Deck 9: Capital Budgeting Techniques

Question 1

The IRR of a project whose cash flows accrue relatively rapidly is more sensitive to changes in the discount rate than is the IRR of a project whose cash flows come in more slowly.

Answer 1

False

Question 2

Effective capital budgeting can improve the timing of asset acquisition and the quality of assets purchased, thereby providing an opportunity to purchase and install assets before they are needed.

Answer 2

True

Question 3

An increase in the discount rate of a project will lead to a decrease in the NPV of the project.

Answer 3

True

Question 4

The main reason that the NPV method is regarded as being conceptually superior to the IRR method, for the purpose of evaluating mutually exclusive investments, is that mutually exclusive projects have multiple IRRs.

Question 5

The NPV and IRR methods will always lead to the same accept/reject decision for mutually exclusive projects.

Question 6

Using the discounted payback method, a project should be accepted when the discounted payback is greater than the project's expected life.

Question 7

One advantage of the payback period method is that it provides a rough measure of a project's liquidity and risk.

Question 8

There exists an IRR solution for each time the direction of cash flows associated with a project is interrupted, that is, each time outflows change to inflows.

Question 9

The primary function of the capital budget is to forecast _____.

A) the target payback periods of the projects undertaken by a firm
B) the funds required for future projects
C) the discounted cash inflow from various projects
D) the terminal value of the cash flows from different projects
E) the projects' multiple internal rates of return

Question 10

When considering two mutually exclusive projects, the financial manager should always select the project whose internal rate of return is the highest, provided the projects have the same initial cost.

Question 11

A capital budgeting project is acceptable if the rate of return required for a project is greater than the project's internal rate of return.

Question 12

The modified IRR (MIRR) method has wide appeal to academics, but most business executives prefer the NPV method to either the regular or modified IRR.

Question 13

In capital budgeting analyses, it is possible that for a particular project, the NPV method and the IRR method both involve the reinvestment of the project's cash flows at the same rate.

Question 14

Small businesses probably make less use of the DCF capital budgeting techniques than large businesses. This may reflect a lack of knowledge on the part of small firms' managers, but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for those firms.

Question 15

The NPV method implicitly assumes that the rate at which cash flows can be reinvested is the required rate of return, whereas the IRR method implies that the firm has the opportunity to reinvest at the project's IRR.

Question 16

The two main purposes of post-audit are to improve forecasts, and to improve operations.

Question 17

The _____ involves comparing the actual results with those predicted by the project's sponsors and explaining why any differences occur.

A) discounted payback
B) internal rate of return
C) post-audit
D) net present value
E) economic value added

Question 18

The post-audit is a simple process in which actual results are compared with forecasted results and any discrepancy must have resulted from the changes in factors that are completely under management's control.

Question 19

Any capital budgeting decision should depend solely on a project's forecasted cash flows and the firm's opportunity rate of return. Such a decision should not be affected by managers' tastes, the choice of accounting method, or the profitability of other independent projects.

Question 20

Project A has a pattern of high cash inflows in the early years, while Project B has majority of its cash inflows in the later years. At the current required rate of return, Projects A and B have identical NPVs. Assuming that interest rates are increasing, other things held constant, this change will cause B to become more preferable than A.

Question 21

The present value of the expected net cash inflows of all the projects undertaken by a firm will most likely exceed the present value of the firm's expected net profit after tax, because:

A) income is reduced by taxes paid, but cash flow is not.
B) there is a greater probability of realizing the projected cash flows than the forecasted income.
C) income is reduced by dividends paid, but cash flow is not.
D) income is reduced by depreciation charges, but cash flows are not.
E) cash flows lead to changes in net working capital, but sales do not.

Question 22

Which of the following statements is true of various methods for capital budgeting?

A) The discounted payback is generally shorter than the regular payback.
B) Any type of project might have multiple rates of return if the IRR is more than the opportunity rate of return.
C) The NPV and IRR methods can lead to conflicting accept/reject decisions only if mutually exclusive projects are being evaluated
D) The NPV and IRR methods can lead to conflicting accept/reject decisions only if independent projects are being evaluated
E) Larger, longer-term projects are favored over smaller, shorter- term alternatives if the required rate of return is relatively high.

