Exam 13: Capital Budgeting

Given two mutually exclusive projects and a zero required rate of return,the payback period and NPV method of selecting investments will always lead to the same decision on which project to undertake.

With the current techniques available,estimating cash flows has become the easiest step in the analysis of a capital budgeting project.

Which of the following statements is correct?

The change in net working capital is always positive,meaning more working capital is required,for projects considered in capital budgeting because all projects are either expansion projects or replacement projects which have expansion effects.

A company is analyzing two mutually exclusive projects,S and L,whose cash flows are shown below: The company's required rate of return is 12 percent.What is the IRR of the better project? (Hint: Note that the better project may or may not be the one with the higher IRR. )

A particular project might have very uncertain cash flows,hence a highly uncertain NPV and IRR,yet it may not have high market risk.

Your company is choosing between the following non-repeatable,equally risky,mutually exclusive projects with the cash flows shown below.Your required rate of return is 10 percent.How much value will your firm sacrifice if it selects the project with the higher IRR? Project S: Project L:

The capital budgeting director of Sparrow Corporation is evaluating a project which costs $200,000,is expected to last for 10 years and produce after-tax cash flows,including depreciation,of $44,503 per year.If the firm's required rate of return is 14 percent and its tax rate is 40 percent,what is the project's IRR?

Carolina Insurance Company,an all-equity life insurance firm,is considering the purchase of a fire insurance company.If the purchase is made,Carolina will be 50 percent larger than before.Currently,Carolina's stock has a beta of 1.2 and the return required is 15.2 percent.The fire insurance company is expected to generate a return of 20 percent with a beta of 2.5.If the risk-free rate is 8 percent and the market risk premium is 6 percent,should Carolina make the investment?

Scott Corporation's new project calls for an investment of $10,000.It has an estimated life of 10 years.The IRR has been calculated to be 15 percent.If cash flows are evenly distributed and the tax rate is 40 percent,what is the annual before-tax cash flow each year? (Assume depreciation is a negligible amount. )

Which of the following statements is correct?

An investment project has an initial cost,and then generates inflows of $50 a year for the next five years.The project has a payback period of 3.6 years.What is the project's internal rate of return?

As the director of capital budgeting for Denver Corporation,you are evaluating two mutually exclusive projects with the following net cash flows: If Denver's required rate of return is 15 percent,you would choose?

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.At the current required rate of return,normal Projects S and L have identical NPVs.Now suppose interest rates and money costs generally decline.Other things held constant,this change will cause L to become preferred to S.

The underlying cause of ranking conflicts between the NPV and IRR methods is differing

You have recently accepted a one year employment term by a firm.The firm has given you the option of receiving your salary as a lump sum value of $30,000 at the end of the year or as 12 monthly payments of $2,400 starting one month after you start work.If your relevant discount rate is 2 percent per month,then which salary options would you prefer? (Ignore taxes,risk,and consumption needs. )Choose the best answer.

Which of the following statements is correct?

Two fellow financial analysts are evaluating a project with the following net cash flows: Year Cash Flow 0 −$10,000 1 100,000 2 −100,000 One analyst says that the project has an IRR of between 12 and 13%.The other analyst calculates an IRR of just under 800%,but fears his calculator's battery is low and may have caused an error.You agree to settle the dispute by analyzing the project cash flows.Which statement best describes the IRR for this project?

Which of the following statements is false?

Estimating the cash flows in a capital project is the easiest and least important part of the capital budgeting process.