Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  The NPV, IRR, MIRR, and discounted payback (using a payback requirement of 3 years or less) methods always lead to the same accept/reject decisions for independent projects. 
B)  For mutually exclusive projects with normal cash flows, the NPV and MIRR methods can never conflict, but their results could conflict with the discounted payback and the regular IRR methods. 
C)  Multiple IRRs can exist, but not multiple MIRRs. This is one reason some people favor the MIRR over the regular IRR. 
D)  If a firm uses the discounted payback method with a required payback of 4 years, then it will accept more projects than if it used a regular payback of 4 years. 
E)  The percentage difference between the MIRR and the IRR is equal to the project's WACC.

Question 2

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

Accepted Answer

A) True 
 B)False

Question 3

Which of the following statements is CORRECT?

Accepted Answer

A)  One defect of the IRR method versus the NPV is that the IRR does not take account of cash flows over a project's full life. 
B)  One defect of the IRR method versus the NPV is that the IRR does not take account of the time value of money. 
C)  One defect of the IRR method versus the NPV is that the IRR does not take account of the cost of capital. 
D)  One defect of the IRR method versus the NPV is that the IRR values a dollar received today the same as a dollar that will not be received until sometime in the future. 
E)  One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects.

Question 4

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.

Accepted Answer

A) True 
 B)False

Question 5

A basic rule in capital budgeting is that if a project's NPV exceeds its IRR, then the project should be accepted.

Accepted Answer

A) True 
 B)False

Question 6

Projects C and D are mutually exclusive and have normal cash flows. Project C has a higher NPV if the WACC is less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is CORRECT?

Accepted Answer

A)  Project D probably has a higher IRR. 
B)  Project D is probably larger in scale than Project C. 
C)  Project C probably has a faster payback. 
D)  Project C probably has a higher IRR. 
E)  The crossover rate between the two projects is below 12%.

Question 7

Which of the following statements is CORRECT?

Accepted Answer

A)  For a project to have more than one IRR, then both IRRs must be greater than the WACC. 
B)  If two projects are mutually exclusive, then they are likely to have multiple IRRs. 
C)  If a project is independent, then it cannot have multiple IRRs. 
D)  Multiple IRRs can only occur if the signs of the cash flows change more than once. 
E)  If a project has two IRRs, then the smaller one is the one that is most relevant, and it should be accepted and relied upon.

Question 8

Assume that the economy is enjoying a strong boom, and as a result interest rates and money costs generally are relatively high. The WACC for two mutually exclusive projects that are being considered is 12%. Project S has an IRR of 20% while Project L's IRR is 15%. The projects have the same NPV at the 12% current WACC. However, you believe that the economy will soon fall into a mild recession, and 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?

Accepted Answer

A)  You should reject both projects because they will both have negative NPVs under the new conditions. 
B)  You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market. 
C)  You should recommend Project L, because at the new WACC it will have the higher NPV. 
D)  You should recommend Project S, because at the new WACC it will have the higher NPV. 
E)  You should recommend Project L because it will have both a higher IRR and a higher NPV under the new conditions.

Question 9

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.

Accepted Answer

A) True 
 B)False

Question 10

The regular payback method is deficient in that it does not take account of cash flows beyond the payback period. The discounted payback method corrects this fault.

Accepted Answer

A) True 
 B)False

Question 11

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.

Accepted Answer

A) True 
 B)False

Question 12

The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zero. Also, the NPV of X is greater than the NPV of Y at the cost of capital. If the two projects are mutually exclusive, Project X should definitely be selected, and the investment made, provided we have confidence in the data. Put another way, it is impossible to draw NPV profiles that would suggest not accepting Project X.

Accepted Answer

A) True 
 B)False

Question 13

Which of the following statements is CORRECT?

Accepted Answer

A)  An NPV profile graph shows how a project's payback varies as the cost of capital changes. 
B)  The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases. 
C)  An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life. 
D)  An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital. 
E)  We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV.

Question 14

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.

Accepted Answer

A) True 
 B)False

Question 15

Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows and are equally risky.

Accepted Answer

A)  If a project's IRR is equal to its WACC, then, under all reasonable conditions, the project's NPV must be negative. 
B)  If a project's IRR is equal to its WACC, then under all reasonable conditions, the project's IRR must be negative. 
C)  If a project's IRR is equal to its WACC, then under all reasonable conditions the project's NPV must be zero. 
D)  There is no necessary relationship between a project's IRR, its WACC, and its NPV. 
E)  When evaluating mutually exclusive projects, those projects with relatively long lives will tend to have relatively high NPVs when the cost of capital is relatively high.

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A)  For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR. 
B)  To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the WACC to find the PV. 
C)  The NPV and IRR methods both assume that cash flows can be reinvested at the WACC. However, the MIRR method assumes reinvestment at the MIRR itself. 
D)  If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the higher IRR probably has more of its cash flows coming in the later years. 
E)  If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years.

Question 17

The NPV method's assumption that cash inflows are reinvested at the cost of capital is generally more reasonable than the IRR's assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method.

Accepted Answer

A) True 
 B)False

Question 18

McCall Manufacturing has a WACC of 10%. The firm is considering two normal, equally risky, mutually exclusive, but not repeatable projects. The two projects have the same investment costs, but Project A has an IRR of 15%, while Project B has an IRR of 20%. Assuming the projects' NPV profiles cross in the upper right quadrant, which of the following statements is CORRECT?

Accepted Answer

A)  Each project must have a negative NPV. 
B)  Since the projects are mutually exclusive, the firm should always select Project B. 
C)  If the crossover rate is 8%, Project B will have the higher NPV. 
D)  Only one project has a positive NPV. 
E)  If the crossover rate is 8%, Project A will have the higher NPV.

Question 19

Projects S and L both have an initial cost of $10,000, followed by a series of positive cash inflows. Project S's undiscounted net cash flows total $20,000, while L's total undiscounted flows are $30,000. At a WACC of 10%, the two projects have identical NPVs. Which project's NPV is more sensitive to changes in the WACC?

Accepted Answer

A)  Project S. 
B)  Project L. 
C)  Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital. 
D)  Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal. 
E)  The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs.

Question 20

The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects that have different lives are being compared.

Accepted Answer

A) True 
 B)False

Exam 11: Capital Budgeting

Which of the following statements is CORRECT?

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

Which of the following statements is CORRECT?

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.

A basic rule in capital budgeting is that if a project's NPV exceeds its IRR, then the project should be accepted.

Projects C and D are mutually exclusive and have normal cash flows. Project C has a higher NPV if the WACC is less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is CORRECT?

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.

The regular payback method is deficient in that it does not take account of cash flows beyond the payback period. The discounted payback method corrects this fault.

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?

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.

Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows and are equally risky.

Which of the following statements is CORRECT?

The NPV method's assumption that cash inflows are reinvested at the cost of capital is generally more reasonable than the IRR's assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method.

The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects that have different lives are being compared.