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

When evaluating mutually exclusive projects,the modified IRR (MIRR)always leads to the same capital budgeting decisions as the NPV method,regardless of the relative lives or sizes of the projects being evaluated.

Computer Consultants Inc.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. WACC: 10.00\% Year 0 1 2 3 Cash flows -\ 1,000 \ 450 \ 450 \ 450

Which of the following statements is CORRECT?

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

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.

Suppose a firm relies exclusively on the payback method when making capital budgeting decisions,and it sets a 4-year payback regardless of economic conditions.Other things held constant,which of the following statements is most likely to be true?

Markman & Sons is considering Projects S and L.These projects are mutually exclusive,equally risky,and not repeatable and their cash flows are shown below.If the decision is made by choosing the project with the higher IRR,how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV,i.e.,no conflict will exist. WACC: 10.00\% Year: 0 1 2 3 4 CFS -\ 1,025 \ 650 \ 450 \ 250 \ 50 CFL -\ 1,025 \ 100 \ 300 \ 500 \ 700

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?

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?

Because "present value" refers to the value of cash flows that occur at different points in time,a series of present values of cash flows should not be summed to determine the value of a capital budgeting project.

A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC).

Last month,Standard Systems analyzed the project whose cash flows are shown below.However,before the decision to accept or reject the project took place,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: 10.00\% New WACC: 11.25\% Year 0 1 2 3 Cash flows - \1 ,000 \ 410 \ 410 \ 410

Consider two projects,X and Y.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?

Both the regular and the modified IRR (MIRR)methods have wide appeal to professors,but most business executives prefer the NPV method to either of the IRR methods.

Normal Projects S and L have the same NPV when the discount rate is zero.However,Project S's cash flows come in faster than those of L.Therefore,we know that at any discount rate greater than zero,L will have the higher NPV.

Farmer Co.is considering Projects S and L,whose cash flows are shown below.These projects are mutually exclusive,equally risky,and not repeatable.If the decision is made by choosing the project with the shorter payback,some value may be forgone.How much value will be lost in this instance? Note that under some conditions choosing projects on the basis of the shorter payback will not cause value to be lost. WACC: 10.25\% Year 0 1 2 3 4 -\ 950 \ 500 \ 800 \ 0 \ 0 -\ 2.100 \ 400 \ 800 \ 800 \ 1.000

If the IRR of normal Project X is greater than the IRR of mutually exclusive (and also normal)Project Y,we can conclude that the firm should always select X rather than Y if X has NPV > 0.

Craig's Car Wash Inc.is considering a project that has the following cash flow and WACC data.What is the project's discounted payback? WACC: 10.00\% Year 0 1 2 3 Cash flows -\ 900 \ 500 \ 500 \ 500

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.

Which of the following statements is CORRECT?