Question 1

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
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Question 2

The modified IRR (MIRR)is normally

Accepted Answer

The answer of The modified IRR (MIRR)is normally
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Question 3

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
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Question 4

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
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Question 5

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?

Accepted Answer

First, let's find the IRR of the project using trial and error or a financial calculator:

Year 0: -$1,000 (initial investment)
Year 1: $500
Year 2: $500
Year 3: $500

IRR ≈ 12.25%

Next, let's find the MIRR of the project using the following steps:

1. Calculate the future value (FV) of all cash inflows at the required rate of return (r=10%):

FV = $500 x ((1+10%)^3 - 1)/10% = $1,732.05

2. Calculate the terminal value (TV) of all cash outflows (the initial investment) at the reinvestment rate (r=10%):

TV = -$1,000 x (1+10%)^3 = -$1,331.00

3. Find the MIRR by solving for the discount rate (d) that equates the present value of TV with the present value of FV:

TV = -$1,000; FV = $1,732.05
PV(TV) = -$1,000 / (1+d)^3
PV(FV) = $1,732.05 / (1+d)^3

Solving for d gives MIRR ≈ 7.16%

The difference between the IRR and MIRR is:

IRR - MIRR = 12.25% - 7.16% = 5.09%

Therefore, the best answer is C.

Question 6

Below are the returns of Nulook Cosmetics and the "market" over a three-year period:  Nulook finances internally using only retained earnings,and it uses the Capital Asset Pricing Model with a historical beta to determine its required rate of return.Currently,the risk-free rate is 7 percent,and the estimated market risk premium is 6 percent.Nulook is evaluating a project which has a cost today of $2,028 and will provide estimated cash inflows of $1,000 at the end of the next 3 years.What is this project's MIRR?

Accepted Answer

The answer of Below are the returns of Nulook Cosmetics...

Question 7

Project X has a cost of $30,000 at t = 0,and it is expected to produce a uniform cash flow stream for 7 years,i.e.,the CF's are the same in Years 1 through 7,and it has a regular IRR of 14 percent.The required rate of return for the project is 12 percent.What is the project's modified IRR (MIRR)?

Accepted Answer

The answer of Project X has a cost of $30,000...

Question 8

The Seattle Corporation has been presented with an investment opportunity which will yield end of year 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 Year10.This investment will cost the firm $150,000 today,and the firm's required rate of return is 10 percent.What is the NPV for this investment?

Accepted Answer

The answer of The Seattle Corporation has been presented with...

Question 9

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

Accepted Answer

The answer of An insurance firm agrees to pay you...

Question 10

You are considering the purchase of an investment that would pay you $5,000 per year for Years 1-5,$3,000 per year for Years 6-8,and $2,000 per year for Years 9 and10.If you require a 14 percent rate of return,and the cash flows occur at the end of each year,then how much should you be willing to pay for this investment?

Accepted Answer

To calculate the present value of this investment, we need to find the present value of each cash flow and then add them up.

For the cash flows of Years 1-5, we need to find the present value of an annuity due (because the cash flows occur at the beginning of each year). Using the formula for present value of an annuity due, we get:

PV of Years 1-5 = $5,000 * [(1 - 1 / (1 + 0.14)⁵) / 0.14] * (1 + 0.14) = $18,619.84

For the cash flows of Years 6-8, we need to find the present value of an ordinary annuity (because the cash flows occur at the end of each year). Using the formula for present value of an ordinary annuity, we get:

PV of Years 6-8 = $3,000 * [(1 - 1 / (1 + 0.14)³) / 0.14] = $7,764.08

For the cash flows of Years 9-10, we only need to find the present value of two future cash flows, so we can use the formula for present value of a single future cash flow. Using the formula, we get:

PV of Years 9-10 = $2,000 / (1 + 0.14)⁹ + $2,000 / (1 + 0.14)¹⁰ = $1,553.39

Now we can add up the present values of all the cash flows to get the total present value of the investment:

Total PV = PV of Years 1-5 + PV of Years 6-8 + PV of Years 9-10
          = $18,619.84 + $7,764.08 + $1,553.39
          = $27,937.31

Therefore, you should be willing to pay $21,937.26 for this investment (the present value of the expected cash flows at a 14% rate of return).

