Question 1

Last month, Standard Systems analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project took place, 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. $\begin{array} { l c c c c } 
\text { Old r: } & 10.00 \% & \text { New r: } & 11.25 \% \
\text { Year } & 0 & 1 & 2 & 3 \
\text { Cash flows } & - \$ 1,000 & \$ 410 & \$ 410 & \$ 410
\end{array}$

Accepted Answer

A) $18.89 
B) $19.88 
C)  $20.93 
D) $22.03 
E)  $23.13

Question 2

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)  the lower the cost of capital used to calculate a project's npv, the lower the calculated npv will be. 
B)  if a project's npv is less than zero, then its irr must be less than the cost of capital. 
C)  if a project's npv is greater than zero, then its irr must be less than zero. 
D)  the npv of a relatively low-risk project should be found using a relatively high cost of capital. 
E)  a project's npv is found by compounding the cash inflows at the irr to find the terminal value (tv), then discounting the tv at the cost of capital.

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 the time value of money. 
B)  one defect of the irr method versus the npv is that the irr does not take account of the cost of capital. 
C)  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. 
D)  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. 
E)  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.

Question 4

Garner Inc. is considering a project that has the following cash flow data. What is the project's payback?
 $\begin{array} { c c c c c } 
\text { Year } & 0 & 1 & 2 & 3 \
\text { Canh tlows } & - \$ 350 & 200 & 200& 200
\end{array}$

Accepted Answer

A)  1.42 years 
B)  1.58 years 
C)  1.75 years 
D)  1.93 years 
E)  2.12 years

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

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 cost of capital, then under all reasonable conditions, the project's irr must be negative. 
B)  if a project's irr is equal to its cost of capital, then under all reasonable conditions the project's npv must be zero. 
C)  there is no necessary relationship between a project's irr, its cost of capital, and its npv. 
D)  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. 
E)  if a project's irr is equal to its cost of capital, then, under all reasonable conditions, the project's npv must be negative.

Question 7

The NPV 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 8

Yoga Center Inc. is considering a project that has the following cash flow and cost of capital (r) data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.
 $\begin{array} { l c c c c c } 
r& 14.00 \% \
\text { Year } &0& 1 & 2 & 3 & 4 \
 \text { Cash flowr } & - \$ 1,200 & 400 & 425 & 450 & 475
\end{array}$

Accepted Answer

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

Question 9

A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC).

Accepted Answer

A) True 
 B)False

Question 10

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 11

Which of the following statements is NOT a disadvantage of the regular payback method?

Accepted Answer

A)  ignores cash flows beyond the payback period. 
B)  does not directly account for the time value of money. 
C)  does not provide any indication regarding a project's liquidity or risk. 
D)  does not take account of differences in size among projects. 
E)  lacks an objective, market-determined benchmark for making decisions.

Question 12

Which of the following statements is CORRECT?

Accepted Answer

A)  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 cost of capital to find the pv. 
B)  the npv and irr methods both assume that cash flows can be reinvested at the cost of capital. however, the mirr method assumes reinvestment at the mirr itself. 
C)  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. 
D)  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. 
E)  for a project with normal cash flows, any change in the cost of capital will change both the npv and the irr.

Question 13

Westwood Painting Co. 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. 
$\begin{array} { l c c c c c } 
&r=12.25 \% \
\text { Year } & 0 & 1 & 2 & 3 & 4 \
\text { Cash flows } & - 850 & 300 & 320 & 340 & 360
\end{array}$

Accepted Answer

A)  13.42% 
B)  14.91% 
C)  16.56% 
D)  18.22% 
E)  20.04%

Question 14

Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?

Accepted Answer

A)  a project's npv increases as the cost of capital declines. 
B)  a project's mirr is unaffected by changes in the cost of capital. 
C)  a project's regular payback increases as the cost of capital declines. 
D)  a project's discounted payback increases as the cost of capital declines. 
E)  a project's irr increases as the cost of capital declines.

Question 15

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 16

Which of the following statements is CORRECT?

Accepted Answer

A)  if the cost of capital declines, this lowers a project's npv. 
B)  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. 
C)  a project's npv depends on the total amount of cash flows the project produces, but because the cash flows are discounted at the cost of capital, it does not matter if the cash flows occur early or late in the project's life. 
D)  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. 
E)  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.

Question 17

Robbins Inc. is considering a project that has the following cash flow and cost of capital (r) data. What is the project's NPV? Note that if a project's expected NPV is negative, it should be rejected. $\begin{array} { l c c c c c c c } 
\text { Year } & 10.25 \%\ & 0 & 1 & 2 & 3 & 4 & 5 \
\text { Cash FlowS } & - 1,000 & 300 & 300 & 300 & 300 & 300
\end{array}$

Accepted Answer

A)  $105.89 
B)  $111.47 
C)  $117.33 
D)  $123.51 
E)  $130.01

Question 18

Pet World is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the cost of capital (and even negative), in which case it will be rejected. 
$\begin{array}{cccccc}
\text { Year } &0 & 1 & 2 & 3 & 4 & 5 \
\hline-\text { Cash flows } &\$ 9.500 & \$ 2.000 & \$ 2.025 & \$ 2.050 & \$ 2.075 & \$ 2.100
\end{array}$

Accepted Answer

A)  2.08% 
B)  2.31% 
C)  2.57% 
D)  2.82% 
E)  3.10%

Question 19

Spence Company is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the cost of capital or negative, in both cases it will be rejected. 
$\begin{array} { l c c c c c } 
\text { Year } & 0 & 1 & 2 & 3 & 4 \
 \text { Cash flows } & - \$ 1,050 & 400 & 400 & \$ 400 & 400
\end{array}$

Accepted Answer

A)  14.05% 
B)  15.61% 
C)  17.34% 
D)  19.27% 
E)  21.20%

Question 20

Projects A and B have identical expected lives and identical initial cash outflows (costs). However, most of one project's cash flows come in the early years, while most of the other project's cash flows occur in the later years. The two NPV profiles are given below:σσσσWhich of the following statements is CORRECT?

Accepted Answer

A)  more of project b's cash flows occur in the later years. 
B)  we must have information on the cost of capital in order to determine which project has the larger early cash flows. 
C)  the npv profile graph is inconsistent with the statement made in the problem. 
D)  the crossover rate, i.e., the rate at which projects a and b have the same npv, is greater than either project's irr. 
E)  more of project a's cash flows occur in the later years.

Exam 12: Capital Budgeting: Decision Criteria

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.

Which of the following statements is CORRECT?

Garner Inc. is considering a project that has the following cash flow data. What is the project's payback? $\begin{array} { c c c c c } \text { Year } & 0 & 1 & 2 & 3 \\\text { Canh tlows } & - \$ 350 & 200 & 200& 200\end{array}$

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

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

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

A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC).

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.

Which of the following statements is NOT a disadvantage of the regular payback method?

Which of the following statements is CORRECT?

Assume a project has normal cash flows. All else equal, 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?