Question 1

The cost of capital for two mutually exclusive projects that are being considered is 12%.Project K has an IRR of 20% while Project R's IRR is 15%.The projects have the same NPV at the 12% current cost of capital.Interest rates are currently high.However, you believe that money costs and thus your cost of capital will soon decline.You also think that the projects will not be funded until the cost of capital 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?

Accepted Answer

The answer of The cost of capital for two mutually...

Question 2

Normal Projects S and L have the same NPV when the discount rate is zero.However, Project S's cash flows come in faster than those of L.Therefore, we know that at any discount rate greater than zero, L will have the higher NPV.

Accepted Answer

Project S, which has faster cash flows, will have a higher NPV at any positive discount rate because earlier cash flows are more valuable when discounted back to the present value.

Question 3

Which of the following statements is CORRECT?

Accepted Answer

This statement is a basic principle of capital budgeting. If a project's IRR exceeds the cost of capital, it means that the project is generating a return that is higher than the cost of the funds used to finance it. Therefore, the project's cash inflows are sufficient to compensate for the cost of capital and generate a surplus, leading to a positive net present value (NPV).

Question 4

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.

Accepted Answer

The internal rate of return (IRR) is the discount rate that causes the net present value (NPV) of the project to equal zero. In other words, it is the discount rate at which the present value of the project's cash inflows equals the present value of its costs. Therefore, 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 5

Which of the following statements is CORRECT?

Accepted Answer

The correct statement is D because when NPV profiles of two projects cross, the one with the lower IRR typically has its larger cash flows occurring later, making it more valuable at higher discount rates. This is because the value of later cash flows is less affected by the discount rate compared to earlier cash flows.

Question 6

Which of the following statements is CORRECT?

Accepted Answer

The correct statement is that the NPV method assumes that cash flows will be reinvested at the cost of capital, while the IRR method assumes reinvestment at the IRR. This is because the NPV method calculates the present value of cash inflows and outflows using the cost of capital as the discount rate, while the IRR method determines the rate at which cash inflows equal the initial investment. The assumption about reinvestment is different for the two methods, which can lead to different project evaluations.

Question 7

Which of the following statements is CORRECT?

Accepted Answer

The answer of Which of the following statements is CORRECT?
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Question 8

The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zero.Also, the NPV of X is greater than the NPV of Y at the cost of capital.If the two projects are mutually exclusive, Project X should definitely be selected, and the investment made, provided we have confidence in the data.Put another way, it is impossible to draw NPV profiles that would suggest not accepting Project X.

Accepted Answer

While Project X has a higher IRR and NPV at a specific cost of capital, NPV profiles could intersect, meaning that for different costs of capital, Project Y might have a higher NPV. The decision depends on the actual cost of capital and how these profiles behave across different rates.

Question 9

Projects S and L are both normal projects with an initial cost of $10,000, followed by a series of positive cash inflows.Project S's undiscounted net cash flows total $20,000, while L's total undiscounted flows are $30,000.At a cost of capital of 10%, the two projects have identical NPVs.Which project's NPV is more sensitive to changes in the cost of capital?

Accepted Answer

Project L's NPV is more sensitive to changes in the cost of capital because it has higher undiscounted cash flows spread over time, making its value more affected by changes in the discount rate compared to Project S.

Question 10

Which of the following statements is CORRECT?

Accepted Answer

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. This is known as the reinvestment rate assumption, and it can lead to the IRR method producing misleading results.

Question 11

Which of the following statements is CORRECT?

Accepted Answer

The IRR method does consider the time value of money, similar to the NPV method, by discounting future cash flows. However, it may not accurately reflect the scale of different projects, as it gives a percentage return rather than an absolute dollar amount, which is a key distinction from the NPV method that can lead to misinterpretation when comparing projects of different sizes.

Question 12

If the IRR of normal Project X is greater than the IRR of mutually exclusive (and also normal) Project Y, we can conclude that the firm should always select X rather than Y if X has NPV > 0.

Accepted Answer

The decision to select Project X over Project Y based solely on a higher IRR can be misleading if not considering the scale of investment, timing of cash flows, and cost of capital. NPV should be the primary criterion for project selection, especially for mutually exclusive projects, as it directly measures the value added to the firm. A project with a higher NPV, even if it has a lower IRR, can be more beneficial for the firm's value.

