Question 1

A project's net present value profile is a graph that plots a project's NPV for various discount rates.

Accepted Answer

The statement is true. The graph that plots a project's NPV for various discount rates is called the net present value profile.

Question 2

What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of ($1,800,000)in year 1,$2,900,000 in year 2,$2,700,000 in year 3,and $2,300,000 in year 4?

Accepted Answer

The answer of What is the IRR for the following...

Question 3

Consider the following projects,X and Y,where the firm can only choose one.Project X costs $600 and has cash flows of $400 in each of the next 2 years.Project Y also costs $600,and generates cash flows of $500 and $275 for the next 2 years,respectively.Which investment should the firm choose if the cost of capital is 10 percent?

Accepted Answer

The answer of Consider the following projects,X and Y,where the...

Question 4

Which of the following is true of NPV profile?

Accepted Answer

NPV profile charts the net present value of a project as a function of the cost of capital. Option A is incorrect because conflicting ranking is usually resolved by using other criteria like payback period or profitability index. Option B is incorrect because a project's NPV is plotted against varying discount rates, not IRR. Option C is incorrect because there is a direct relationship between IRR and NPV, not an inverse relationship.

Question 5

Net present value (NPV)assumes that intermediate cash inflows are reinvested at the cost of capital,whereas internal rate of return (IRR)assumes that intermediate cash inflows can be reinvested at a rate equal to the project's IRR.

Accepted Answer

This statement is accurate. NPV assumes that cash inflows are reinvested at the cost of capital, while IRR assumes that cash inflows can be reinvested at a rate equal to the project's IRR.

Question 6

A project's net present value profile is a graph that plots a project's IRR for various discount rates.

Accepted Answer

A project's net present value (NPV) profile is a graph that plots the NPV of a project for various discount rates, not the IRR. The IRR is the discount rate at which the NPV equals zero.

Question 7

What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash inflows of $1,800,000 in year 1,$1,900,000 in year 2,$1,700,000 in year 3,and $1,300,000 in year 4?

Accepted Answer

The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. To find the IRR, one typically uses financial calculators, spreadsheet software like Excel, or iterative mathematical methods, as it involves solving for the root of a polynomial equation. Given the cash flows, the IRR for this project is approximately 13.57%.

Question 8

For conventional projects,both NPV and IRR techniques will always generate the same accept-reject decision.

Accepted Answer

It is possible for NPV and IRR to generate conflicting decisions for conventional projects if cash flows occur at non-normal time periods or if there are mutually exclusive projects. In such cases, NPV is generally considered a more reliable method of decision-making.

Question 9

Consider the following projects,X and Y where the firm can only choose one.Project X costs $600 and has cash flows of $400 in each of the next 2 years.Project Y also costs $600,and generates cash flows of $500 and $275 for the next 2 years,respectively.Which investment should the firm choose if the cost of capital is 25 percent?

Accepted Answer

The answer of Consider the following projects,X and Y where...

Question 10

On a purely theoretical basis,IRR is the better approach to capital budgeting than NPV because IRR implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

Accepted Answer

IRR actually assumes that intermediate cash inflows are reinvested at the project's own internal rate of return, not the firm's cost of capital, which can lead to unrealistic reinvestment rate assumptions, especially if the IRR is significantly high. NPV uses a discount rate that reflects the firm's cost of capital, providing a more realistic approach to evaluating the value added by a project.

Question 11

Net present value profiles are most useful when selecting among mutually exclusive projects.

Accepted Answer

Net present value profiles allow for a direct comparison between the cash flows and present values of different projects. This is particularly useful in choosing between mutually exclusive projects, where only one can be selected. By comparing the net present value profiles of each project, it becomes easier to identify which one is likely to generate the most value for the company.

Question 12

Tangshan Mining Company is considering investing in a new mining project.The firm's cost of capital is 12 percent and the project is expected to have an initial after-tax cost of $5,000,000.Furthermore,the project is expected to provide after-tax operating cash flows of $2,500,000 in year 1,$2,300,000 in year 2,$2,200,000 in year 3,and ($1,300,000)in year 4?
(a)Calculate the project's NPV.
(b)Calculate the project's IRR.
(c)Should the firm make the investment?

Accepted Answer

The answer of Tangshan Mining Company is considering investing in...

Question 13

In general,projects with similar-sized investments and lower cash inflows in the early years tend to be preferred at higher discount rates.

Accepted Answer

At higher discount rates, projects with larger cash inflows in the early years are generally preferred because the value of money received sooner is not as heavily reduced by the discounting process.

Question 14

Projects having higher cash inflows in the early years tend to be less sensitive to changes in the cost of capital and are therefore often acceptable at higher discount rates compared to projects with higher cash inflows that occur in the later years.

Accepted Answer

Projects with higher early cash inflows are less sensitive to changes in the cost of capital because the present value of those cash flows will be higher compared to cash flows received in later years. Therefore, these projects can be accepted at higher discount rates.

Question 15

Net present value profiles are most useful when selecting among independent projects.

Accepted Answer

Net present value profiles are most useful for comparing mutually exclusive projects to understand how the value of each project changes with different discount rates, rather than for selecting among independent projects where each project can be evaluated on its own merits.

Question 16

Although differences in the magnitude and timing of cash flows explain conflicting rankings under the NPV and IRR techniques,the underlying cause is the implicit assumption concerning the reinvestment of intermediate cash inflows.

Accepted Answer

The statement accurately describes the reason for conflicting rankings under NPV and IRR techniques. The difference in the assumption about the reinvestment of intermediate cash inflows leads to discrepancies in ranking projects.

Question 17

Conflicting rankings in the case of mutually exclusive projects using NPV and IRR often result from differences in the magnitude and/or timing of cash flows.

Accepted Answer

Conflicting rankings between NPV and IRR for mutually exclusive projects can occur due to differences in the timing and/or size of cash flows.

Question 18

In general,the greater the difference between the magnitude and/or timing of cash inflows,the greater the likelihood of conflicting ranking between NPV and IRR.

Accepted Answer

When there is a large difference between cash inflows, it can lead to conflicting rankings between NPV and IRR because NPV discounts cash flows at a present value rate while IRR assumes a reinvestment rate. This can result in different rankings based on the timing of cash flows.

Question 19

The IRR method assumes the cash flows are reinvested at the internal rate of return rather than the required rate of return.

Accepted Answer

The IRR method assumes that the cash flows generated by a project are reinvested at the same rate of return as the project itself. This is why the IRR is often referred to as the "internal" rate of return. It is important to note that this assumption may not always hold true in reality, but it is a useful and widely used tool for evaluating investment opportunities.

Question 20

On a purely theoretical basis,NPV is the better approach to capital budgeting than IRR because NPV implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

Accepted Answer

This statement is true. NPV is a better approach because it takes into account the time value of money and assumes that all cash flows, including intermediate cash inflows, are reinvested at the firm's cost of capital. IRR, on the other hand, assumes that intermediate cash inflows are reinvested at the IRR, which may not accurately reflect the firm's cost of capital.

Quiz 10: Capital Budgeting Techniques