Question 23

Which of the following statements is true about capital budgeting analysis?

A) Higher discount rates are used for computing the net present values (NPVs) of riskier cash flows.
B) A project with only cash outflows and no cash inflows would have two internal rates of return (IRRs).
C) The payback period method should be used for capital budgeting decisions if there is a conflict in the project rankings as per the NPV method and the IRR method.
D) The net present value (NPV) method should be used to evaluate independent projects, and the internal rate of return (IRR) method for mutually exclusive projects.
E) The payback period method should be used for capital budgeting decisions if the project has multiple cash outflows.

Question 24

The Seattle Corporation identifies an investment opportunity that will yield end of year cash flows of $30,000 per year in Years 1 through 2, $35,000 per year in Years 3 through 4, and $40,000 in Year 5. This investment will cost the firm $100,000 today, and the firm's required rate of return is 10 percent. What is the NPV for this investment? (Round off the answer to two decimal places.)

A) $23,653.26
B) $27,104.46
C) $44,226.00
D) $40,235.34
E) $35,768.45

Question 25

Ace Inc. is evaluating two mutually exclusive projects-Project A and Project B. The initial cash outflow is $50,000 for each project. Project A results in cash inflows of $15,625 at the end of each of the next five years. Project B results in one cash inflow of $99,500 at the end of the fifth year. The required rate of return of Ace Inc. is 10 percent. Ace Inc. should invest in:

A) Project B because it has no cash inflows in the first four years of its life.
B) Project B because it has a higher net present value (NPV).
C) Project A because it will yield cash every year for five years.
D) Project A because it has a positive net present value (NPV).
E) Project A because it will generate cash in the initial years of its life.

Question 26

Union Atlantic Corporation, which has a required rate of return equal to 14 percent, is evaluating a capital budgeting project. The initial cash outflow is $170,000 and cash inflow at the year-end of each of the following four years is $60,750. According to this information, which of the following statements is correct?

A) The project's internal rate of return (IRR) must be less than 14 percent.
B) The project's discounted payback must be less that its economic life.
C) The project is acceptable as the net present value of the project is positive.
D) The project's discounted payback period should be compared with the traditional payback period to make the correct decision.
E) The project is not acceptable as the net present value is less than the difference in the total cash inflow and cash outflow.

Question 27

Which of the following statements is true of the internal rate of return?

A) It is the required rate of return to achieve value maximization.
B) It is the discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows.
C) It is the discount rate at which the net present value of a project is minimum.
D) It is the rate of return at which a project's payback period is shortest.
E) It is the discount rate to be used for a project with multiple cash outflows.

Question 28

Other things held constant, an increase in the required rate of return will result in _____.

A) a decrease in the net present value of a project
B) a decrease in the internal rate of return (IRR) of a project
C) a decrease in the discounted payback period of a project
D) an increase in multiple internal rates of return of a project
E) a decrease in the cash outflow required for a project

Question 29

Which of the following statements is true of capital budgeting analysis?

A) A project's discounted payback is normally shorter than its regular payback because discounted payback takes account of the required rate of return.
B) In the NPV method, the discount rate is specified and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found.
C) If the required rate of return is less than the crossover rate for two mutually exclusive projects' NPV profiles, a NPV/IRR conflict will not occur.
D) If you are choosing between two projects that have the same life, and if their NPV profiles cross, then the smaller project will probably be the one with the steeper NPV profile.
E) If the required rate of return is relatively high, this will favor larger, longer-term projects over smaller, shorter- term alternatives because it is good to earn high rates on larger amounts over longer periods.

Question 30

Two firms-Tangerine Inc. and Cyan Inc. analyze the same project for capital budgeting decision. Tangerine Inc. determines that the project's internal rate of return (IRR) is 9 percent. Cyan Inc. uses the net present value (NPV) method and determines that the project is unacceptable. Given this information, which of the following statements is correct?

