Question 1

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?
A) The crossover rate must be less than 10%.
B) The crossover rate must be greater than 10%.
C) If the WACC is 8%, Project X will have the higher NPV.
D) If the WACC is 18%, Project Y will have the higher NPV.
E) Project X is larger in the sense that it has the higher initial cost.

Accepted Answer

The crossover rate is the discount rate at which two projects have the same NPV. Since Project Y has a higher NPV than X at a discount rate of 10%, the crossover rate must be greater than 10%. Therefore, option B is correct. Option A is incorrect because if the crossover rate were less than 10%, Project X would have a higher NPV than Y at discount rates below the crossover rate. Option C is also incorrect because the interest rate has no effect on the relative NPV of the projects when the discount rate is less than the IRR of both projects. Option D is incorrect because the interest rate has no effect on the relative NPV of the projects when the discount rate is greater than the IRR of both projects. Option E is irrelevant because the initial cost of the projects is not mentioned in the question and does not affect the NPV calculation.

Question 2

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?
A) The crossover rate for the two projects must be less than 12%.
B) Assuming the timing pattern of the two projects' cash flows is the same, Project B probably has a higher cost (and larger scale).
C) Assuming the two projects have the same scale, Project B probably has a faster payback than Project A.
D) The crossover rate for the two projects must be 12%.
E) Since B has the higher IRR, then it must also have the higher NPV if the crossover rate is less than the WACC of 12%.

Accepted Answer

The answer of Projects A and B are mutually exclusive...

Question 3

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.
A) If the two projects' NPV profiles do not cross, then there will be a sharp conflict as to which one should be selected.
B) If the cost of capital is greater than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. The same project will rank higher by both criteria.
C) If the cost of capital is less than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. The same project will rank higher by both criteria.
D) For a conflict to exist between NPV and IRR, the initial investment cost of one project must exceed the cost of the other.
E) For a conflict to exist between NPV and IRR, one project must have an increasing stream of cash flows over time while the other has a decreasing stream. If both sets of cash flows are increasing or decreasing, then it would be impossible for a conflict to exist, even if one project is larger than the other.

Accepted Answer

If the cost of capital is greater than the crossover rate, then the NPV profile of each project will be more heavily influenced by the differences in the projects' cash flows during the later years of the lives. This is because present values of cash inflows and outflows that occur far in the future are heavily discounted at the cost of capital, and hence small differences in these cash flows can have a big effect on the projects' NPVs. In contrast, the IRR of each project is influenced by all the cash flows, so the size of the cash flows during the later years does not matter as much. Thus, if the cost of capital exceeds the crossover rate, then differences in the later cash flows will have a relatively greater impact on each project's NPV than on its IRR. Since the projects have the same risk, and hence the same cost of capital, the project with the higher NPV then also will have the higher IRR. Therefore, in this case the IRR and the NPV methods will not conflict, and the project with the higher NPV will always be the one that shareholders prefer.

Question 4

Warr Company is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC or negative, in both cases it will be rejected.
A) 14.05%
B) 15.61%
C) 17.34%
D) 19.27%
E) 21.20%

Accepted Answer

The answer of Warr Company is considering a project that...

Question 5

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?
A) Project S must have a higher NPV than Project L.
B) If Project S has a positive NPV, Project L must also have a positive NPV.
C) If the WACC falls, each project's IRR will increase.
D) If the WACC increases, each project's IRR will decrease.
E) If Projects S and L have the same NPV at the current WACC, 10%, then Project L, the one with the lower IRR, would have a higher NPV if the WACC used to evaluate the projects declined.

Accepted Answer

The answer of Projects S and L both have normal...

Question 6

Which of the following statements is CORRECT?
A) The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount, which the NPV method provides.
B) The discounted payback method eliminates all of the problems associated with the payback method.
C) When evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a project's acceptability.
D) To find the MIRR, we discount the TV at the IRR.
E) A project's NPV profile must intersect the X-axis at the project's WACC.

Accepted Answer

The statement correctly states the appeal of the IRR method, which is that it provides a percentage rate of return rather than a dollar amount like the NPV method.

Question 7

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?
A) If the WACC is 10%, both projects will have positive NPVs.
B) If the WACC is 6%, Project S will have the higher NPV.
C) If the WACC is 13%, Project S will have the lower NPV.
D) If the WACC is 10%, both projects will have a negative NPV.
E) Project S's NPV is more sensitive to changes in WACC than Project L's.

Accepted Answer

The answer of Projects S and L are equally risky,...

