Question 1

Which of the following statements is CORRECT?
A) One defect of the IRR method versus the NPV is that the IRR does not take account of the time value of money.
B) One defect of the IRR method versus the NPV is that the IRR does not take account of the cost of capital.
C) One defect of the IRR method versus the NPV is that the IRR values a dollar received today the same as a dollar that will not be received until sometime in the future.
D) One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects.
E) One defect of the IRR method versus the NPV is that the IRR does not take account of cash flows over a project's full life.

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 2

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. When two projects have equal risk but are mutually exclusive, the decision between the two projects comes down to the project with the higher NPV or IRR. If the cost of capital exceeds the rate at which the projects' NPV profiles cross, both methods will lead to the same decision. However, if the cost of capital is lower, the NPV method may be preferred because it takes into account the actual dollar value of the project's cash flows.

Question 3

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 point.Therefore,NPV_X may be either higher or lower than NPV_Y.

Question 4

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 5

Which of the following statements is CORRECT?
A) One defect of the IRR method is that it does not take account of the time value of money.
B) One defect of the IRR method is that it does not take account of the cost of capital.
C) One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future.
D) One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.
E) One defect of the IRR method is that it does not take account of cash flows over a project's full life.

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 6

Which of the following statements is CORRECT?
A) If a project has "normal" cash flows, then its MIRR must be positive.
B) If a project has "normal" cash flows, then it will have exactly two real IRRs.
C) The definition of "normal" cash flows is that the cash flow stream 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.
D) If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR.
E) If a project has "normal" cash flows, then its IRR must be positive.

Accepted Answer

A project with "normal" cash flows 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 projects can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR. The MIRR can be positive or negative for a project with "normal" cash flows. The IRR does not have to be positive for a project with "normal" cash flows. Therefore, options A, B, C, and E are incorrect.

Question 7

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 regular IRR is found by compounding the cash inflows at the WACC to find the present value (PV), then discounting the TV to find the IRR.
B) If a project's IRR is smaller than the WACC, then its NPV will be positive.
C) A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost.
D) If a project's IRR is positive, then its NPV must also be positive.
E) A project's regular IRR is found by compounding the initial cost at the WACC to find the terminal value (TV), then discounting the TV at the WACC.

Accepted Answer

The statement that correctly identifies the Internal Rate of Return (IRR) is C. IRR is the discount rate that sets the present value of the expected cash inflows equal to the initial cost of the project. Option A describes the calculation of the regular NPV, not the regular IRR. Option B is incorrect because a project's NPV will be positive only if its IRR is greater than the WACC. Option D is incorrect because a project's NPV can be positive or negative at any given IRR. Option E describes the calculation of the terminal value, not the IRR.

Question 8

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 9

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

Capital budgeting decisions should be based on objective criteria and not affected by personal preferences or other unrelated projects. The decision should solely rely on projected cash flows and the cost of capital.

Question 10

Which of the following statements is CORRECT?
A) Projects with "normal" cash flows can have two or more real IRRs.
B) Projects with "normal" cash flows must have two changes in the sign of the cash flows, e.g., from negative to positive to negative. If there are more than two sign changes, then the cash flow stream is "nonnormal."
C) The "multiple IRR problem" can arise if a project's cash flows are "normal."
D) Projects with "nonnormal" cash flows are almost never encountered in the real world.
E) Projects with "normal" cash flows can have only one real IRR.

Accepted Answer

Projects with "normal" cash flows, which have only one change in the sign of cash flows (from negative to positive), typically have only one real IRR.

Question 11

Which of the following statements is CORRECT?
A) The discounted payback method recognizes all cash flows over a project's life, and it also adjusts these cash flows to account for the time value of money.
B) The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today.
C) The regular payback is useful as an indicator of a project's liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project.
D) The regular payback does not consider cash flows beyond the payback year, but the discounted payback overcomes this defect.
E) The regular payback method recognizes all cash flows over a project's life.

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 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.
A) One drawback of the regular payback for evaluating projects is that this method does not properly account for the time value of money.
B) If a project's payback is positive, then the project should be rejected because it must have a negative NPV.
C) The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
D) If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time.
E) The longer a project's payback period, the more desirable the project is normally considered to be by this criterion.

Accepted Answer

The regular payback method only considers the time it takes to recoup the initial investment and ignores the time value of money, which can lead to incorrect decisions regarding profitability.

Question 13

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

An increase in the WACC will also impact the IRR of a project, as it represents the discount rate at which the NPV of a project equals zero. Therefore, the accept/reject decision under the IRR method is not completely independent of the cost of capital.

Question 14

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

As interest rates and money costs decline, the present value of future cash flows increases. This would make the longer life of Project L with larger cash flows in the future more valuable, causing it to become preferred over Project S.

Question 15

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 quadrant. 11ea42d0_c089_ab76_9abf_f31d83148dbc_TB2090_00

Question 16

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

Both NPV (Net Present Value) and IRR (Internal Rate of Return) methods will lead to the same accept/reject decision for independent projects if 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 threshold, making them acceptable investments.

Question 17

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) The lower the WACC used to calculate a project's NPV, the lower the calculated NPV will be.
B) If a project's NPV is less than zero, then its IRR must be less than the WACC.
C) If a project's NPV is greater than zero, then its IRR must be less than zero.
D) The NPV of a relatively low-risk project should be found using a relatively high WACC.
E) A project's NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC.

Accepted Answer

If a project's NPV is less than zero, it means that the project is not generating returns over the required rate of return (WACC), so it cannot have an IRR greater than or equal to the WACC. Therefore, the IRR must be less than the WACC.

Question 18

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 regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR.
B) If a project's IRR is greater than the WACC, then its NPV must be negative.
C) To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs.
D) To find a project's IRR, we must find a discount rate that is equal to the WACC.
E) A project's regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC.

Accepted Answer

The internal rate of return (IRR) is the discount rate that makes the present value (PV) of the expected cash inflows equal to the PV of the expected cash outflows of a project. Therefore, to find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs. Option A is incorrect because the regular IRR is found by solving for the discount rate that equates the PV of the inflows to the PV of the outflows, not by discounting the inflows at the WACC. Option B is incorrect because if a project's IRR is greater than the WACC, then its NPV must be positive, not negative. Option D is incorrect because the IRR is not necessarily equal to the WACC, which is the minimum rate of return required by investors. Option E is incorrect because we cannot find the IRR by compounding the cash inflows at the WACC to find the terminal value and then discounting this TV at the WACC.

Question 19

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 to...

Question 20

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. 11ea42d0_c089_ab77_9abf_5b9d28e642c1_TB2090_00

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

Which of the following statements is CORRECT?

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.

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.

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?

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.

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.

Which of the following statements is CORRECT?

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.

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.

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? 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.

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.

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.