Question 1

There is sometimes a ranking problem among NPV and IRR when selecting among mutually exclusive investments. This ranking problem only occurs when

Accepted Answer

The answer of There is sometimes a ranking problem among...

Question 2

Net present value profiles are most useful when selecting among mutually exclusive projects.

Accepted Answer

Net present value profiles can be used to compare the cash flows of different projects and determine which project would be more profitable. This is particularly useful when choosing between mutually exclusive projects, where only one project can be pursued. By comparing the net present value profiles of each project, a decision can be made on which one would provide a higher return on investment.

Question 3

On a purely theoretical basis, NPV is a better approach to capital budgeting than IRR because NPV implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

Accepted Answer

The statement is true. NPV takes into account the time value of money and assumes that any cash inflows generated by an investment can be reinvested at the firm's cost of capital. On the other hand, IRR assumes that any cash inflows are reinvested at the IRR, which may not be the appropriate cost of capital for the firm. This can lead to misleading investment decisions. Therefore, from a theoretical perspective, NPV is considered a better approach to capital budgeting than IRR.

Question 4

A project's net present value profile is a graph that plots a project's IRR for various discount rates.

Accepted Answer

A project's net present value (NPV) profile is a graph that plots the NPV of a project for various discount rates, not the IRR. The IRR is the discount rate at which the NPV equals zero.

Question 5

Certain mathematical properties may cause a project with a nonconventional cash flow pattern to have multiple IRRs; this problem does not occur with the NPV approach.

Accepted Answer

This statement is true. The mathematical properties that cause multiple IRRs include changes in the sign of cash flows or multiple sign changes within a project's life. The NPV approach, on the other hand, only has one calculated result and is not affected by these mathematical properties.

Question 6

Conflicting rankings in the case of mutually exclusive projects using NPV and IRR often results from differences in the magnitude and/or timing of cash flows.

Accepted Answer

Conflicting rankings between NPV and IRR can occur when the cash flows of mutually exclusive projects are different in terms of their magnitude or timing. This is because each method values cash flows differently and makes different assumptions about reinvestment rates.

Question 7

Consider the following projects, X and Y where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project B also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 25 percent?

Accepted Answer

The answer of Consider the following projects, X and Y...

Question 8

For conventional projects, both NPV and IRR techniques will always generate the same accept-reject decision, but differences in their underlying assumptions can cause them to rank mutually exclusive projects differently.

Accepted Answer

While NPV and IRR generally agree on accept-reject decisions for conventional projects, they can rank mutually exclusive projects differently due to differing assumptions about reinvestment rates and cash flow timing.

Question 9

What is the IRR for the following project if its initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3 and $1,300,000 in year 4?

Accepted Answer

To calculate the IRR, we need to find the discount rate that makes the present value of the cash inflows equal to the initial cost. Using a financial calculator or Excel, we find that the IRR for the project is approximately 13.57%. Therefore, the best choice is C) 13.57%.

Question 10

Tangshan Mining Company is considering investing in a new mining project. The firm's cost of capital is 12 percent and the project is expected to have an initial after tax cost of $5,000,000. Furthermore, the project is expected to provide after-tax operating cash flows of $2,500,000 in year 1, $2,300,000 in year 2, $2,200,000 in year 3 and ($1,300,000) in year 4?
(a) Calculate the project's NPV.
(b) Calculate the project's IRR.
(c) Should the firm make the investment?

Accepted Answer

The answer of Tangshan Mining Company is considering investing in...

Question 11

Net present value (NPV) assumes that intermediate cash inflows are reinvested at the cost of capital, whereas internal rate of return (IRR) assumes that intermediate cash inflows can be reinvested at a rate equal to the project's IRR.

Accepted Answer

This statement is true. NPV assumes that all cash inflows are reinvested at the cost of capital, while IRR assumes that all cash inflows are reinvested at the project's IRR.

Question 12

What is the IRR for the following project if its initial after tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of ($1,800,000) in year 1, $2,900,000 in year 2, $2,700,000 in year 3 and $2,300,000 in year 4?

Accepted Answer

The answer of What is the IRR for the following...

Question 13

The IRR method assumes the cash flows are reinvested at the internal rate of return rather than the required rate of return

Accepted Answer

The IRR method assumes that cash flows are reinvested at the internal rate of return, which is the rate that makes the net present value of the cash flows equal to zero. This is different from the required rate of return, which is typically the minimum rate of return that an investor expects to receive.

Question 14

Since the cost of capital tends to be a reasonable estimate of the rate at which the firm could actually reinvest intermediate cash inflows, the use of NPV is in theory preferable to IRR.

Accepted Answer

The statement is true. The cost of capital is the rate of return that a firm must earn on its invested capital to satisfy its investors, so it represents a reasonable estimate of the rate at which the company can reinvest intermediate cash inflows. In contrast, the Internal Rate of Return (IRR) assumes that all cash inflows from a project are reinvested at the same rate, which is not a realistic assumption. Therefore, NPV is considered to be a more accurate method for evaluating investment opportunities.

Question 15

A project's net present value profile is a graph that plots a project's NPV for various discount rates.

Accepted Answer

The statement is true.

Question 16

Net present value profiles are most useful when selecting among independent projects.

Accepted Answer

Net present value profiles are most useful for comparing mutually exclusive projects to understand how the value of each project changes with different discount rates, rather than for selecting among independent projects where each project can be evaluated on its own merits.

Question 17

In general, projects with similar-sized investments and lower early-year cash inflows (lower cash inflows in the early years) tend to be preferred at higher discount rates.

Accepted Answer

Projects with lower early-year cash inflows are less attractive at higher discount rates because the present value of future cash inflows is reduced more significantly, making them less appealing compared to projects with higher early-year cash inflows.

Question 18

Consider the following projects, X and Y, where the firm can only choose one. Project X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also costs $600, and generates cash flows of $500 and $275 for the next 2 years, respectively. Which investment should the firm choose if the cost of capital is 10 percent?

Accepted Answer

The firm should choose Project X because its Net Present Value (NPV) is higher. Calculating NPV for both projects at a 10% discount rate:  - Project X: NPV = ($400 / 1.1) + ($400 / 1.1^2) - $600 = $363.64 + $330.58 - $600 = $94.22  - Project Y: NPV = ($500 / 1.1) + ($275 / 1.1^2) - $600 = $454.55 + $226.45 - $600 = $81.00  Since Project X has a higher NPV, it is the better investment.

Question 19

Projects having higher cash inflows in the early years tend to be less sensitive to changes in the cost of capital and are therefore often acceptable at higher discount rates compared to projects with higher cash inflows that occur in the later years.

Accepted Answer

Projects with higher early cash inflows have a higher present value and are therefore less sensitive to changes in the cost of capital. As a result, they are often acceptable at higher discount rates than projects with higher cash inflows that occur later on.

Question 20

On a purely theoretical basis, NPV is the better approach to capital budgeting than IRR because IRR implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

Accepted Answer

NPV assumes reinvestment at the firm's cost of capital, while IRR assumes reinvestment at the IRR itself.

Quiz 10: Capital Budgeting Techniques