Answer Options:
a. 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.
b. You should recommend Project L, because at the new WACC it will have the higher NPV.
c. You should recommend Project S, because at the new WACC it will have the higher NPV.
d. You should recommend Project L, because at the new WACC it will have the higher IRR.
e. You should recommend Project L because it will have both a higher IRR and a higher NPV under the new conditions.
Answer: D. You should recommend Project L, because at the new WACC it will have the higher IRR.
Question: Any cash flows that can be classified as incremental to a particular project—i.e., results directly from the decision to undertake the project—should be reflected in the capital budgeting analysis.
Answer Options:
a. True
b. False
Answer: A. True
Question: Accelerated depreciation has an advantage for profitable firms in that it moves some cash flows forward, thus increasing their present value. On the other hand, using accelerated depreciation generally lowers the reported current year’s profits because of the higher depreciation expenses. However, the reported profits problem can be solved by using different depreciation methods for tax and stockholder reporting purposes.
Answer Options:
a. True
b. False
Answer: A. True
Question: Which of the following statements is INCORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.
Answer Options:
a. The longer a project’s payback period, the more desirable the project is normally considered to be by this criterion.
b. One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.
c. If a project’s payback is positive, then the project should be rejected because it must have a negative NPV.
d. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
e. If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time.
Answer: A. The longer a project’s payback period, the more desirable the project is normally considered to be by this criterion.
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.
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.
Answer Options:
a. True
b. False
Answer: B. False
Question: Which of the following statements is CORRECT?
Answer Options:
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 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. 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: A firm should never accept a project if its acceptance would lead to an increase in the firm’s cost of capital (its WACC).
Answer Options:
a. True
b. False
Answer: False
Question: It is extremely difficult to estimate the revenues and costs associated with large, complex projects that take several years to develop. This is why subjective judgment is often used for such projects along with discounted cash flow analysis.
Answer Options:
a. True
b. False
Answer: A. True
Question: 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.
Answer Options:
a. True
b. False
Answer: True
Question: Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions for capital budgeting projects.
Answer Options:
a. True
b. False
Answer: B. False
Question: Which of the following statements is CORRECT?
Answer Options:
a. The MIRR and NPV decision criteria can never conflict.
b. The IRR method can never be subject to the multiple IRR problem, while the MIRR method can be.
c. One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.
d. The higher the WACC, the shorter the discounted payback period.
e. The MIRR method assumes that cash flows are reinvested at the crossover rate.
Answer: C. One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.
Question: The optimal capital budget is the size of the capital budget where the rate of return on the marginal project is equal to the marginal cost of capital.
Answer Options:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Options:
a. Using accelerated depreciation rather than straight line would normally have no effect on a project’s total projected cash flows but it would affect the timing of the cash flows and thus the NPV.
b. Under current laws and regulations, corporations must use the same depreciation method (e.g., straight line or accelerated) for stockholder reporting and tax purposes.
c. Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions.
d. Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project’s projected NPV.
e. A good example of a sunk cost is the cost a situation where Home Depot opens a new store, and that leads to a decline in sales of one of the firm’s existing stores.
Answer: A. Using accelerated depreciation rather than straight line would normally have no effect on a project’s total projected cash flows but it would affect the timing of the cash flows and thus the NPV.
Question: 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.
Answer Options:
a. A project’s regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC.
b. A project’s regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR.
c. If a project’s IRR is greater than the WACC, then its NPV must be negative.
d. To find a project’s IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project’s costs.
e. To find a project’s IRR, we must find a discount rate that is equal to the WACC.
Answer: D. To find a project’s IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project’s costs.
Question: Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?
Answer Options:
a. A project’s IRR increases as the WACC declines.
b. A project’s NPV increases as the WACC declines.
c. A project’s MIRR is unaffected by changes in the WACC.
d. A project’s regular payback increases as the WACC declines.
e. A project’s discounted payback increases as the WACC declines.
Answer: B. A project’s NPV increases as the WACC declines.
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.
Answer Options:
a. True
b. False
Answer: B. False
Question: Which of the following statements is CORRECT? 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.
Answer Options:
a. True
b. False
Answer: True