Question 1

Which of the following statements is CORRECT?

Accepted Answer

An NPV profile graph is designed to show decision makers how a project's net present value (NPV) varies with the discount rate (cost of capital), not its risk or payback. The graph will generally have a negative (downward) slope, indicating that as the discount rate increases, the NPV of the project decreases. The appropriate discount rate used for the graph is the weighted average cost of capital (WACC), which takes into account the cost of both debt and equity capital used to finance the project.

Question 2

Which of the following statements is CORRECT?

Accepted Answer

The IRR method does consider the time value of money, similar to NPV, and it does account for cash flows over a project's full life. However, it may not properly reflect differences in project sizes, which is a limitation compared to NPV.

Question 3

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, with faster incoming 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 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

One drawback of the regular payback method is that it doesn't take into account the time value of money. This means that the method doesn't adjust the cash flows for the fact that a dollar received in the future is worth less than a dollar received today. Therefore, the regular payback method may not provide an accurate measure of the profitability of a project.

Question 5

theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital The decision criterion should not be affected by managers' tastes, choice of accounting method, or the profitability of other independent projects.

Accepted Answer

According to financial theory, capital budgeting decisions should only consider forecasted cash flows and the cost of capital, and should not be influenced by managerial preferences, accounting methods, or the profitability of other unrelated projects.

Question 6

Which of the following statements is CORRECT?

Accepted Answer

The regular payback method is still used today as a rough indicator of a project's liquidity. It tells managers how long it will take to recover their initial investment. However, it does not account for the time value of money and does not consider cash flows beyond the payback period. The discounted payback method overcomes these limitations by adjusting cash flows to their present values and considering all cash flows over a project's life. Therefore, statement A and D are incorrect. Statement B is partially correct but no longer widely used is an exaggeration, as many small businesses still rely on the regular payback method. Statement E is incorrect as the regular payback method does not account for the time value of money.

Question 7

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 exceeds the rate at which the projects' NPV profiles cross.

Accepted Answer

When the cost of capital exceeds the rate at which the projects' NPV profiles cross, the IRR method may suggest the project with the higher IRR is the better investment, while the NPV method may suggest the project with lower IRR but higher NPV is the better investment. This creates a conflict between the two methods.

Question 8

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 at which the present value of the cash inflows equals the present value of the initial investment (outflow). Therefore, statement C is correct. Statement A is incorrect because it describes the calculation of the Modified IRR (MIRR), not the regular IRR. Statement B is incorrect because if the IRR is smaller than the WACC, the project's NPV will be negative. Statement D is incorrect because a project's IRR and NPV can have opposite signs if the cash flows occur at different points in time. Statement E is incorrect because it describes the calculation of the terminal value, not the regular IRR.

Question 9

Which of the following statements is CORRECT?

Accepted Answer

"Normal" cash flows refer to a cash flow stream that 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, whereas a project with "nonnormal" cash flows might have more than one real IRR. Therefore, option D is correct. Option A is incorrect because a project with "normal" cash flows can have a negative MIRR if the cost of capital is higher than the reinvestment rate of the intermediate cash flows. Option B is incorrect because a project with "normal" cash flows can have only one real IRR. Option C is incorrect as it describes the definition of "normal" cash flows. Option E is also incorrect as a project with "normal" cash flows may have a negative IRR.

Question 10

Which of the following statements is CORRECT?

Accepted Answer

Statement e is correct.The others are false.If you draw an NPV profile for one project,you will see that if the WACC is less than the IRR,the NPV will be positive.

Question 11

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 IRR rule can be misleading for mutually exclusive projects; the project with the higher IRR is not always the better choice if it doesn't maximize the NPV. The firm should select the project with the higher NPV, not necessarily the higher IRR.

Question 12

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.

Accepted Answer

When interest rates and money costs decline, the present value of future cash flows increases, particularly for cash flows that occur later in a project's life. Given that Project L has larger cash flows later in its life, it will benefit more from the decrease in interest rates and become more preferred over Project S, which has higher cash flows earlier in its life.

Question 13

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 cost of capital.

Accepted Answer

The NPV and IRR methods will lead to the same accept/reject decisions for independent projects if the IRRs are greater than the cost of capital, as both methods would indicate that the projects are profitable.

Question 14

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

The statement is false because it is possible for the NPV profiles of mutually exclusive projects to cross, meaning that at different costs of capital, the project with the lower IRR could have a higher NPV. Therefore, it is not impossible to draw NPV profiles that suggest not accepting Project X.

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) is the discount rate that makes the net present value (NPV) of a project's cash inflows and outflows equal to zero. In other words, the IRR is the discount rate that equates the present value of future cash inflows to the present value of the project's 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. Choices A, B, D, and E are incorrect because they either misstate the calculation of the IRR or present an incorrect relationship between the IRR and the NPV or WACC.

Question 16

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 higher the WACC used to calculate the NPV, the higher the discount rate applied to future cash inflows, reducing their present value and resulting in a lower calculated NPV.

Question 17

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 less than the projects' cost of capital.

Accepted Answer

The answer of NPV and IRR methods, when used to...

Question 18

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's NPV is less than zero, it means that the project's cost of capital (WACC) is greater than the project's internal rate of return (IRR). This is because the NPV is calculated by discounting the cash flows at the project's cost of capital, and if the NPV is negative, it means that the present value of the cash inflows is less than the present value of the cash outflows. Therefore, the IRR must be less than the WACC.

Question 19

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 can lead to unrealistic and inaccurate results.

Question 20

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.

Accepted Answer

The discounted payback method still does not account for cash flows beyond the payback period; it only considers the time value of money for cash flows within the payback period.

Quiz 12: Capital Budgeting

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital The decision criterion should not be affected by managers' tastes, choice of accounting method, or the profitability of other independent projects.

Which of the following statements is CORRECT?

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 exceeds the rate at which the projects' NPV profiles cross.

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?

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.

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 cost of capital.

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? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.

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 less than the projects' cost of capital.

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?

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.