Question 1

Projects S and L both have normal cash flows,and the projects have the same risk,hence both are evaluated with the same WACC,10%.However,S has a higher IRR than L.Which of the following statements is CORRECT?

Accepted Answer

Refer to the NPV profile below.Statement a is false,because you do not know which project has the higher NPV unless you know the WACC.Statement b is false,because if the WACC is greater than IRR_L but less than IRR_S then Project S will have a positive NPV and Project L's NPV will be negative.Statements c and d are false,because IRR is independent of WACC.Statement e is true,because Project S has the higher IRR,so Project L's NPV profile is above Project S's when the WACC is less than the crossover rate. ? 11ea856c_8b9c_c289_9aec_b1ce4c96722a_TB1222_00

Question 2

Taggart Inc.is considering a project that has the following cash flow data.What is the project's payback? $$\begin{array} { l c c c c } 
\text { Year } & 0 & 1 & 2 & 3 \
\hline  \text { Cash flows } & - \$ 1,075 & \$ 500 & \$ 500 & \$ 500
\end{array}$$

Accepted Answer

The payback period is the time it takes for the project to recoup its initial investment. Here, the initial investment is $1,075. In the first year, $500 is recouped, and in the second year, another $500 is recouped, totaling $1,000 at the end of year 2. To recoup the remaining $75, it will take 0.15 years (since $500 per year is being recouped, $75 is 15% of $500). Therefore, the total payback period is 2 years + 0.15 years = 2.15 years.

Question 3

Projects S and L are equally risky,mutually exclusive,and have normal cash flows.Project S has an IRR of 15%,while Project L's IRR is 12%.The two projects have the same NPV when the WACC is 7%.Which of the following statements is CORRECT?

Accepted Answer

?The easiest way to think about this question is to begin by drawing an NPV profile as shown below,then using it to decide which statement is correct.
? 11ea856c_8b9b_62f4_9aec_ad9e29ece4e1_TB1222_00 ?
Statement a is true,because both projects have an IRR greater than the WACC and thus will have a positive NPV.Statement b is false,because at 6%,the WACC is less than the crossover rate and Project L has a higher NPV than S.Statement c is false,because at 13% the WACC is greater than the crossover rate and S would have a higher NPV than L.Statement d is false,because of reasons mentioned for statement a.Statement e is false,because Project L's NPV profile is steeper,which means Project L's NPV is more sensitive to changes in WACC.

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 could prove that (1)if the IRR is equal to the WACC,then the MIRR and the IRR will be equal, (2)if the IRR is greater than the WACC,the MIRR will be less than the IRR,and (3)the MIRR will be greater than the IRR if the IRR is less than the WACC.This situation exists because the MIRR assumes reinvestment at the WACC and therefore compounds at that rate,while the IRR assumes reinvestment at the IRR itself and therefore compounds at the IRR.Therefore,if the IRR exceeds the WACC,the TV found under the IRR method will be larger,and vice versa.The IRR and the MIRR are found as the rate that causes the PV of the TV to equal the cost.Therefore,if the IRR exceeds the WACC,causing the IRR's TV to be larger,then the IRR will exceed the MIRR,and vice versa.As a result,statement c is correct--if the IRR exceeds the WACC,the IRR will exceed the MIRR.The other statements are false.Note too that this answer could also be confirmed with a numerical example.

Question 5

Projects A and B are mutually exclusive and have normal cash flows.Project A has an IRR of 15% and B's IRR is 20%.The company's WACC is 12%,and at that rate Project A has the higher NPV.Which of the following statements is CORRECT?

Accepted Answer

Consider the following NPV profile graph:
? 11ea856c_8b9d_85dc_9aec_71ea736d5dd3_TB1222_00 ?
We can see that statements a,d,and e are all incorrect.Statement b is also incorrect,because if the projects have the same timing pattern,then A must have the higher cost.That leaves statement c as being correct,and that conclusion is confirmed by noting that since A has the steeper slope,its cash flows must come in slower,hence B has the faster cash flows and thus the faster payback.

Question 6

Project X's IRR is 19% and Project Y's IRR is 17%.The projects have the same risk and the same lives,and each has constant cash flows during each year of their lives.If the WACC is 10%,Project Y has a higher NPV than X.Given this information,which of the following statements is CORRECT?