A) The net present value of the project must be positive for both the firms.
B) Cyan Inc.'s internal rate of return (IRR) from the project is less than 9 percent.
C) Tangerine's CFO should use the traditional payback period method to evaluate the project.
D) Tangerine Inc. should use a discount rate of more than 9 percent for capital budgeting analysis by the net present value (NPV) method.
E) Cyan Inc.'s required rate of return is greater than 9 percent.

Question 31

A firm's effective capital budgeting procedures result in:

A) lower net present values (NPVs).
B) a higher stock price.
C) a higher expected rate of return.
D) lower internal rates of return.
E) a higher number of projects having multiple internal rates of return.

Question 32

In capital budgeting analysis, the riskiness of a project is evaluated to:

A) determine the multiple internal rates of return from the project.
B) determine the appropriate rate of return to use for computing the present value of the estimated cash flows.
C) determine the duration of the project.
D) determine the role of management to ensure project completion within stipulated time.
E) determine the opportunity rate of return.

Question 33

If the NPV of a project is positive, it means that:

A) the project's discounted payback period is longer than the useful life of the project.
B) the internal rate of return is lower than the discount rate used.
C) the project is not acceptable on a risk adjusted basis.
D) the project's discounted payback period is less than its payback period.
E) accepting the project increases the value of the firm.

Question 34

The net present value (NPV) of a project is negative when the discount rate used is:

A) equal to the internal rate of return.
B) equal to the yield to maturity of the bonds issued to finance the project.
C) greater than the internal rate of return.
D) lower than the coupon rate of the bonds issued to finance the project.
E) less than the internal rate of return.

Question 35

Which of the following statements is correct about the use of the net present value (NPV) method and the internal rate of return (IRR) method for capital budgeting decisions?

A) The NPV method assumes that cash flows will be reinvested at the required rate of return while the IRR method assumes reinvestment opportunity at the IRR.
B) The NPV method assumes that cash flows will be reinvested at the risk-free rate while the IRR method assumes reinvestment at the required rate of return.
C) The NPV method assumes that cash flows will be reinvested at the required rate of return while the IRR method assumes reinvestment at the risk-free rate.
D) The NPV method assumes that cash flows are not influenced by the inflation rate while the IRR method uses a rate of return after inflation adjustment.
E) The NPV method assumes that the project generates no cash flows beyond the payback period while the IRR method assumes no cash flow in the first year of the life of a project.

Question 36

If a project's net benefit computed on a present value basis-that is, NPV-is positive, then:

A) its internal rate of return is equal to the required rate of return.
B) it is considered a risk-free project.
C) it is considered an acceptable investment.
D) the required rate of return is not attainable.
E) its payback period is more than the maximum cost-recovery time established by the firm.

Question 37

An insurance firm agrees to pay you $3,310 at the end of 20 years if you pay a premium of $100 per year at the end of each of the 20 years. Find the internal rate of return to the nearest whole percentage point.

A) 9%
B) 7%
C) 5%
D) 3%
E) 11%

Question 38

A project's net present value is equal to:

A) the present value of the expected future cash flows minus the present value of all the cash outflows.
B) the present value of the cash outflows plus the present value of cash inflows.
C) the present value of the last cash inflow.
D) the present value of all the expected future cash outflows.
E) the present value of all the cash inflows after the full recovery of the initial investment.

Question 39

The capital budgeting director of Sparrow Corporation is evaluating a project that costs $200,000, is expected to last for 10 years and produces after-tax cash flows, including depreciation, of $44,503 per year. If the firm's required rate of return is 14 percent and its tax rate is 40 percent, what is the project's IRR?

A) 8 percent
B) 14 percent
C) 18 percent
D) −5 percent
E) 12 percent

Question 40

If a capital budgeting project is purchased, a firm's value, and thus its stockholders' wealth, will increase by the amount of the project's _____.

A) net cash flow discounted at the required rate of return
B) cash inflows discounted at the required rate of return
C) nondiscounted cash inflows
D) cash inflows discounted at the internal rate of return
E) net present value (NPV)

Question 41

A project's terminal value is _____.

