Question 1

Which of the following statements is CORRECT?

Accepted Answer

A) 	Trade credit is provided only to relatively large, strong firms. 
B) 	Commercial paper is a form of short-term financing that is primarily used by large, strong, financially stable companies. 
C) 	Short-term debt is favored by firms because, while it is generally more expensive than long-term debt, it exposes the borrowing firm to less risk than long-term debt. 
D) 	Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate. 
E) 	Commercial paper is typically offered at a long-term maturity of at least five years. 
A) 	Trade credit is provided only to relatively large, strong firms. 
B) 	Commercial paper is a form of short-term financing that is primarily used by large, strong, financially stable companies. 
C) 	Short-term debt is favored by firms because, while it is generally more expensive than long-term debt, it exposes the borrowing firm to less risk than long-term debt. 
D) 	Commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate. 
E) 	Commercial paper is typically offered at a long-term maturity of at least five years.

Question 2

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.

Accepted Answer

A)  9.32% 
B)  10.35% 
C)  11.50% 
D)  12.78% 
E)  14.20% 
A)  9.32% 
B)  10.35% 
C)  11.50% 
D)  12.78% 
E)  14.20%

Question 3

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. 
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 4

You are considering two mutually exclusive, equally risky, projects. Both have IRRs that exceed the WACC. Which of the following statements is CORRECT? Assume that the projects have normal cash flows, with one outflow followed by a series of inflows.

Accepted Answer

A) 	If the two projects' NPV profiles do not cross, then there will be a sharp conflict as to which one should be selected. 
B) 	If the cost of capital is greater than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects.	The same project will rank higher by both criteria. 
C) 	If the cost of capital is less than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects.	The same project will rank higher by both criteria. 
D) 	For a conflict to exist between NPV and IRR, the initial investment cost of one project must exceed the cost of the other. 
E) 	For a conflict to exist between NPV and IRR, one project must have an increasing stream of cash flows over time while the other has a decreasing stream.	If both sets of cash flows are increasing or decreasing, then it would be impossible for a conflict to exist, even if one project is larger than the other. 
A) 	If the two projects' NPV profiles do not cross, then there will be a sharp conflict as to which one should be selected. 
B) 	If the cost of capital is greater than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects.	The same project will rank higher by both criteria. 
C) 	If the cost of capital is less than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects.	The same project will rank higher by both criteria. 
D) 	For a conflict to exist between NPV and IRR, the initial investment cost of one project must exceed the cost of the other. 
E) 	For a conflict to exist between NPV and IRR, one project must have an increasing stream of cash flows over time while the other has a decreasing stream.	If both sets of cash flows are increasing or decreasing, then it would be impossible for a conflict to exist, even if one project is larger than the other.

Question 5

The 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 6

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

Question 7

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 8

Which of the following statements is CORRECT?

Accepted Answer

A)  The regular payback method recognizes all cash flows over a project's life. 
B)  The discounted payback method recognizes all cash flows over a project's life, and it also adjusts these cash flows to account for the time value of money. 
C)  The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today. 
D)  The regular payback is useful as an indicator of a project's liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project. 
E)  The regular payback does not consider cash flows beyond the payback year, but the discounted payback overcomes this defect. 
A)  The regular payback method recognizes all cash flows over a project's life. 
B)  The discounted payback method recognizes all cash flows over a project's life, and it also adjusts these cash flows to account for the time value of money. 
C)  The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today. 
D)  The regular payback is useful as an indicator of a project's liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project. 
E)  The regular payback does not consider cash flows beyond the payback year, but the discounted payback overcomes this defect.

Question 9

Jazz World 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)  $41.25 
B)  $45.84 
C)  $50.93 
D)  $56.59 
E)  $62.88 
A)  $41.25 
B)  $45.84 
C)  $50.93 
D)  $56.59 
E)  $62.88

Question 10

Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?

Accepted Answer

A)  A project's IRR increases as the WACC declines. 
B)  A project's NPV increases as the WACC declines. 
C)  A project's MIRR is unaffected by changes in the WACC. 
D)  A project's regular payback increases as the WACC declines. 
E)  A project's discounted payback increases as the WACC declines. 
A)  A project's IRR increases as the WACC declines. 
B)  A project's NPV increases as the WACC declines. 
C)  A project's MIRR is unaffected by changes in the WACC. 
D)  A project's regular payback increases as the WACC declines. 
E)  A project's discounted payback increases as the WACC declines.

