Question 1

Ellmann 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

The answer of Ellmann Systems is considering a project that...

Question 2

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

Accepted Answer

11ea7757_ce7e_393b_81a5_81d34ea764e8_TB2122_00 Statement d is true, while the others are false.

Question 3

Robbins 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 Robbins Inc.is considering a project that has...

Question 4

Consider 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)If Project S has a positive NPV, Project L must also have a positive NPV.
B)If the WACC falls, each project's IRR will increase.
C)If the WACC increases, each project's IRR will decrease.
D)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.
E)Project S must have a higher NPV than Project L.

Accepted Answer

Refer to the NPV profile below. Statement a is false, because if the WACC is greater than IRR_L but less than IRR_S then Project S will have a positive NPV and Project L's NPV will be negative. Statements b and c are false, because IRR is independent of WACC. Statement d is true, because Project S has the higher IRR, so Project L's NPV profile is above Project S's when the WACC is less than the crossover rate. Statement e is false, because you do not know which project has the higher NPV unless you know the WACC. 11ea7757_ce7e_d57e_81a5_8f2befaf52bc_TB2122_00

Question 5

You are on the staff of O'Hara Inc.The CFO believes project acceptance should be based on the NPV,but Andrew O'Hara,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, although its NPV is positive, it has an IRR that is less than the WACC.
B)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.
C)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.
D)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.
E)You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.

Accepted Answer

The optimal recommendation is to accept the project because the NPV is positive and the MIRR exceeds the WACC. The fact that the project has two IRRs is not relevant in this case, and the focus should be on the MIRR, which takes into account the reinvestment rate assumption implicit in the project's cash flows. By accepting the project, the firm's value will increase, and this should be explained to the president to get his support. The CFO's preference for NPV as the basis for project acceptance should be respected but does not override the president's preference for IRR as the minimum hurdle rate.

Question 6

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

Accepted Answer

Again, it is useful to draw NPV profiles that fit the description given in the question. Any number that meets the criteria will do. 11ea7757_ce7e_875d_81a5_174aee8833bb_TB2122_00 As we can see from the graph, statement a is true; the other statements are false.

Question 7

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 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.
B)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.
C)For a conflict to exist between NPV and IRR, the initial investment cost of one project must exceed the cost of the other.
D)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.
E)If the two projects' NPV profiles do not cross, then there will be a sharp conflict as to which one should be selected.

Accepted Answer

Again, it is useful to draw NPV profiles that fit the description given in the question. Any numbers that meet the criteria will do. 11ea7757_ce7e_604c_81a5_69bb42090ee1_TB2122_00 Statement a is true. Statement b is false. Statement c is false because a conflict can result from differences in the timing of the cash flows. Statement d is false because scale differences can result in profile crossovers and thus conflicts. Statement e is false, because if the profiles do not cross, then one will dominate the other, with both a higher IRR and a higher NPV at every discount rate.

Question 8

Clifford 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 will cross, and the larger project will look better based on the NPV at all positive values of WACC.
B)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.
C)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.
D)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.
E)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.

Accepted Answer

11ea7757_ce7f_23a0_81a5_53e112552545_TB2122_00 Statement c is true; the other statements are false.

Question 9

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

Accepted Answer

The easiest way to think about this question is to begin by drawing an NPV profile as shown below, then using it to decide which statement is correct. 11ea7757_ce7e_122a_81a5_e390d26e75ed_TB2122_00 Statement e is true, because both projects have an IRR greater than the WACC and thus will have a positive NPV. Statement a is false, because at 6%, the WACC is less than the crossover rate and Project L has a higher NPV than S. Statement b is false, because at 13% the WACC is greater than the crossover rate and S would have a higher NPV than L. Statement c is false, because of reasons mentioned in statement a. Statement d is false, because Project L's NPV profile is steeper, which means Project L's NPV is more sensitive to changes in WACC than Project S's NPV.

Question 10

McGlothin 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

Using the cumulative cash flows, we can see that the project's cash investment is recovered between year 2 and year 3. The payback period can be calculated as: 
Year 2 + [($200,000 - $94,000) / $86,000] = 2.30 years. Therefore, the correct answer is C.

Question 11

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 less than its regular IRR.
B)If a project's IRR is greater than its WACC, then the MIRR will be less than the IRR.
C)If a project's IRR is greater than its WACC, then the MIRR will be greater than the IRR.
D)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.
E)A project's MIRR is always greater than its regular IRR.

