Answer Choices:
a. True
b. False
Answer: False
Question: If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital, the payback method and NPV method would always lead to the same decision on which project to undertake.
Answer Choices:
a. True
b. False
Answer: b. False
Question: 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.
Answer Choices:
a. True
b. False
Answer: a. True
Question: One advantage of the payback method for evaluating potential investments is that it provides information about a project’s liquidity and risk.
Answer Choices:
a. True
b. False
Answer: a. True
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?
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 the higher IRR at the new WACC.
Answer: d. You should recommend Project S, because at the new WACC it will have the higher NPV.
Question: 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 very small firms.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
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.
Answer: a. If a project with normal cash flows has an IRR greater than the WACC, the project must also have a positive NPV.
Question: An increase in the firm’s WACC will decrease projects’ NPVs, which could change the accept/reject decision for any potential project. However, such a change would have no impact on projects’ IRRs. Therefore, the accept/reject decision under the IRR method is independent of the cost of capital.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
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.
Answer: 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: Which of the following statements is CORRECT?
Answer Choices:
a. An NPV profile graph shows how a project’s payback varies as the cost of capital changes.
b. The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases.
c. An NPV profile graph is designed to give decision makers an idea about how a project’s risk varies with its life.
d. An NPV profile graph is designed to give decision makers an idea about how a project’s contribution to the firm’s value varies with the cost of capital.
e. We cannot draw a project’s NPV profile unless we know the appropriate WACC for use in evaluating the project’s NPV.
Answer: d. An NPV profile graph is designed to give decision makers an idea about how a project’s contribution to the firm’s value varies with the cost of capital.
Question: The IRR 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: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The regular payback method recognizes all cash flows over a project’s life.
b. The discounted payback method recognizes all cash flows over a project’s life, and it also adjusts these cash flows to account for the time value of money.
c. The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today.
d. The regular payback is useful as an indicator of a project’s liquidity because it gives managers an idea of how fast the firm’s investment will generate cash flows that cover the project’s cost.
Answer: d. The regular payback is useful as an indicator of a project’s liquidity because it gives managers an idea of how fast the firm’s investment will generate cash flows that cover the project’s cost.
Question: Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?
Answer Choices:
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 phenomenon called “multiple internal rates of return” arises when two or more mutually exclusive projects that have different lives are being compared.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The shorter a project’s payback period, the less desirable the project is normally considered to be by this criterion.
b. One drawback of the payback criterion is that this method does not take account of cash flows beyond the payback period.
c. If a project’s payback is positive, then the project should be accepted because it must have a positive NPV.
d. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
Answer: b. One drawback of the payback criterion is that this method does not take account of cash flows beyond the payback period.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.
b. The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR.
c. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate.
d. The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
e. The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
Answer: a. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.
Question: Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project’s life.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
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: For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR.
Question: Other things held constant, an increase in the cost of capital will result in a decrease in a project’s IRR.
Answer Choices:
a. True
b. False
Answer: b. False
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 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.
Answer: d. A project’s IRR is the discount rate that causes the PV of the inflows to equal the project’s cost.
Question: Which of the following statements is CORRECT?
a. The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount.
Answer Choices:
Answer: The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount.
Question: 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.
Answer Choices:
a. True
b. False
Answer: b. False