Question 1

A project's IRR:
A)is the average rate of return necessary to pay back the project's capital providers.
B)will change with the cost of capital.
C)is equal to the discounted cash flows divided by the number of cash flows if the cash flows are a perpetuity.
D)All of these answers are correct.

Accepted Answer

The answer of A project's IRR:
A)is the average rate of...

Question 2

Which of the following statements is correct?
A)A weakness of both payback and discounted payback is that neither accounts for cash flows received after the payback.
B)Discounted payback uses a more aggressive reinvestment rate assumption than payback.
C)Neither payback nor discounted payback uses time value of money concepts.
D)None of these statements is correct.

Accepted Answer

Payback and discounted payback both consider the time it takes to recover the initial investment, but neither accounts for cash flows received after the payback. Therefore, statement A is correct. Statement B is incorrect, as discounted payback actually uses a more conservative reinvestment rate assumption than payback. Statement C is also incorrect, as both payback and discounted payback do use time value of money concepts.

Question 3

All of the following capital budgeting tools are suitable for firms facing time constraints EXCEPT:
A)NPV.
B)payback.
C)discounted payback.
D)All of these answers are suitable for firms facing time constraints.

Accepted Answer

The answer of All of the following capital budgeting tools...

Question 4

All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT:
A)MIRR.
B)profitability index.
C)payback.
D)NPV.

Accepted Answer

Payback is not suitable for non-normal cash flows because it only considers the time it takes to recover the initial investment, and does not take into account the timing or amount of future cash flows. MIRR, profitability index, and NPV are all suitable for non-normal cash flows as they are based on a time value of money approach and consider the timing and amount of all cash flows.

Question 5

Suppose you have a project whose discounted payback is equal to its termination date.What can you say for sure about its PI?
A)The discounted payback will be greater than zero.
B)It will have a PI and NPV of zero.
C)The NPV and IRR will yield the same decision.
D)The IRR will just equal the cost of capital.

Accepted Answer

If the discounted payback is equal to the termination date, then the sum of the discounted cash flows will be zero at that date. Therefore, the project's NPV and PI will also be zero. So, the correct choice is B.

Question 6

A capital budgeting method that converts a project's cash flows using a more consistent reinvestment rate prior to applying the IRR decision rule is referred to as:
A)IRR.
B)EAR.
C)NPV.
D)MIRR.

Accepted Answer

The method described matches the Modified Internal Rate of Return (MIRR) method, which is specifically designed to address issues with the inconsistent reinvestment rate assumption of the traditional Internal Rate of Return (IRR) method. Ear refers to the Effective Annual Rate, which is not a capital budgeting method, and NPV is a different approach altogether.

Question 7

A firm is evaluating a potential investment that is expected to generate cash flows of $100 in years 1 through 4 and $400 in years 5 through 7.The initial investment is $750.What is the payback for this investment?
A)4.88 years
B)4.48 years
C)5.88 years
D)5.48 years

Accepted Answer

The payback period is the time it takes for the investment to generate cash flows to recover the initial investment cost. Here, the investment generates $100 annually for the first 4 years, totaling $400, and then $400 annually for the next 3 years. By the end of year 4, the investment has recovered $400 of the initial $750. In year 5, it generates another $400, fully recovering the initial investment and providing an excess. To find the exact payback period, calculate how much of year 5's cash flow is needed to reach $750. Since $400 in year 5 covers the remaining $350 needed ($750 - $400 from years 1-4), the payback period is 4 years plus the fraction of year 5 needed to recover the full investment. This fraction is $350 (the remaining amount to be recovered by the end of year 4) divided by $400 (the cash flow in year 5), which equals 0.875 (or 7/8) of a year. Therefore, the total payback period is 4 years + 0.875 years = 4.875 years, or approximately 4.88 years when rounded.

Question 8

Which of the following is incorrect regarding the IRR statistic?
A)For independent projects, IRR will give the same accept/reject decision as NPV.
B)For the IRR statistic to give a different accept/reject decision from NPV, the cash flows must be non-normal and the projects must be mutually exclusive.
C)To solve for the IRR, one can simply solve the NPV formula for the rate that will make the NPV equal to zero.
D)None of these statements is incorrect.

Accepted Answer

The statement "For the IRR statistic to give a different accept/reject decision from NPV, the cash flows must be non-normal and the projects must be mutually exclusive" is incorrect. In reality, the IRR and NPV may give different decisions even for normal cash flows and non-mutually exclusive projects. Therefore, option B is incorrect. Options A, C, and D are all correct statements.

Question 9

A capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows is referred to as:
A)PI.
B)IRR.
C)NPV.
D)MIRR.

Accepted Answer

NPV (Net Present Value) generates a decision rule by comparing the discounted value of expected future cash inflows with the discounted value of expected future cash outflows. The project with a positive NPV is accepted, and the project with negative NPV is rejected. NPV measures the amount of wealth generated by the project and is considered as the best capital budgeting technique as it considers the time value of money and is suitable for long-term investment decisions. The other options, PI (Profitability Index), IRR (Internal Rate of Return), and MIRR (Modified Internal Rate of Return), are also popular capital budgeting techniques, but they are not as comprehensive and accurate as NPV.

Question 10

All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT:
A)MIRR.
B)profitability index.
C)IRR.
D)NPV.

Accepted Answer

The Internal Rate of Return (IRR) method assumes normal cash flows (initial outlay followed by a series of positive cash inflows). It may not provide reliable results for projects with non-normal cash flows (e.g., projects with alternating positive and negative cash flows over their life), leading to multiple IRRs or no IRR at all. MIRR, profitability index, and NPV do not have this limitation and can handle non-normal cash flows more effectively.