Accepted Answer

One could prove that (1) if the IRR is equal to the WACC, then the MIRR and the IRR will be equal, (2) if the IRR is greater than the WACC, the MIRR will be less than the IRR, and (3) the MIRR will be greater than the IRR if the IRR is less than the WACC. This situation exists because the MIRR assumes reinvestment at the WACC and therefore compounds at that rate, while the IRR assumes reinvestment at the IRR itself and therefore compounds at the IRR. Therefore, if the IRR exceeds the WACC, the TV found under the IRR method will be larger, and vice versa. The IRR and the MIRR are found as the rate that causes the PV of the TV to equal the cost. Therefore, if the IRR exceeds the WACC, causing the IRR's TV to be larger, then the IRR will exceed the MIRR, and vice versa. As a result, statement b is correct⎯if the IRR exceeds the WACC, the IRR will exceed the MIRR. The other statements are false. Note too that this answer could also be confirmed with a numerical example.

Question 12

Martin Manufacturing is considering two normal,equally risky,mutually exclusive,but not repeatable projects.Martin's WACC is 10%.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)Since the projects are mutually exclusive, the firm should always select Project B.
B)If the crossover rate is 8%, Project B will have the higher NPV.
C)Only one project has a positive NPV.
D)If the crossover rate is 8%, Project A will have the higher NPV.
E)Each project must have a negative NPV.

Accepted Answer

Statement b is true, while the other statements are false. If we draw an NPV profile graph, we would see that A must have the steeper slope. If the crossover is 8% and the WACC is 10%, then B will have the higher NPV.

Question 13

Which of the following statements is CORRECT?
A)The discounted payback method eliminates all of the problems associated with the payback method.
B)When evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a project's acceptability.
C)To find the MIRR, we discount the TV at the IRR.
D)A project's NPV profile must intersect the X-axis at the project's WACC.
E)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.

Accepted Answer

The IRR (Internal Rate of Return) method is popular among managers because it provides a rate of return, which can be more intuitive or easier to compare across projects, unlike the NPV (Net Present Value) method, which provides the value in dollar terms.

Question 14

Scott 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 find the NPV, we need to discount the cash flows using the WACC.

Using the formula:
NPV = CF/(1+r)^t

where CF is cash flow, r is the discount rate (WACC), and t is the time period, we get:

NPV = -400/(1+0.09)^1 + 100/(1+0.09)^2 + 200/(1+0.09)^3 + 300/(1+0.09)^4 + 600/(1+0.09)^5

NPV = $85.86

Since the NPV is positive, we should accept the project. Therefore, the best choice is C.

Question 15

Nichols 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 Nichols Inc.is considering a project that has...

Question 16

Spence 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 Spence Company is considering a project that...

Question 17

Hart 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 Hart Corp.is considering a project that has...

Question 18

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

Accepted Answer

Consider the following NPV profile graph: 11ea7757_ce7f_4ab1_81a5_d9593685c9ea_TB2122_00 We can see that statements c, d, and e are incorrect. Statement a is also incorrect, because if the projects have the same timing pattern, then A must have the higher cost. That leaves statement b as being correct, and that conclusion is confirmed by noting that since A have the steeper slope, its cash flows must come in slower; hence, B's cash flows come in more quickly and thus has the faster payback.

Question 19

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 IRR must be negative.
B)If a project's IRR is equal to its WACC, then under all reasonable conditions the project's NPV must be zero.
C)There is no necessary relationship between a project's IRR, its WACC, and its NPV.
D)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.
E)If a project's IRR is equal to its WACC, then, under all reasonable conditions, the project's NPV must be negative.

Accepted Answer

11ea7757_ce7e_fc8f_81a5_d1ac0c1c40db_TB2122_00 Recall that the very definition of the IRR is the discount rate at which the NPV is zero. Therefore, statement b is true. The other statements are false.

Question 20

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 less than its regular IRR.
B)If a project's IRR is greater than its WACC, then its MIRR will be greater than the IRR.
C)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.
D)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.
E)A project's MIRR is always greater than its regular IRR.

Accepted Answer

Answer d is essentially the definition of the MIRR; hence, it is correct.

Quiz 12: Capital Budgeting: Decision Rules

Ellmann 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.

Lancaster 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?

Robbins 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.

Consider 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?

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.

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?

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

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?

Scott 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.

Nichols 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.

Spence 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.

Hart 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.

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?

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

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.