Answer: a
Question: Other things held constant, an increase in the cost of capital will result in a decrease in a project’s IRR.
Answer Options:
a. True
b. False
Answer: b. False
Question: The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows.
Answer Options:
a. True
b. False
Answer: a. True
Question: For planning purposes, managers must forecast the total capital budget because the amount of capital raised affects the WACC. a. True b. False
Answer: b
Question: Which of the following statements is CORRECT? a. For a project to have more than one IRR, then both IRRs must be greater than the WACC. b. If two projects are mutually exclusive, then they are likely to have multiple IRRs. c. If a project is independent, then it cannot have multiple IRRs. d. Multiple IRRs can only occur if the signs of the cash flows change more than once. e. If a project has two IRRs, then the smaller one is the one that is most relevant, and it should be accepted and relied upon.
Answer: d
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? 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: e
Question: Which of the following statements is CORRECT? a. An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted. b. Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method. c. A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank’s other offices. d. A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project. e. If sunk costs are considered and reflected in a project’s cash flows, then the project’s calculated NPV will be higher than it otherwise would have been had the sunk costs been ignored.
Answer: d
Question: If an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land. a. True b. False
Answer: a
Question: The following are all examples of real options that are discussed in the text: (1) protection options, (2) flexibility options, (3) timing options, and (4) abandonment options. a. True b. False
Answer: b
Question: Suppose a firm’s CFO thinks that an externality is present in a project, but that it cannot be quantified with any precision—estimates of its effect would really just be guesses. In this case, the externality should be ignored—i.e., not considered at all—because if it were considered it would make the analysis appear more precise than it really is. a. True b. False
Answer: b
Question: Which of the following statements is CORRECT? 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: c
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 Options:
a. True
b. False
Answer: b. False
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. a. True b. False
Answer: b
Question: Which of the following statements is CORRECT? 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
Question: Assuming that their NPVs based on the firm’s cost of capital are equal, the NPV of a project whose cash flows accrue relatively rapidly will be more sensitive to changes in the discount rate than the NPV of a project whose cash flows come in later in its life.
Answer Options:
a. True
b. False
Answer: b. False
Question: The change in net operating working capital associated with new projects is always positive, because new projects mean that more operating working capital will be required. a. True b. False
Answer: b