A) the present value of all the cash outflows including the initial cost of investment
B) the cash inflow in the last year of the project
C) the sum of the future values of the cash inflows compounded at the firm's required rate of return
D) the sum of the cash inflows after full recovery of the initial investment in the project
E) the excess of the cash outflows over the cash inflows generated by the project

Question 42

Smart Solutions Inc. is evaluating a capital project for expansion. The project costs $10,000 and it is expected to generate $5,000 per year for three years. If the required rate of return is 10%, what is the terminal value of the project?

A) $15,000
B) $16,550
C) $11,550
D) $14,050
E) $12,500

Question 43

Two mutually exclusive projects each have a cost of $10,000. The total, undiscounted cash flows from Project L are $15,000, while the undiscounted cash flows from Project S total $13,000. Their NPV profiles cross at a discount rate of 10 percent. Which of the following statements best describes this situation?

A) The NPV and IRR methods will select the same project if the required rate of return is greater than 10 percent; for example, 18 percent.
B) The NPV and IRR methods will select the same project if the cost of capital is less than 10 percent; for example, 8 percent.
C) As the NPV profiles cross at a discount rate of 10 percent resulting in conflict, none of these two projects should be selected.
D) Project L should be selected at any required rate of return, because it has a higher IRR.
E) Project S should be selected at any required rate of return, because it has a higher IRR.

Question 44

Which of the following criteria should be used to choose a project if there is a conflict between two mutually exclusive projects?

A) The project whose internal rate of return is higher than its modified internal rate of return should be chosen.
B) The project whose internal rate of return is equal to the expected rate of return should be chosen.
C) The project with a higher net present value (NPV) should be chosen.
D) The project whose payback period is equal to the expected years required to recover the original investment should be chosen.
E) The project whose discounted payback period is longer than its traditional payback period should be chosen.

Question 45

The reinvestment rate assumption that the cash flows from a project can be reinvested at the internal rate of return, is made in the _____.

A) net present value (NPV) method
B) discounted payback period method
C) payback period method
D) internal rate of return (IRR) method
E) modified internal rate of return (MIRR) method

Question 46

Project A has a cost of $1,000, and it will produce end-of-year net cash inflows of $500 per year for 3 years. The project's required rate of return is 10 percent. What is the difference between the project's IRR and its MIRR? (Round off the answer to two decimal places.)

A) 3.88%
B) 4.31%
C) 5.09%
D) 5.75%
E) 6.21%

Question 47

Which of the following statements is true of a capital budgeting project with negative net present value (NPV)?

A) The project's internal rate of return is also negative.
B) The project's discounted payback period is greater than its economic life.
C) A firm should invest in a project with negative NPV if the initial investment outlay is low.
D) The project's traditional payback period is greater than the firm's expected payback period.
E) The project's internal rate of return is higher than the discount rate used for NPV analysis.

Question 48

The more realistic reinvestment rate assumption, the required rate of return, is implicit in the _____.

A) payback period method and the discounted payback period method
B) internal rate of return (IRR) method and the multiple internal rate of return method (MIRR)
C) multiple internal rate of return method (MIRR) and the discounted payback period method
D) discounted payback period method and the net present value (NPV) method
E) net present value (NPV) method and the multiple internal rate of return method (MIRR)

Question 49

A project should be accepted if _____.

A) its payback period is more than the expected number of years to recover the original investment
B) its internal rate of return (IRR) exceeds the required rate of return
C) it yields multiple internal rates of return
D) it involves multiple cash inflows and cash outflows during the life of the project
E) its undiscounted cash flows are more than the discounted cash flows

Question 50

Which of the following results from a negative cash flow that occurs at the end of a project's life in addition to the initial investment in the project?

A) Higher return from the investment in the project
B) Lower project terminal value as compared to the cost of the project
C) Negative net cash flow from the project
D) More than one internal rate of return (IRR) of the project
E) Shorter payback period for the project

Question 51

Which of the following statements is true of the payback period method of capital budgeting?

A) It is the simplest and oldest formal model to evaluate capital budgeting projects.
B) It directly accounts for the time value of money.
C) It considers the discounted value of cash flows beyond the payback period.
D) It always results in maximizing the value of the firm.
E) It incorporates risk into the discount rate used to solve the payback period.

Question 52

Which of the following statements is true of the modified internal rate of return?

