Exam 12: Capital Budgeting: Decision Criteria

Computer Consultants Inc. is considering a project that has the following cash flow and cost of capital (r) data. What is the project's MIRR? Note that a project's MIRR can be less than the cost of capital (and even negative), in which case it will be rejected. r=10.00\% Year 0 1 2 3 Cash Elows -\ 1,000 \ 400 \ 400 \ 450

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.

Poder 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 -\ 750 \ 300 \ 325 \ 350

Suzanne's Cleaners is considering a project that has the following cash flow data. What is the project's payback? Year 0 1 2 3 4 5 Cash flows -\ 1,100 \ 300 \ 310 \ 320 \ 330 \ 340

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 cost of capital (r). The Fed's action did not affect the forecasted cash flows. By how much did the change in the r affect the project's forecasted NPV? Note that a project's expected NPV can be negative, in which case it should be rejected. Old r: 8.00\% New r: 11.25\% Year 0 1 2 3 Cash flows -\ 1,000 \ 410 \ 410 \ 410

Carolina 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. r:7.75\% Year 0 1 2 3 4 -\ 1,050 \ 675 \ 650 -\ 1,050 \ 360 \ 360 \ 360 360

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 cost of capital is 7%. Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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.

A project's IRR is independent of the firm's cost of capital. In other words, a project's IRR doesn't change with a change in the firm's cost of capital.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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. r=10.25\% Year 0 1 2 3 4 CFS -\ 950 \ 500 \ 800 \ 0 \ 800

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.

Langton 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. r=700\% Year 0 1 2 3 4 -\ 1,100 \ 550 \ 600 \ 100 \ 100 -\ 2,750 \ 725 \ 725 \ 800 \ 1,400

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.

Consider projects S and L. Both have normal cash flows, and the projects have the same risk, hence both are evaluated with the same cost of capital, 10%. However, S has a higher IRR than L. Which of the following statements is CORRECT?

Murray 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 wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise Murray on the best procedure. If the wrong decision criterion is used, how much potential value would Murray lose? r 1:6.00\% Year 0 1 2 3 4 -\ 1,025 \ 380 \ 380 \ 380 \ 380 -\ 2,150 \ 765 \ 765 \ 765 \ 765

Projects S and L, whose cash flows are shown below, are mutually exclusive, equally risky, and not repeatable. Hooper Inc. is considering which of these two projects to undertake. If the decision is made by choosing the project with the higher IRR, how much value will be forgoneσ 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, so no value will be lost if the IRR method is used. r :10.25\% Year 0 1 2 3 4 -\ 2,050 \ 750 \ 760 \ 770 \ 780 -\ 4,300 \ 1,500 \ 1,518 \ 1,536 \ 1,554

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.