Exam 10: Capital Budgeting Techniques

Certain mathematical properties may cause a project with a nonconventional cash flow pattern to have multiple IRRs; this problem does not occur with the NPV approach.

Net present value profiles are most useful when selecting among mutually exclusive projects.

Consider the following projects, X and Y, where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 10 percent?

Conflicting rankings in the case of mutually exclusive projects using NPV and IRR often result from differences in the magnitude and/or timing of cash flows.

Which pattern of cash flow stream is the most difficult to use when evaluating projects?

Net present value profiles are most useful when selecting among independent projects.

A project must be rejected if its payback period is less than the maximum acceptable payback period.

If a firm has unlimited funds, it is able to accept all independent projects that provide an acceptable return.

Mutually exclusive projects are projects whose cash flows are unrelated to one another; the acceptance of one does not eliminate the others from further consideration.

Capital budgeting is the process of evaluating and selecting short-term investments that are consistent with the firm's goal of maximizing owners' wealth.

Which of the following is an unsophisticated capital budgeting technique?

Since the payback period can be viewed as a measure of risk exposure, many firms use it as a supplement to other decision techniques.

If a firm has limited funds to invest, all the mutually exclusive projects that meet its minimum investment criteria should be implemented.

Which of the following is an example of a nonconventional pattern of cash flows?

When the net present value is negative, the internal rate of return is ________ the cost of capital.

A nonconventional cash flow pattern associated with capital investment projects consists of an initial ________.

In comparing the internal rate of return and net present value methods of evaluation, ________.

On a purely theoretical basis, IRR is the better approach to capital budgeting than NPV because IRR implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

The internal rate of return (IRR) is defined as the discount rate that equates the net present value with the initial investment associated with a project.

Although differences in the magnitude and timing of cash flows explain conflicting rankings under the NPV and IRR techniques, the underlying cause is the implicit assumption concerning the reinvestment of intermediate cash inflows.