Question 1

Tesar Chemicals 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 NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or lost.

Accepted Answer

A)  $138.10 
B)  $149.21 
C)  $160.31 
D)  $171.42 
E)  $182.52

Question 2

Projects A and B have identical expected lives and identical initial cash outflows (costs)Which of the following statements is CORRECT?

Accepted Answer

A)  More of Project A's cash flows occur in the later years. 
B)  More of Project B's cash flows occur in the later years. 
C)  We must have information on the cost of capital in order to determine which project has the larger early cash flows. 
D)  The NPV profile graph is inconsistent with the statement made in the problem. 
E)  The crossover rate, i.e., the rate at which Projects A and B have the same NPV, is greater than either project's IRR.

Question 3

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.

Accepted Answer

A)  A project's regular IRR is found by compounding the initial cost at the WACC to find the terminal value (TV), then discounting the TV at the WACC. 
B)  A project's regular IRR is found by compounding the cash inflows at the WACC to find the present value (PV), then discounting the TV to find the IRR. 
C)  If a project's IRR is smaller than the WACC, then its NPV will be positive. 
D)  A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost. 
E)  If a project's IRR is positive, then its NPV must also be positive.

Question 4

The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows.

Accepted Answer

A) True 
 B)False

Question 5

The NPV and IRR methods, when used to evaluate two independent and equally risky projects, will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their cost of capital.

Accepted Answer

A) True 
 B)False

Question 6

Which of the following statements is CORRECT?

Accepted Answer

A)  One defect of the IRR method is that it does not take account of cash flows over a project's full life. 
B)  One defect of the IRR method is that it does not take account of the time value of money. 
C)  One defect of the IRR method is that it does not take account of the cost of capital. 
D)  One defect of the IRR method is that it 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 is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.

Question 7

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 8

No conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, if the projects' cost of capital exceeds the rate at which the projects' NPV profiles cross.

Accepted Answer

A) True 
 B)False

Question 9

Small businesses make less use of DCF capital budgeting techniques than large businesses. This may reflect a lack of knowledge on the part of small firms' managers, but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for small firms.

Accepted Answer

A) True 
 B)False

Question 10

Jazz World Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected.

Accepted Answer

A)  $41.25 
B)  $45.84 
C)  $50.93 
D)  $56.59 
E)  $62.88

Question 11

Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method puts the other one first. In theory, such conflicts should be resolved in favor of the project with the higher IRR.

Accepted Answer

A) True 
 B)False

Question 12

Fernando Designs is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?

Accepted Answer

A)  1.88 years 
B)  2.09 years 
C)  2.29 years 
D)  2.52 years 
E)  2.78 years

Question 13

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 14

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

Question 15

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. Neither has negative cash flows after Year 0, and at the current cost of capital, the two projects have identical NPVs. Now suppose interest rates and money costs decline. Other things held constant, this change will cause L to become preferred to S.

Accepted Answer

A) True 
 B)False

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A)  If a project has "normal" cash flows, then its IRR must be positive. 
B)  If a project has "normal" cash flows, then its MIRR must be positive. 
C)  If a project has "normal" cash flows, then it will have exactly two real IRRs. 
D)  The definition of "normal" cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project's life. 
E)  If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR.

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

Thorley Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative, in both cases it will be rejected.

Accepted Answer

A)  9.43% 
B)  9.91% 
C)  10.40% 
D)  10.92% 
E)  11.47%

Question 19

Which of the following statements is CORRECT?

Accepted Answer

A)  The NPV method was once the favorite of academics and business executives, but today most authorities regard the MIRR as being the best indicator of a project's profitability. 
B)  If the cost of capital declines, this lowers a project's NPV. 
C)  The NPV method is regarded by most academics as being the best indicator of a project's profitability, hence most academics recommend that firms use only this one method. 
D)  A project's NPV depends on the total amount of cash flows the project produces, but because the cash flows are discounted at the WACC, it does not matter if the cash flows occur early or late in the project's life. 
E)  The NPV and IRR methods may give different recommendations regarding which of two mutually exclusive projects should be accepted, but they always give the same recommendation regarding the acceptability of a normal, independent project.

Question 20

Which of the following statements is CORRECT?

Accepted Answer

A)  If a project with normal cash flows has an IRR greater than the WACC, the project must also have a positive NPV. 
B)  If Project A's IRR exceeds Project B's, then A must have the higher NPV. 
C)  A project's MIRR can never exceed its IRR. 
D)  If a project with normal cash flows has an IRR less than the WACC, the project must have a positive NPV. 
E)  If the NPV is negative, the IRR must also be negative.

Exam 11: The Basics of Capital Budgeting

Projects A and B have identical expected lives and identical initial cash outflows (costs) 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.

The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows.

The NPV and IRR methods, when used to evaluate two independent and equally risky projects, will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their cost of capital.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

No conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, if the projects' cost of capital exceeds the rate at which the projects' NPV profiles cross.

Jazz World Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected.

Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method puts the other one first. In theory, such conflicts should be resolved in favor of the project with the higher IRR.

Fernando Designs is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?

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

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.

Thorley Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative, in both cases it will be rejected.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?