Question 1

No 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

This statement is true. The conflict between NPV and IRR methods arises when evaluating mutually exclusive projects with different levels of risk, and the projects' cash flows are irregular or unconventional. However, if two projects are equally risky and mutually exclusive, there will be no conflict between the two methods as long as the projects' cost of capital is higher than the rate at which their NPV profiles cross. This rate is also known as the "crossover rate," and it represents the point at which the two projects have the same NPV. If the cost of capital is higher than the crossover rate, then the NPV method will favor the project with the higher NPV, while the IRR method will prefer the project with the higher IRR.

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

We can see from the graph that S has the higher NPV if r > 0. 11ea1b84_8bae_249a_a54a_c37871dd4d65_TB3581_00

Question 3

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 sets the present value of the cash inflows equal to the initial cost of a project. Therefore, statement C is correct. Statement A is incorrect because regular IRR is found by setting the PV of the cash inflows equal to the initial cost and solving for the IRR. Statement B is incorrect because if a project's IRR is smaller than the WACC, its NPV will be negative. Statement D is incorrect because a project can have a positive IRR and a negative NPV if the IRR is less than the WACC. Statement E is incorrect because regular IRR is found by setting the PV of the cash inflows equal to the initial cost and solving for the IRR; there is no need to calculate a terminal 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

The regular payback method only looks at the time it takes to recover the initial investment and does not take into account the time value of money, which is a major drawback. This means that cash inflows received later in the project's life are given the same weight as cash inflows received earlier, which is not correct. Discounted payback method solves this problem by taking into account the time value of money by discounting the cash flows. Therefore, statements B, C, D, and E are incorrect. Statement B is incorrect because a project's payback period may be positive but still have a positive NPV. Statement C is incorrect because only the discounted payback method overcomes the time value of money problem. Statement D is incorrect because it is the opposite of what happens. A company that uses the same payback requirement for all projects will tend to accept short-lived projects and reject long-lived projects. This will cause the company's risk to decrease over time. Statement E is incorrect because the shorter the payback period, the more desirable the project is considered by this criterion.

Question 5

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

A decline in interest rates and money costs will decrease the present value of future cash flows, which will have a greater impact on the longer-lived Project L compared to the shorter-lived Project S. Therefore, Project L is more likely to become preferred over Project S with the decline in interest rates and money costs.

Question 6

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

We do not know if the cost of capital is to the right or left of the crossover pointrue.therefore, NPVX may be either higher or lower than NPVY.

Question 7

The 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 corrects the fault of not considering the timing of cash flows, but it does not correct for the nonconsideration of after-payback cash flows.

Question 8

In 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 the principles of capital budgeting, decisions should be based on forecasted cash flows and the opportunity cost of capital, and should not be influenced by managerial biases, accounting methods, or the profitability of other projects. This ensures that investment decisions are made objectively, based on their potential to create value for the firm's shareholders.

Question 9

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

Project X may have a negative NPV if r > IRR.the NPV profile line crosses the horizontal axis, and the NPV at the cost of capital is in the lower right quadrantrue. 11ea1b84_8bad_fd89_a54a_110ffc3bc861_TB3581_00

Question 10

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 cost of capital.

Accepted Answer

The NPV (Net Present Value) and IRR (Internal Rate of Return) methods generally lead to the same accept/reject decisions for independent projects when the projects' IRRs are greater than the cost of capital. This is because both methods will indicate that the projects are expected to generate returns above the required rate, making them financially viable. Differences in decisions typically arise in cases of mutually exclusive projects or when the projects have non-normal cash flows (e.g., differing scale, timing, or cash flow patterns).

Question 11

Which of the following statements is CORRECT?

Accepted Answer

The IRR would rank a project that cost $100 and had a 100% IRR ahead of a project that cost $1, 000, 000 and had an IRR of 90%.The larger project would increase the firm's value more, as the NPV would demonstrate.

Question 12

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 present value of its cash inflows is less than the initial investment, which indicates that the project is not generating enough return to cover the cost of capital. Therefore, the IRR, which represents the rate of return generated by the project, must be less than the WACC, which represents the cost of capital. The other statements are incorrect. The lower the WACC, the higher the calculated NPV will be (not lower). If a project's NPV is greater than zero, it means that the project is generating enough return to cover the cost of capital, so its IRR must be greater than the WACC (not less than zero). The WACC used to calculate a project's NPV should reflect the riskiness of its cash flows, so a relatively low-risk project should be discounted at a relatively low WACC (not a high WACC). The formula to find a project's NPV is to discount its cash inflows at the WACC, not to compound them at the IRR and then discount the terminal value.

Question 13

If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital, the payback method and NPV method would always lead to the same decision on which project to undertake.

Accepted Answer

One project might have cash flows that extend well past the payback year, leading to different rankings.

Question 14

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 IRR is the discount rate that makes the NPV of the project equal to zero. Therefore, to find the IRR, we need to solve for the discount rate that equates the present value of the cash inflows with the present value of the project's costs. Choices A, B, D, and E are all incorrect because they either describe the calculation of the regular NPV, confuse the relationship between IRR and NPV, or provide incorrect formulas for calculating the IRR.

Question 15

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 a project can only have one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR. The statement in option A is incorrect because a project with "normal" cash flows might have a negative MIRR if the cost of capital is high. Option B is also incorrect because a project with "normal" cash flows can have only one real IRR. Option C defines "normal" cash flows but is not a statement. Option E is incorrect because a project with "normal" cash flows might have a negative IRR if the cost of capital is high.

Question 16

The 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 The NPV and IRR methods, when used...

Question 17

Which of the following statements is CORRECT?

Accepted Answer

The IRR assumes reinvestment at the IRR, and that is generally not as valid as assuming reinvestment at the WACC, as with the NPV.

Question 18

An increase in the firm's WACC will decrease projects' NPVs, which could change the accept/reject decision for any potential project.However, such a change would have no impact on projects' IRRs.Therefore, the accept/reject decision under the IRR method is independent of the cost of capital.

Accepted Answer

The IRR method involves comparing the project's IRR to the firm's cost of capital (WACC). If the WACC changes, it could affect the accept/reject decision under the IRR method because a project acceptable at a lower WACC might not be acceptable at a higher WACC, even though the project's IRR itself does not change.

Question 19

Which of the following statements is CORRECT?

Accepted Answer

Statement d is true.The payback does indicate how long it should take to recover the investment; hence, it is a measure of liquidity.

Question 20

Which of the following statements is CORRECT?

Accepted Answer

Projects with "normal" cash flows, where the cash flow stream starts with an initial outlay followed by a series of positive cash inflows, can only have one real Internal Rate of Return (IRR). This is because the mathematical properties of such cash flows ensure that the net present value (NPV) curve crosses the horizontal axis at only one point, indicating a single IRR.

Quiz 10: The basics of capital budgeting: evaluating cash flows

No 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.

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.

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.

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.

The 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.

In 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.

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 cost of capital.

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.

If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital, the payback method and NPV method would always lead to the same decision on which project to undertake.

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?

The 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?

An increase in the firm's WACC will decrease projects' NPVs, which could change the accept/reject decision for any potential project.However, such a change would have no impact on projects' IRRs.Therefore, the accept/reject decision under the IRR method is independent of the cost of capital.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?