A) The discount rate that forces the future value of the terminal value to equal the future value of the costs is the modified internal rate of return (MIRR).
B) The discount rate that forces the present value of the terminal value to equal the present value of the costs is the modified internal rate of return (MIRR).
C) The required rate of return that forces the future value of the terminal value to equal the present value of the costs is the modified internal rate of return (MIRR).
D) The discount rate that forces the present value of the terminal value to equal the future value of the costs is the modified internal rate of return (MIRR).
E) The discount rate that forces the present value of the terminal value to equal the sum of undiscounted cash inflows is the modified internal rate of return (MIRR).

Question 53

Tangerine Inc. is evaluating a capital project for investment. The initial cash outflow in Year 0 is $1,500 followed by cash inflow of $500 each year for four years. Which of the following is the terminal value of the project? Assume the required rate of return is 12%. (Round off the answer to two decimal places.)

A) $3,336.78
B) $2,486.23
C) $2,389.66
D) $1,889.45
E) $1,626.57

Question 54

Los Angeles Lumber Company (LALC) is considering a project with a cost of $1,000 at Year 0 and inflows of $300 at the end of Years 1-5. LALC's cost of capital is 10 percent. What is the project's modified IRR (MIRR)? (Round off the answer to two decimal places.)

A) 10.04 percent
B) 12.87 percent
C) 15.23 percent
D) 18.34 percent
E) 20.72 percent

Question 55

Which of the following is an advantage of the modified internal rate of return (MIRR) over the traditional internal rate of return?

A) Modified internal rate of return (MIRR) assumes that the cash flows are reinvested at the project's own internal rate of return (IRR).
B) Modified internal rate of return (MIRR) assumes that the terminal value of the project is the profit from the project.
C) Modified internal rate of return (MIRR) assumes that the cash flows are reinvested at the required rate of return.
D) Modified internal rate of return (MIRR) assumes that the future value of cash outflow is equal to the terminal value of the project.
E) Modified internal rate of return (MIRR) assumes that the multiple cash outflows in a project increase the required rate of return of the project.

Question 56

The traditional internal rate of return (IRR) assumes that cash flows are reinvested at the _____.

A) firm's expected rate of return
B) project's internal rate of return
C) market rate of return
D) risk-free rate of return
E) firm's opportunity rate return

Question 57

To add the greatest value to a firm, mutually exclusive projects that differ in scale or timing should be evaluated using the _____.

A) payback period method
B) internal rate of return (IRR) method
C) multiple internal rate of return method (MIRR)
D) net present value (NPV) method
E) discounted payback period method

Question 58

Which of the following statements is true of a project whose cash flows accrue relatively rapidly?

A) The payback period is longer than the years expected to recover the original investment.
B) The net present value is not very sensitive to changes in the discount rate.
C) The required rate of return is revised throughout the duration of the project.
D) The net present value of the project is always negative if cash flows accrue rapidly.
E) The project will have multiple internal rates of return due to rapidly accruing cash flows.

Question 59

Modified internal rate of return is the discount rate that forces the present value of the terminal value to be equal to _____.

A) the future value of the terminal value
B) the future value of the cash outflows
C) the present value of the cash inflows
D) the future value of the cash inflows
E) the present value of costs

Question 60

The multiple internal rate of return (MIRR) is a better indicator of a project's true profitability because:

A) only cash flows after payback period are discounted.
B) of the assumption of a shorter payback period than the maximum cost recovery time established by firm.
C) it assumes that the cash flows are reinvested at the required rate of return.
D) of the assumption that the cash flows are reinvested at risk-free rate.
E) the cash flows are discounted at the internal rate of return.

Question 61

Which of the following methods of capital budgeting is based on the concept that it is better to recover the cost of (investment in) a project sooner rather than later?

A) Internal rate of return (IRR) method
B) Traditional payback period method
C) Modified internal rate of return (MIRR) method
D) Net present value (NPV) method
E) Maturity value method

Question 62

Which of the following statements is true when a project's discounted payback is less than its useful life?