Question 11

Under what conditions can a rate-based statistic yield a different accept/reject decision than NPV?
A)Independent projects that are evaluated at a high cost of capital.
B)Mutually exclusive projects that are evaluated at a low cost of capital.
C)Any projects that exhibit differences in scale or timing.
D)Mutually exclusive projects that exhibit differences in scale or timing.

Accepted Answer

When comparing mutually exclusive projects with different scales or timings, the rate-based statistic may yield a different accept/reject decision than NPV. This is because the rate-based statistic (such as IRR) assumes that cash flows are reinvested at the same rate as the project's initial rate of return, whereas NPV accounts for the actual cost of capital over time. As a result, if one project has larger or earlier cash inflows than another, the rate-based statistic may favor that project even if its NPV is lower. Therefore, when comparing mutually exclusive projects with different scales or timings, NPV should be the primary decision-making criterion.

Question 12

A project has normal cash flows.Its IRR is 15 percent and its cost of capital is 10 percent.Which of the following statements is incorrect?
A)The project has only one negative cash flow.
B)The project's MIRR is less than 15 percent but greater than 10 percent.
C)The project's discounted payback is less than the project's payback.
D)The project's NPV > 0.

Accepted Answer

The answer of A project has normal cash flows.Its IRR...

Question 13

Which of the following statements is correct regarding the NPV profile?
A)The IRR appears as the intersection of the NPV profile with the x-axis.
B)The IRR appears at the crossover point or where the two profiles intersect.
C)NPV profiles for independent projects with normal cash flows will intersect.
D)All of these statements are correct.

Accepted Answer

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

Question 14

All of the following are strengths of payback EXCEPT:
A)its benchmark is not determined by a relevant external constraint.
B)it incorporates the time value of money.
C)it uses a conservative reinvestment rate.
D)none of these.

Accepted Answer

The answer of All of the following are strengths of...

Question 15

All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT:
A)MIRR.
B)profitability index.
C)discounted payback.
D)NPV.

Accepted Answer

The answer of All of the following capital budgeting tools...

Question 16

Which of the following statements is correct?
A)Discounted payback solves all the shortcomings of payback.
B)The reinvestment rate of NPV and MIRR is the same.
C)The MIRR and IRR have the same reinvestment rate.
D)All of these are correct statements.

Accepted Answer

The answer of Which of the following statements is correct?
A)Discounted...

Question 17

A decision rule and associated methodology for converting the NPV statistic into a rate-based metric is referred to as:
A)NPV.
B)profitability index.
C)MIRR.
D)discounted payback.

Accepted Answer

The answer of A decision rule and associated methodology for...

Question 18

All of the following are strengths of NPV EXCEPT:
A)it works equally well for independent and mutually exclusive projects.
B)managers have a preference for using a statistic that is in percent instead of dollars.
C)it uses a conservative reinvestment rate assumption.
D)these are all strengths of the NPV statistic.

Accepted Answer

Managers do not necessarily have a preference for using a statistic that is in percent instead of dollars. It may vary from manager to manager and also depend on the nature of the project.

Question 19

Which of the following best describes the NPV profile?
A)A graph of a project's NPV as a function of possible IRRs.
B)A graph of a project's NPV over time.
C)A graph of a project's NPV as a function of possible capital costs.
D)None of these statements is correct.

Accepted Answer

An NPV profile is a graph that shows the relationship between a project's net present value (NPV) and different discount rates, which are often the project's cost of capital.

Question 20

Which of the following tools is suitable for choosing between mutually exclusive projects?
A)NPV
B)IRR
C)MIRR
D)None are suitable

Accepted Answer

NPV (Net Present Value) is the best tool to use when choosing between mutually exclusive projects because it calculates the difference between the present value of cash inflows and the present value of cash outflows for each project. The project with the higher NPV should be chosen as it will generate more value for the company. IRR (Internal Rate of Return) and MIRR (Modified Internal Rate of Return) are also useful tools, but they may not always provide a clear choice between mutually exclusive projects.

Quiz 13: Weighing Net Present Value and Other Capital Budgeting Criteria

A project's IRR:

Which of the following statements is correct?

All of the following capital budgeting tools are suitable for firms facing time constraints EXCEPT:

All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT:

Suppose you have a project whose discounted payback is equal to its termination date.What can you say for sure about its PI?

A capital budgeting method that converts a project's cash flows using a more consistent reinvestment rate prior to applying the IRR decision rule is referred to as:

A firm is evaluating a potential investment that is expected to generate cash flows of $100 in years 1 through 4 and $400 in years 5 through 7.The initial investment is $750.What is the payback for this investment?

Which of the following is incorrect regarding the IRR statistic?

A capital budgeting technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flows is referred to as:

All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT:

Under what conditions can a rate-based statistic yield a different accept/reject decision than NPV?

A project has normal cash flows.Its IRR is 15 percent and its cost of capital is 10 percent.Which of the following statements is incorrect?

Which of the following statements is correct regarding the NPV profile?

All of the following are strengths of payback EXCEPT:

All of the following capital budgeting tools are suitable for non-normal cash flows EXCEPT:

Which of the following statements is correct?

A decision rule and associated methodology for converting the NPV statistic into a rate-based metric is referred to as:

All of the following are strengths of NPV EXCEPT:

Which of the following best describes the NPV profile?

Which of the following tools is suitable for choosing between mutually exclusive projects?