Question 11

Alyeska Salmon Inc.,a large salmon canning firm operating out of Valdez,Alaska,has a new automated production line project it is considering.The project has a cost of $275,000 and is expected to provide after-tax annual cash flows of $73,306 for eight years.The firm's management is uncomfortable with the IRR reinvestment assumption and prefers the modified IRR approach.You have calculated a required rate of return for the firm of 12 percent.What is the project's MIRR?

Accepted Answer

To calculate MIRR, we need to first find the terminal value of the project's cash flows. Using a financial calculator or Excel, we can input the following:
- PV = -275,000 (cost of the project)
- PMT = 73,306 (annual cash flow)
- FV = 0 (we want to find the terminal value)
- n = 8 (number of years)

Solving for FV, we get a terminal value of $861,109.81.

Next, we need to find the discount rate that equates the present value of the project's cost with the future value of its cash inflows. We can do this by using the MIRR formula:
MIRR = [(FV positive cash flows / PV negative cash flows) ^ (1/n)] - 1

To account for the firm's preferred reinvestment assumption, we assume that positive cash flows will be reinvested at the cost of capital (12%). Negative cash flows are assumed to be financed by external sources (e.g. debt or equity) at their cost of capital.

Using this approach, we can calculate MIRR as follows:

- Calculate the present value of negative and positive cash flows separately:
    - PV negative cash flows = 275,000 (project cost)
    - PV positive cash flows = 0 (since we assume they will be reinvested at the cost of capital)

- Calculate the future value of positive cash flows using the project's reinvestment rate (12%):
    - FV positive cash flows = 73,306 * [(1 + 0.12) ^ 8 - 1] / 0.12 = 707,009.94

- Calculate MIRR:
    - MIRR = [(FV positive cash flows / PV negative cash flows) ^ (1/n)] - 1
    - MIRR = [(707,009.94 / 275,000) ^ (1/8)] - 1
    - MIRR = 15.95%

Rounding to one decimal place, the project's MIRR is 16.0%. Therefore, the correct answer is choice (D).

Question 12

In comparing two mutually exclusive projects of equal size and equal life,which of the following statements is most correct?

Accepted Answer

The NPV and IRR methods assume reinvestment of cash flows at the project's cost of capital, while the MIRR method assumes reinvestment at the firm's cost of capital. Therefore, the MIRR method tends to give more accurate rankings of mutually exclusive projects than the NPV and IRR methods. Both statements a and c are correct because the IRR method may generate multiple rates of return for certain cash flow patterns, and the MIRR method may adjust for differences in project size or timing of cash flows that the NPV and IRR methods do not account for. Therefore, neither the NPV nor the IRR method always provides the most accurate ranking of mutually exclusive projects.

Question 13

Two projects being considered are mutually exclusive and have the following projected cash flows:  At what rate (approximately)do the NPV profiles of Projects A and B cross?

Accepted Answer

The answer of Two projects being considered are mutually exclusive...

Question 14

Two fellow financial analysts are evaluating a project with the following net cash flows:  One analyst says that the project has an IRR of between 12 and 13%.The other analyst calculates an IRR of just under 800%,but fears his calculator's battery is low and may have caused an error.You agree to settle the dispute by analyzing the project cash flows.Which statement best describes the IRR for this project?

Accepted Answer

The answer of Two fellow financial analysts are evaluating a...

Question 15

Two projects being considered are mutually exclusive and have the following cash flows:  If the required rate of return on these projects is 10 percent,which would be chosen and why?

Accepted Answer

The answer of Two projects being considered are mutually exclusive...

Question 16

Michigan Mattress Company is considering the purchase of land and the construction of a new plant.The land,which would be bought immediately (at t = 0),has a cost of $100,000 and the building,which would be erected at the end of the first year (t = 1),would cost $500,000.It is estimated that the firm's after-tax cash flow will be increased by $100,000 starting at the end of the second year,and that this incremental flow would increase at a 10 percent rate annually over the next 10 years.What is the approximate payback period?

Accepted Answer

To calculate the payback period, we need to determine how long it takes for the initial investment to be recovered.

The initial investment is $100,000 for the land and $500,000 for the building, which gives us a total investment of $600,000.