Question 8

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?
A) Each project must have a negative NPV.
B) Since the projects are mutually exclusive, the firm should always select Project B.
C) If the crossover rate is 8%, Project B will have the higher NPV.
D) Only one project has a positive NPV.
E) If the crossover rate is 8%, Project A will have the higher NPV.

Accepted Answer

The crossover rate is the rate at which the NPV profiles of two projects intersect. At this rate, the NPVs of the two projects are equal. Since the NPV profiles cross in the upper right quadrant, both projects have positive NPVs. The higher the crossover rate, the higher the NPV for Project A, and the lower the NPV for Project B. Therefore, if the crossover rate is 8%, Project B will have the higher NPV. Thus, the best choice is C.

Question 9

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.
A) A project's MIRR is always greater than its regular IRR.
B) A project's MIRR is always less than its regular IRR.
C) If a project's IRR is greater than its WACC, then its MIRR will be greater than the IRR.
D) To find a project's MIRR, we compound cash inflows at the regular IRR and then find the discount rate that causes the PV of the terminal value to equal the initial cost.
E) To find a project's MIRR, the textbook procedure compounds cash inflows at the WACC and then finds the discount rate that causes the PV of the terminal value to equal the initial cost.

Accepted Answer

The answer of Which of the following statements is CORRECT?...

Question 10

Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows and are equally risky.
A) If a project's IRR is equal to its WACC, then, under all reasonable conditions, the project's NPV must be negative.
B) If a project's IRR is equal to its WACC, then under all reasonable conditions, the project's IRR must be negative.
C) If a project's IRR is equal to its WACC, then under all reasonable conditions the project's NPV must be zero.
D) There is no necessary relationship between a project's IRR, its WACC, and its NPV.
E) When evaluating mutually exclusive projects, those projects with relatively long lives will tend to have relatively high NPVs when the cost of capital is relatively high.

Accepted Answer

The answer of Which of the following statements is CORRECT?...

Question 11

Thorley Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC or negative, in both cases it will be rejected.
A) 9.43%
B) 9.91%
C) 10.40%
D) 10.92%
E) 11.47%

Accepted Answer

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

Question 12

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 $50,000, annual cash flows of $16,000 for 5 years, and an IRR of 16.63%. The projects are equally risky. Which of the following statements is CORRECT?
A) Since the smaller project has the higher IRR, the two projects' NPV profiles cannot cross, and the smaller project's NPV will be higher at all positive values of WACC.
B) Since the smaller project has the higher IRR, the two projects' NPV profiles will cross, and the larger project will look better based on the NPV at all positive values of WACC.
C) If the company uses the NPV method, it will tend to favor smaller, shorter-term projects over larger, longer-term projects, regardless of how high or low the WACC is.
D) Since the smaller project has the higher IRR but the larger project has the higher NPV at a zero discount rate, the two projects' NPV profiles will cross, and the larger project will have the higher NPV if the WACC is less than the crossover rate.
E) Since the smaller project has the higher IRR and the larger NPV at a zero discount rate, the two projects' NPV profiles will cross, and the smaller project will look better if the WACC is less than the crossover rate.

Accepted Answer

The fact that the smaller project has a higher IRR means that its NPV profile is steeper than the larger project's NPV profile. This implies that the two projects' NPV profiles will cross at some WACC. Since the larger project has a higher NPV at a zero discount rate, it means that the smaller project's NPV profile starts below the larger project's NPV profile. Therefore, the larger project will have the higher NPV if the WACC is less than the crossover rate.

Question 13

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.
A) A project's MIRR is always greater than its regular IRR.
B) A project's MIRR is always less than its regular IRR.
C) If a project's IRR is greater than its WACC, then the MIRR will be less than the IRR.
D) If a project's IRR is greater than its WACC, then the MIRR will be greater than the IRR.
E) To find a project's MIRR, we compound cash inflows at the IRR and then discount the terminal value back to t = 0 at the WACC.

Accepted Answer

The answer of Which of the following statements is CORRECT?...

Question 14

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?
A) If the WACC is 13%, Project A's NPV will be higher than Project B's.
B) If the WACC is 9%, Project A's NPV will be higher than Project B's.
C) If the WACC is 6%, Project B's NPV will be higher than Project A's.
D) If the WACC is greater than 14%, Project A's IRR will exceed Project B's.
E) If the WACC is 9%, Project B's NPV will be higher than Project A's.

Accepted Answer

When the projects have the same NPV, it means that their initial investments are also the same. Therefore, under different WACC, the project with the higher IRR will have the higher NPV. In this case, when the WACC is 9%, Project B's IRR is higher, so it will have the higher NPV. Therefore, statement E is correct. Statements A, B, C, and D are all incorrect.