Accepted Answer

Again,it is useful to draw NPV profiles that fit the description given in the question.Any number that meets the criteria will do.
? 11ea856c_8b9b_ff37_9aec_c5a59f1db208_TB1222_00 ?
As we can see from the graph,statement b is true,but the other statements are false.

Question 7

A company is choosing between two projects.The larger project has an initial cost of $100,000,annual cash flows of $30,000 for 5 years,and an IRR of 15.24%.The smaller project has an initial cost of $51,600,annual cash flows of $16,000 for 5 years,and an IRR of 16.65%.The projects are equally risky.Which of the following statements is CORRECT?

Accepted Answer

Statement d is true;the other statements are false.
? 11ea856c_8b9d_10ab_9aec_b5564b33c098_TB1222_00

Question 8

Anderson Systems is considering a project that has the following cash flow and WACC data.What is the project's NPV? Note that if a project's projected NPV is negative,it should be rejected. $$\begin{array} { l c c c c } 
\text { WACC: } & { 11.00 \% } \
\text { Year } & 0 & 1 & 2 & 3 \
\hline  \text { Cash flows } & - \$ 1,000 & \$ 500 & \$ 500 & \$ 500
\end{array}$$

Accepted Answer

The answer of Anderson Systems is considering a project that...

Question 9

Simms Corp.is considering a project that has the following cash flow data.What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative,in both cases it will be rejected. $$\begin{array} { l c c c c } 
\text { Year } & 0 & 1 & 2 & 3 \
\hline  \text { Cash flows } & - \$ 1,025 & \$ 425 & \$ 425 & \$ 425
\end{array}$$

Accepted Answer

The answer of Simms Corp.is considering a project that has...

Question 10

Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows and are equally risky.

Accepted Answer

Recall that the very definition of the IRR is the discount rate at which the NPV is zero. 11ea856c_8b9c_e99a_9aec_aba4c50511bd_TB1222_00 ?
Therefore,statement c is true.All the other statements are false.

Question 11

Warr Company is considering a project that has the following cash flow data.What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative,in both cases it will be rejected.
? $$\begin{array} { l c c c c c } 
\text { Year } & 0 & 1 & 2 & 3 & 4 \
\hline \text { Cash flows } & - \$ 1540 & \$ 400 & \$ 400 & \$ 400 & \$ 400
\end{array}$$
?

Accepted Answer

The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. In this case, option C (5.41%) is the correct IRR for the project, as it is the rate at which the present value of the project's cash inflows equals the initial investment, making the NPV equal to zero. Calculating IRR typically requires using financial calculators or software because it involves solving for the rate in the NPV equation.

Question 12

Harry's Inc.is considering a project that has the following cash flow and WACC data.What is the project's NPV? Note that if a project's projected NPV is negative,it should be rejected. $$\begin{array} { l c c c c c c } 
\text { WACC: } & 9.50 \% & & & & \
\text { Year } & 0 & 1 & 2 & 3 & 4 & 5 \
\hline  \text { Cash flows } & - \$ 1,000 & \$ 300 & \$ 300 & \$ 300 & \$ 300 & \$ 300
\end{array}$$

Accepted Answer

The answer of Harry's Inc.is considering a project that has...

Question 13

Which of the following statements is CORRECT?

Accepted Answer

The statement correctly explains one of the advantages of the IRR method over the NPV method. The IRR method expresses the return on investment as a percentage, while the NPV method gives the dollar value of the profit or loss.

Question 14

You are on the staff of Camden Inc.The CFO believes project acceptance should be based on the NPV,but Steve Camden,the president,insists that no project should be accepted unless its IRR exceeds the project's risk-adjusted WACC.Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and -$100,000 at the end of Year 2.The president and the CFO both agree that the appropriate WACC for this project is 10%.At 10%,the NPV is $2,355.37,but you find two IRRs,one at 6.33% and one at 527.01%,and a MIRR of 11.32%.Which of the following statements best describes your optimal recommendation,i.e. ,the analysis and recommendation that is best for the company and least likely to get you in trouble with either the CFO or the president?