Question 11

Kosovski Company is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and are not repeatable. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under some conditions choosing projects on the basis of the IRR will cause
$0)00 value to be lost.

Accepted Answer

A)  $11.45 
B)  $12.72 
C)  $14.63 
D)  $16.82 
E)  $19.35 
A)  $11.45 
B)  $12.72 
C)  $14.63 
D)  $16.82 
E)  $19.35

Question 12

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. 
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 13

Ingram Electric Products 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.

Accepted Answer

A)  8.86% 
B)  9.84% 
C)  10.94% 
D)  12.15% 
E)  13.50% 
A)  8.86% 
B)  9.84% 
C)  10.94% 
D)  12.15% 
E)  13.50%

Question 14

Noe Drilling Inc. 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 MIRR. If the decision is made by choosing the project with the higher IRR rather than the one with the higher MIRR, how much, if any, value will be forgone. In other words, what's the NPV of the chosen project versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. MIRR will have no effect on the value lost.

Accepted Answer

A)  $185.90 
B)  $197.01 
C)  $208.11 
D)  $219.22 
E)  $230.32 
A)  $185.90 
B)  $197.01 
C)  $208.11 
D)  $219.22 
E)  $230.32

Question 15

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?

Accepted Answer

A)  The crossover rate must be less than 10%. 
B)  The crossover rate must be greater than 10%. 
C)  If the WACC is 8%, Project X will have the higher NPV. 
D)  If the WACC is 18%, Project Y will have the higher NPV. 
E)  Project X is larger in the sense that it has the higher initial cost. 
A)  The crossover rate must be less than 10%. 
B)  The crossover rate must be greater than 10%. 
C)  If the WACC is 8%, Project X will have the higher NPV. 
D)  If the WACC is 18%, Project Y will have the higher NPV. 
E)  Project X is larger in the sense that it has the higher initial cost.

Question 16

Projects A and B are mutually exclusive and have normal cash flows. Project A has an IRR of 15% and B's IRR is 20%. The company's WACC is 12%, and at that rate Project A has the higher NPV. Which of the following statements is CORRECT?

Accepted Answer

A)  The crossover rate for the two projects must be less than 12%. 
B)  Assuming the timing pattern of the two projects' cash flows is the same, Project B probably has a higher cost (and larger scale). 
C)  Assuming the two projects have the same scale, Project B probably has a faster payback than Project A. 
D)  The crossover rate for the two projects must be 12%. 
E)  Since B has the higher IRR, then it must also have the higher NPV if the crossover rate is less than the WACC of 12%.
Problems 
A)  The crossover rate for the two projects must be less than 12%. 
B)  Assuming the timing pattern of the two projects' cash flows is the same, Project B probably has a higher cost (and larger scale). 
C)  Assuming the two projects have the same scale, Project B probably has a faster payback than Project A. 
D)  The crossover rate for the two projects must be 12%. 
E)  Since B has the higher IRR, then it must also have the higher NPV if the crossover rate is less than the WACC of 12%.
Problems

Question 17

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 18

A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose?

Accepted Answer

A)  $188.68 
B)  $198.61 
C)  $209.07 
D)  $219.52 
E)  $230.49 
A)  $188.68 
B)  $198.61 
C)  $209.07 
D)  $219.52 
E)  $230.49

Exam 10: The Basics of Capital Budgeting

Which of the following statements is CORRECT?

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.

You are considering two mutually exclusive, equally risky, projects. Both have IRRs that exceed the WACC. Which of the following statements is CORRECT? Assume that the projects have normal cash flows, with one outflow followed by a series of inflows.

The 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.

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?

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.

Which of the following statements is CORRECT?

Jazz World 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.

Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Ingram Electric Products 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.

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?

Projects A and B are mutually exclusive and have normal cash flows. Project A has an IRR of 15% and B's IRR is 20%. The company's WACC is 12%, and at that rate Project A has the higher NPV. Which of the following statements is CORRECT?

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.

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

Filters