRR will exceed Project B's. 
E)  If the WACC is 9%, Project B's NPV will be higher than Project A's. 
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 greater than 14%, Project A's IRR will exceed Project B's. 
E)  If the WACC is 9%, Project B's NPV will be higher than Project A's.

Exam 10: The Basics of Capital Budgeting

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

Which of the following statements is CORRECT?

Four of the following statements are truly disadvantages of the regular payback method, but one is not a disadvantage of this method. Which one is NOT a disadvantage of the payback method?

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?

The 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.

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 IRR can be less than the WACC (and even negative), in which case it will be rejected.

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

Tuttle Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's expected NPV is negative, it should be rejected.

Warnock Inc. 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.

Which of the following statements is CORRECT?

The 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.

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risks and Rates of Return

Stocks and Their Valuation

Financial Options and Applications in Corporate Finance

The Cost of Capital

Cash Flow Estimation and Risk Analysis

Financial Planning and Forecasting Financial Statements

Corporate Valuation, Value-Based Management, and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Working Capital Management

Multinational Financial Management

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Initial Public Offerings, Investment Banking, and Financial Restructuring

Mergers, Lbos, Divestitures, and Holding Companies

Bankruptcy, Reorganization, and Liquidation

Derivatives and Risk Management

Portfolio Theory, Asset Pricing Models, and Behavioral Finance

Real Options

Analysis of Capital Structure Theory

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not-For-Profit Businesses

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