Exam 10: The Basics of Capital Budgeting: Evaluating Cash Flows

Corner Jewelers,Inc.recently analyzed the project whose cash flows are shown below.However,before the company 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: 11.25\% Year 0 1 2 3 Cash flows - \1 ,000 \ 410 \ 410 \ 410

You 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?

If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital,the payback method and NPV method would always lead to the same decision on which project to undertake.

Which of the following statements is CORRECT?

McGlothin Inc.is considering a project that has the following cash flow data.What is the project's payback? Year 0 1 2 3 Cash flows -\ 1.150 \ 500 \ 500 \ 500

Robbins Inc.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. WACC: 10.25\% Year 0 1 2 3 4 5 Cash flows -\ 1.000 \ 300 \ 300 \ 300 \ 300 \ 300

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.

An increase in the firm's WACC will decrease projects' NPVs,which could change the accept/reject decision for any potential project.However,such a change would have no impact on projects' IRRs.Therefore,the accept/reject decision under the IRR method is independent of the cost of capital.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

The 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 high.However,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?

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?

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? Assume that the project being considered has normal cash flows,with one cash outflow at t = 0 followed by a series of positive cash flows.

Which of the following statements is CORRECT?

Ellmann Systems 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. WACC: 9.00\% Year 0 1 2 3 Cash flows -\ 1.000 \ 500 \ 500 \ 500

No conflict will exist between the NPV and IRR methods,when used to evaluate two equally risky but mutually exclusive projects,if the projects' cost of capital exceeds the rate at which the projects' NPV profiles cross.

Current Design Co.is considering two mutually exclusive,equally risky,and not repeatable projects,S and L.Their cash flows are shown below.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 -\ 1,100 \ 550 \ 600 \ 100 \ 100 -\ 2,700 \ 650 \ 725 \ 800 \ 1,400

Which of the following statements is CORRECT?