Answer: d
Question: Which of the following statements is CORRECT? 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.
Answer: a
Question: Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product? a. A firm has a parcel of land that can be used for a new plant site or be sold, rented, or used for agricultural purposes. b. A new product will generate new sales, but some of those new sales will be from customers who switch from one of the firm’s current products. c. A firm must obtain new equipment for the project, and $1 million is required for shipping and installing the new machinery. d. A firm has spent $2 million on research and development associated with a new product. These costs have been expensed for tax purposes, and they cannot be recovered regardless of whether the new project is accepted or rejected. e. A firm can produce a new product, and the existence of that product will stimulate sales of some of the firm’s other products.
Answer: d
Question: Which of the following statements is CORRECT? 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 using only this one method and disregard other methods. 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.
Answer: e
Question: Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process. a. True b. False
Answer: b
Question: For a project with one initial cash outflow followed by a series of positive cash inflows, the modified IRR (MIRR) method involves compounding the cash inflows out to the end of the project’s life, summing those compounded cash flows to a terminal value (TV), and then finding the discount rate that causes the PV of the TV to equal the project’s cost.
Answer Options:
a. True
b. False
Answer: a. True
Question: If a firm’s projects differ in risk, then one way of handling this problem is to evaluate each project with the appropriate risk-adjusted discount rate. a. True b. False
Answer: a
Question: The NPV method is based on the assumption that projects’ cash flows are reinvested at the project’s risk-adjusted cost of capital.
Answer Options:
a. True
b. False
Answer: a. True
Question: Real options are options to buy real assets, especially stocks, rather than interest-bearing assets, like bonds. a. True b. False
Answer: b
Question: Capital rationing is the situation in which a firm can raise only a specified, limited amount of capital regardless of how many good projects it has.
Answer Options:
a. True
b. False
Answer: a. True
Question: Traditional discounted cash flow (DCF) analysis—where a project’s cash flows are estimated and then discounted to obtain an expected NPV—has been the cornerstone of capital budgeting since the 1950s. However, in recent years, it has been demonstrated that DCF techniques do not always lead to proper capital budgeting decisions due to the existence of real options. a. True b. False
Answer: b
Question: The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken, assuming the asset is used for its full tax life, is greater. a. True b. False
Answer: b
Question: A basic rule in capital budgeting is that if a project’s NPV exceeds its IRR, then the project should be accepted.
Answer Options:
a. True
b. False
Answer: b. False
Question: Assume that the economy is in a mild recession, and as a result interest rates and money costs generally are relatively low. The WACC for two mutually exclusive projects that are being considered is 8%. Project S has an IRR of 20% while Project L’s IRR is 15%. The projects have the same NPV at the 8% current WACC. However, you believe that the economy is about to recover, and money costs and thus your WACC will also increase. You also think that the projects will not be funded until the WACC has increased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT? 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 the higher IRR at the new WACC.
Answer: d
Question: Which of the following statements is CORRECT? a. Projects with “normal” cash flows can have only one real IRR. b. Projects with “normal” cash flows can have two or more real IRRs. c. Projects with “normal” cash flows must have two changes in the sign of the cash flows, e.g., from negative to positive to negative. If there are more than two sign changes, then the cash flow stream is “nonnormal.” d. The “multiple IRR problem” can arise if a project’s cash flows are “normal.” e. Projects with “nonnormal” cash flows are almost never encountered in the real world.
Answer: a