Answer Choices:
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.
Answer: 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: A 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 is less than the rate at which the projects’ NPV profiles cross.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Suppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4-year payback regardless of economic conditions. Other things held constant, which of the following statements is most likely to be true?
Answer Choices:
a. It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV).
b. It will accept too many long-term projects and reject too many short-term projects (as judged by the NPV).
c. The firm will accept too many projects in all economic states because a 4-year payback is too low.
d. The firm will accept too few projects in all economic states because a 4-year payback is too high.
e. If the 4-year payback results in accepting just the right set of projects under average economic conditions, then this payback will result in too few long-term projects when the economy is weak.
Answer: d. The firm will accept too few projects in all economic states because a 4-year payback is too high.
Question: When considering two mutually exclusive projects, the firm should always select the project whose internal rate of return is the highest, provided the projects have the same initial cost. This statement is true regardless of whether the projects can be repeated or not.
Answer Choices:
a. True
b. False
Answer: b. False
Question: 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.
Answer Choices:
a. True
b. False
Answer: b. False
Question: 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 costs of capital.
Answer Choices:
a. True
b. False
Answer: b. False
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 form a terminal value (TV), and then finding the discount rate that causes the PV of the TV to equal the project’s cost.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
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.
Answer: Multiple IRRs can exist, but not multiple MIRRs. This is one reason some people favor the MIRR over the regular IRR.
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 Choices:
a. True
b. False
Answer: a. True
Question: 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?
Answer Choices:
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%.
Answer: a. Project D probably has a higher IRR.
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 Choices:
a. A project’s NPV is generally found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting the TV at the IRR to find its PV.
b. The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.
c. If a project’s NPV is greater than zero, then its IRR must be less than the WACC.
d. If a project’s NPV is greater than zero, then its IRR must be less than zero.
e. The NPVs of relatively risky projects should be found using relatively low WACCs.
Answer: b. The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.
Question: 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?
Answer Choices:
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.
Answer: c. You should recommend Project L, because at the new WACC it will have the higher 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 Choices:
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 the 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: Which of the following statements is CORRECT?
Answer Choices:
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: 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: Which of the following statements is CORRECT?
Answer Choices:
a. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
b. The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
c. The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
e. The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
Answer: d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
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 Choices:
a. True
b. False
Answer: a. True
Question: Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process. Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects’ cash flows.
Answer Choices:
a. True
b. False
Answer: True
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 Choices:
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: b. One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.
Question: The NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, will lead to different accept/reject decisions and thus capital budgets if the cost of capital at which the projects’ NPV profiles cross is greater than the crossover rate.
Answer Choices:
a. True
b. False
Answer: b. False