The after-tax cash flow that will be generated starting at the end of the second year is $100,000, which will increase by 10 percent each year for the next 10 years. To calculate the cash flows, we can use the following formula:

Year 2 = $100,000 
Year 3 = $110,000 
Year 4 = $121,000 
Year 5 = $133,100 
Year 6 = $146,410 
Year 7 = $161,051 
Year 8 = $177,156 
Year 9 = $194,872 
Year 10 = $214,359 
Year 11 = $235,795

To determine the payback period, we need to calculate how long it takes for the cumulative cash flows to equal the initial investment.

Year 1: -$600,000 
Year 2: -$500,000 
Year 3: -$390,000 
Year 4: -$269,000 
Year 5: -$135,900 
Year 6: $10,510 
Year 7: $171,561 
Year 8: $348,717 
Year 9: $543,589 
Year 10: $758,948 
Year 11: $994,743

The cumulative cash flows turn positive at the end of year 6, so the payback period is between year 5 and year 6. To estimate the payback period more accurately, we can use linear interpolation:

Payback period = Year 5 + ((Investment at Year 5) / (Cash flow in Year 6)) 
Payback period = 5 + ((-$135,900) / ($146,410)) 
Payback period = 5.93 (rounded to the nearest whole number)

Therefore, the approximate payback period is 6 years, which means that the initial investment will be fully recovered at the end of year 6.

Question 17

Which of the following statements is correct?

Accepted Answer

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

Question 18

The capital budgeting director of Sparrow Corporation is evaluating a project which costs $200,000,is expected to last for 10 years and produce 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?

Accepted Answer

To find the internal rate of return (IRR), we need to find the discount rate at which the present value of the cash inflows equals the cost of the investment. Using a financial calculator or Excel, we can solve for the IRR by setting the present value of the cash flows equal to the initial investment:
-$200,000 + $44,503 / (1 + IRR) + $44,503 / (1 + IRR)^2 + ... + $44,503 / (1 + IRR)^10 = 0

Using trial and error, we can find that an interest rate of 18% will make the present value of the cash inflows equal to the initial investment. Therefore, the project's IRR is 18%.

Note that the required rate of return (14%) is lower than the IRR (18%), indicating that the project is expected to earn a return higher than what the company requires. Therefore, the project is a good investment and Sparrow Corporation should proceed with it.

Question 19

Which of the following is most correct? The modified IRR (MIRR)method:

Accepted Answer

The MIRR method overcomes the problem of multiple rates of return and compounds cash flows at the required rate of return, which answers options B and C. It also overcomes the problems of cash flow timing and project size, which is a criticism of the regular IRR method, this answer option is D. Additionally, option A is incorrect because the MIRR method may not always lead to the same ranking decision as NPV, especially for mutually exclusive projects. Therefore, answer option E is correct.

Question 20

Two projects being considered by a firm are mutually exclusive and have the following projected cash flows:  Based only on the information given,which of the two projects would be preferred,and why?

Accepted Answer

Project B has a higher IRR of 18% compared to Project A's IRR of 12%. The IRR indicates the rate of return on the initial investment, and a higher IRR means better profitability. Therefore, Project B would be preferred over Project A.

Quiz 9: Capital Budgeting Techniques

Which of the following statements is correct?

The modified IRR (MIRR) is normally

Which of the following statements is correct?

Which of the following statements is correct?

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?

Project X has a cost of $30,000 at t = 0,and it is expected to produce a uniform cash flow stream for 7 years,i.e.,the CF's are the same in Years 1 through 7,and it has a regular IRR of 14 percent.The required rate of return for the project is 12 percent.What is the project's modified IRR (MIRR) ?

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

In comparing two mutually exclusive projects of equal size and equal life,which of the following statements is most correct?

Two projects being considered are mutually exclusive and have the following projected cash flows: At what rate (approximately) do the NPV profiles of Projects A and B cross?

Two projects being considered are mutually exclusive and have the following cash flows: If the required rate of return on these projects is 10 percent,which would be chosen and why?

Which of the following statements is correct?

Which of the following is most correct? The modified IRR (MIRR) method:

Two projects being considered by a firm are mutually exclusive and have the following projected cash flows: Based only on the information given,which of the two projects would be preferred,and why?