Accepted Answer

Statement c is true,while the other statements are false.It is not necessary to calculate the two IRRs and the MIRR as the data in the problem are correct,but we show the Excel calculations below.
? 11ea856c_8b9c_2648_9aec_c7c44362ac4e_TB1222_00

Question 15

McCall Manufacturing has a WACC of 10%.The firm is considering two normal,equally risky,mutually exclusive,but not repeatable projects.The two projects have the same investment costs,but Project A has an IRR of 15%,while Project B has an IRR of 20%.Assuming the projects' NPV profiles cross in the upper right quadrant,which of the following statements is CORRECT?

Accepted Answer

Statement c is true,while the other statements are false.If we draw an NPV profile graph,we would see that A must have the steeper slope.If the crossover is 8% and the WACC is 10%,then B will have the higher NPV.

Question 16

Tuttle Enterprises is considering a project that has the following cash flow and WACC data.What is the project's NPV? Note that if a project's projected NPV is negative,it should be rejected. $$\begin{array} { l c c c c c } 
\text { WACC: } & { 11.50 \% } & & & & \
\text { Year } & 0 & 1 & 2 & 3 & 4 \
\hline  \text { Cash flows } & - \$ 1,000 & \$ 350 & \$ 350 & \$ 350 & \$ 350
\end{array}$$

Accepted Answer

The Net Present Value (NPV) of a project is calculated by discounting the project's cash flows back to their present value using the Weighted Average Cost of Capital (WACC) as the discount rate, and then summing those present values. The formula for NPV is:$$ NPV = \sum \frac{CF_t}{(1 + WACC)^t} $$where $CF_t$ is the cash flow at time $t$, and $WACC$ is the Weighted Average Cost of Capital.Given:- WACC = 11.50% or 0.115- Year 0 cash flow = -$1,000- Year 1-4 cash flows = $350 each yearThe NPV calculation is as follows:$$ NPV = -\$1,000 + \frac{\$350}{(1 + 0.115)^1} + \frac{\$350}{(1 + 0.115)^2} + \frac{\$350}{(1 + 0.115)^3} + \frac{\$350}{(1 + 0.115)^4} $$$$ NPV = -\$1,000 + \$314.35 + \$282.03 + \$253.40 + \$227.58 $$$$ NPV = -\$1,000 + \$1,077.36 $$$$ NPV = \$77.36 $$The closest option to \$77.36 is E) \$74.36.

Question 17

Thorley Inc.is considering a project that has the following cash flow data.What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative,in both cases it will be rejected. $$\begin{array} { l c c c c c c } 
\text { Year } & 0 & 1 & 2 & 3 & 4 & 5 \
\hline  \text { Cash flows } & - \$ 1,100 & \$ 325 & \$ 325 & \$ 325 & \$ 325 & \$ 325
\end{array}$$
?

Accepted Answer

The answer of Thorley Inc.is considering a project that has...

Question 18

You are considering two mutually exclusive,equally risky,projects.Both have IRRs that exceed the WACC.Which of the following statements is CORRECT? Assume that the projects have normal cash flows,with one outflow followed by a series of inflows.

Accepted Answer

Again,it is useful to draw NPV profiles that fit the description given in the question.Any numbers that meet the criteria will do.
? 11ea856c_8b9b_b116_9aec_fbeb492d3a75_TB1222_00 ?
Statement a is false,because if the profiles do not cross,then one will dominate the other,with both a higher IRR and a higher NPV at every discount rate.Statement b is true.Statement c is false.Statement d is false because a conflict can result from differences in the timing of the cash flows.Statement e is false because scale differences can result in profile crossovers and thus conflicts.

Question 19

Westchester Corp.is considering two equally risky,mutually exclusive projects,both of which have normal cash flows.Project A has an IRR of 11%,while Project B's IRR is 14%.When the WACC is 8%,the projects have the same NPV.Given this information,which of the following statements is CORRECT?

Accepted Answer

Statement e is true,while the others are false.
? 11ea856c_8b9b_8a05_9aec_7d770fa90cf0_TB1222_00

Question 20

Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows,with one cash outflow at t = 0 followed by a series of positive cash flows.

Accepted Answer

Answer e is essentially the definition of the MIRR,hence it is correct.

Quiz 11: The Basics of Capital Budgeting