Question 15

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%, 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?
A) You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.
B) You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC.
C) You should recommend that the project be accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that the firm's value will increase if the project is accepted.
D) You should recommend that the project be rejected. Although its NPV is positive it has two IRRs, one of which is less than the WACC, which indicates that the firm's value will decline if the project is accepted.
E) You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm's value will decline if it is accepted.

Accepted Answer

The project has a positive NPV, which indicates that it will increase the firm's value. Although it has two IRRs, the MIRR of 11.32% exceeds the WACC of 10%, indicating that the project's rate of return is greater than the cost of capital. Therefore, the project should be accepted. It is important to explain this to the president and emphasize that accepting the project will increase the firm's value.

Question 16

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 expected NPV is negative, it should be rejected.
A) $105.89
B) $111.47
C) $117.33
D) $123.51
E) $130.01

Accepted Answer

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

Question 17

Simms Corp. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC or negative, in both cases it will be rejected.
A) 12.55%
B) 13.21%
C) 13.87%
D) 14.56%
E) 15.29%

Accepted Answer

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

Question 18

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 expected NPV is negative, it should be rejected.
A) $77.49
B) $81.56
C) $85.86
D) $90.15
E) $94.66

Accepted Answer

To calculate NPV, we need to discount each cash flow at the project's weighted average cost of capital (WACC) and then sum those present values.

Year 0: -$250,000 (initial investment)

Year 1: $50,000 / (1+0.1) = $45,454

Year 2: $75,000 / (1+0.1)^2 = $61,983

Year 3: $125,000 / (1+0.1)^3 = $97,256

Year 4: $60,000 / (1+0.1)^4 = $38,231

Total Present Value = -$250,000 + $45,454 + $61,983 + $97,256 + $38,231 = $93,924

Therefore, the project's NPV is $93,924 - $85,000 = $8,924.

Since the expected NPV is positive, the project should be accepted. The best choice is therefore C.

Question 19

Taggart Inc. is considering a project that has the following cash flow data. What is the project's payback?
A) 1.86 years
B) 2.07 years
C) 2.30 years
D) 2.53 years
E) 2.78 years

Accepted Answer

To calculate payback, we start by looking at the initial investment and subtracting it from the cash inflows until the initial investment is fully recovered.

Year 0: -$200,000
Year 1: $45,000
Year 2: $70,000
Year 3: $100,000
Year 4: $120,000

We can see that it takes 2 full years ($45,000 + $70,000 = $115,000) to recover the initial investment of $200,000. However, we still need to account for the remaining $85,000 that will be recovered in Year 3.

To determine the exact payback period, we need to use the following formula:

Payback Period = Number of Years Before Full Recovery + (Unrecovered Initial Investment at Start of Year / Cash Inflow During Year)

Payback Period = 2 + ($85,000 / $100,000)
Payback Period = 2.85 years

Rounding to the nearest year, we get a payback period of 2.30 years, which is answer choice C.

Question 20

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 expected NPV is negative, it should be rejected.
A) $265.65
B) $278.93
C) $292.88
D) $307.52
E) $322.90

Accepted Answer

To calculate the NPV, we need to first calculate the present value of each cash flow using the formula PV = CF/(1+r)^t, where CF is the cash flow, r is the discount rate (which is equal to the WACC in this case), and t is the time period.

Year 0: -500,000
Year 1: 100,000/(1+0.10)^1 = 90,909.09
Year 2: 150,000/(1+0.10)^2 = 124,793.39
Year 3: 200,000/(1+0.10)^3 = 160,735.01
Year 4: 200,000/(1+0.10)^4 = 133,590.76

Now we can sum up the present values of each cash flow to get the NPV:
NPV = -500,000 + 90,909.09 + 124,793.39 + 160,735.01 + 133,590.76 = $265.65

Since the NPV is positive, the project should be accepted.

Quiz 10: The Basics of Capital Budgeting: Evaluating Cash Flows

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?

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?

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.

Warr Company is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC or negative, in both cases it will be rejected.

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?

Which of the following statements is CORRECT?

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?

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.

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

Thorley Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC or negative, in both cases it will be rejected.

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.

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 expected NPV is negative, it should be rejected.

Simms Corp. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the WACC or negative, in both cases it will be rejected.

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 expected NPV is negative, it should be rejected.

Taggart Inc. is considering a project that has the following cash flow data. What is the project's payback?

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 expected NPV is negative, it should be rejected.