A) The terminal value of the future cash flows that the project is expected to generate is less than the future value of the initial cost of the asset.
B) The future cash flows that the project is expected to generate are less than the initial cost of the asset.
C) The present value of the future cash flows that the project is expected to generate exceeds the initial cost of the asset.
D) The future value of the cash flows from the resale of the asset acquired for the project is expected to exceed the initial cost of the asset.
E) The cost recovery from the project is expected to exceed the maximum cost-recovery time established by the firm.

Question 63

Which of the following statements is true of a project with a long payback period?

A) A long payback period increases the project's risk.
B) A long payback period ensures enough liquidity for the firm.
C) A long payback period ensures positive net present value of the project.
D) A long payback period results in the expected rate of return being more than the internal rate of return.
E) A long payback period results in the terminal value of the project being higher than the present value of its cash outflows.

Question 64

Which of the following statements is true of a project with a positive net present value (NPV)?

A) The project's internal rate of return is less than the expected rate of return.
B) The project has multiple internal rates of return.
C) The project's terminal value is less than the future value of the initial investment in the project.
D) The project's initial investment is recovered on a present value basis prior to the end of the project's useful life.
E) The present value of project's cash inflows and multiple cash outflows discounted at internal rate of return are equal.

Question 65

Which of the following statements is true of capital budgeting methods that consider the time value of money to evaluate independent projects?

A) They choose the projects with the highest rate of return.
B) They provide the same accept/reject decisions.
C) They choose the project with the shortest payback period.
D) They provide the highest terminal values of the projects.
E) They choose the project with multiple internal rates of return.

Question 66

With the improvement in the technology and understanding of discounting techniques, both NPV and IRR methods of capital budgeting became more popular because _____.

A) these techniques provide correct decisions with respect to payback period minimization
B) these techniques provide correct decisions with respect to the maximization of the required rate of return
C) these techniques provide correct decisions with respect to value maximization
D) these techniques provide correct decisions with respect to the minimization of the number of IRRs for every project
E) these techniques provide correct decisions with respect to the maximization of the initial capital investment

Question 67

An investment project has an initial cost, and then generates inflows of $50 a year for the next five years. The project has a payback period of 3.6 years. What is the project's investment cost?

A) $250
B) $500
C) $180
D) $140
E) $325

Question 68

Discounted payback's primary advantage over traditional payback is that:

A) discounted payback considers cash flows that occur after the discounted payback period.
B) discounted payback is always shorter than the traditional payback period.
C) discounted payback considers the time value of money.
D) discounted payback ensures more payback by accepting projects with longer payback period.
E) discounted payback ensures faster recovery of investment by accepting projects with longer payback periods.

Question 69

Seattle Inc. identifies an investment opportunity, which will yield cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. The initial cash outflow is $150,000, and the firm's required rate of return is 10 percent. Assume cash flows occur evenly during the year, 1/365th each day. What is the payback period for this investment? (Round off the answer to two decimal places.)

A) 5.23 years
B) 4.86 years
C) 4.00 years
D) 6.12 years
E) 4.35 years

Question 70

A ranking conflict that occurs when evaluating two mutually exclusive projects using the NPV technique and the IRR technique can be resolved by _____.

A) using the profitability index method
B) using the modified internal rate of return (MIRR) method
C) using the internal rate of return (IRR) method
D) using discounted payback period method
E) using traditional payback period method

Question 71

The net present value (NPV) is preferred to the internal rate of return (IRR) for capital budgeting decisions because:

A) the internal rate of return (IRR) does not allow you to determine if the project is acceptable.
B) the net present value (NPV) is the only method that allows you to determine which independent project is acceptable.
C) the net present value (NPV) allows you to compare mutually exclusive projects.
D) the internal rate of return (IRR) for a project is different for each firm.
E) the net present value (NPV) contains information about a projects "safety margin" which is not inherent in the internal rate of return (IRR).

Question 72

As per the payback period method, a project is acceptable to a firm if _____.

A) the total cash inflows yield a rate of return more than the expected rate of return from the project
B) the payback period is longer than the life of the project
C) there are no cash outflows during the payback period
D) discounted value of cash inflows is less than the initial investment
E) the payback period is less than the maximum cost-recovery time established by the firm