Question 13

The cost of capital for two mutually exclusive projects that are being considered is 8%.Project K has an IRR of 20% while Project R's IRR is 15%.The projects have the same NPV at the 8% current cost of capital.However, you believe that money costs and thus your cost of capital will also increase.You also think that the projects will not be funded until the cost of capital 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?

Accepted Answer

Since the projects have equal NPVs at the current cost of capital, the project with the higher IRR (Project K) is better. Additionally, since the cash flows of both projects are not affected by changes in economic conditions and the cost of capital will increase, the higher IRR project will still have the higher NPV at the new cost of capital. Therefore, it is recommended to choose Project K. Delaying the decision could result in potential loss of market share, and choosing Project R based on its current NPV would not be the best decision as it would have a lower NPV after the cost of capital increases.

Question 14

Which of the following statements is CORRECT?

Accepted Answer

The MIRR is often preferred over the regular IRR because it assumes that cash inflows are reinvested at the cost of capital, which is a more realistic assumption than assuming reinvestment at the project's IRR. This helps to avoid the multiple IRR problem that can occur with the regular IRR method. The other statements are either incorrect or incomplete.

Question 15

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.

Accepted Answer

The internal rate of return (IRR) of a project is the discount rate that causes the present value of the cash inflows to equal the initial cost of the project. Therefore, statement C is correct. Statement A is incorrect because it describes the process for finding the modified IRR, not the regular IRR. Statement B is incorrect because if the IRR is less than the cost of capital, then the project's NPV will be negative. Statement D is incorrect because a project can have a positive IRR but still have a negative NPV if the cost of capital is higher than the IRR. Statement E is incorrect because it describes the process for finding the terminal value, not the regular IRR.

Question 16

Which of the following statements is CORRECT?

Accepted Answer

An NPV profile graph is designed to show decision makers how a project's contribution to the firm's value varies with the cost of capital. The graph plots the project's NPV at different discount rates. The slope of the graph will generally be negative, indicating that as the discount rate (cost of capital) increases, the project's NPV decreases. Therefore, choice A is incorrect. Choice B describes a risk profile graph, not an NPV profile graph. Choice D is incorrect because we can draw the NPV profile graph using a range of discount rates to show how the project's value changes at different levels of cost of capital. Choice E is incorrect because an NPV profile graph does not show payback period.

Question 17

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.

Accepted Answer

If a project has normal cash flows and its IRR exceeds its cost of capital, then the project's NPV must be positive. This is because a project's IRR represents the discount rate at which the project's NPV equals zero. If the IRR is greater than the cost of capital, then the project's cash inflows are being discounted at a rate lower than their actual return, resulting in a positive NPV. This relationship holds true regardless of the IRR or NPV of other projects being considered.

Question 18

Which of the following statements is CORRECT?

Accepted Answer

C) Multiple IRRs can occur only if the signs of the cash flows change more than once. This is because the existence of multiple IRRs is associated with non-conventional cash flows, where the cash flow signs change more than once, leading to the possibility of calculating more than one IRR.

Question 19

Which of the following statements is CORRECT?

Accepted Answer

A project with "normal" cash flows has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project's life. Such projects can have only one real IRR. Projects with "nonnormal" cash flows (i.e. cash flows with multiple sign changes) can have more than one real IRR. The MIRR can be positive or negative, depending on the discount rate used in its calculation. The sign of the IRR (positive or negative) depends on the pattern of cash flows, not just whether they are "normal."

Question 20

Projects A and B have identical expected lives and identical initial cash outflows (costs).However, most of one project's cash flows come in the early years, while most of the other project's cash flows occur in the later years.The two NPV profiles are given below:  Which of the following statements is CORRECT?

Accepted Answer

The answer of Projects A and B have identical expected...

Quiz 10: The Basics of Capital Budgeting: Evaluating Cash Flows

Normal Projects S and L have the same NPV when the discount rate is zero.However, Project S's cash flows come in faster than those of L.Therefore, we know that at any discount rate greater than zero, L will have the higher NPV.

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

If the IRR of normal Project X is greater than the IRR of mutually exclusive (and also normal) Project Y, we can conclude that the firm should always select X rather than Y if X has NPV > 0.

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?