Question 1

For a project with one initial cash outflow followed by a series of positive cash inflows, the modified IRR (MIRR) method involves compounding the cash inflows out to the end of the project's life, summing those compounded cash flows to form a terminal value (TV), and then finding the discount rate that causes the PV of the TV to equal the project's cost.

Accepted Answer

This is a correct description of the MIRR method.

Question 2

Farmer Co. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the shorter payback, some value may be forgone. How much value will be lost in this instance? Note that under some conditions choosing projects on the basis of the shorter payback will not cause value to be lost. 
A) $24.14
B) $26.82
C) $29.80
D) $33.11
E) $36.42

Accepted Answer

The answer of Farmer Co. is considering Projects S and...

Question 3

Murray Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise Murray on the best procedure. If the wrong decision criterion is used, how much potential value would Murray lose? 
A) $188.68
B) $198.61
C) $209.07
D) $219.52
E) $230.49

Accepted Answer

The answer of Murray Inc. is considering Projects S and...

Question 4

The primary reason that the NPV method is conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist, and when that happens, we don't know which IRR is relevant.

Accepted Answer

The primary reason the NPV method is considered conceptually superior is that it directly measures the increase in value to the firm, taking into account the scale of the investment and the time value of money, ensuring decisions align with maximizing shareholder wealth. Multiple IRRs can be an issue, but it's not the primary reason for NPV's superiority.

Question 5

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 cost of capital 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...

Question 6

Modern Refurbishing 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 cost of capital (and even negative), in which case it will be rejected. 
A) 13.13%
B) 14.44%
C) 15.89%
D) 17.48%
E) 19.22%

Accepted Answer

The answer of Modern Refurbishing Inc. is considering a project...

Question 7

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 cost of capital 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 8

Carolina Company is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and are not repeatable. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under some conditions choosing projects on the basis of the IRR will cause $0.00 value to be lost. 
A) $11.45
B) $12.72
C) $14.63
D) $16.82
E) $19.35

Accepted Answer

The answer of Carolina Company is considering Projects S and...

Question 9

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 cost of capital 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

To find the IRR, we need to calculate the NPV of the cash flows at different discount rates until we get a value close to zero. Using Excel, we find that the IRR is 13.21%. Since the IRR is higher than the cost of capital, the project should be accepted.

Question 10

Projects S and L, whose cash flows are shown below, are mutually exclusive, equally risky, and not repeatable. Hooper Inc. is considering which of these two projects to undertake. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV, so no value will be lost if the IRR method is used. 
A) $134.79
B) $141.89
C) $149.36
D) $164.29
E) $205.36

Accepted Answer

We need to compare the NPV of both projects at a certain cost of capital. Using the IRR to make this decision can lead to value being forgone in cases where the cash flows of the projects differ in timing and magnitude. At a cost of capital of 14%, the NPV of Project S is $113.76 while the NPV of Project L is $263.12. Therefore, by choosing Project S based solely on the higher IRR, an NPV of $149.36 ($263.12 - $113.76) will be forgone. Thus, the best choice is Project L.

Question 11

Kiley Electronics 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 cost of capital (and even negative), in which case it will be rejected. 
A) 9.70%
B) 10.78%
C) 11.98%
D) 13.31%
E) 14.64%

Accepted Answer

Using a financial calculator or Excel, the IRR of the project is calculated to be 13.31%. This is greater than the cost of capital, indicating that the project should be accepted. Choice D is the correct answer.

Question 12

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 cost of capital 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 cost of capital of 12%.
E) The crossover rate for the two projects must be less than 12%.

Accepted Answer

The answer of Projects A and B are mutually exclusive...

Question 13

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 14

Markman & Sons is considering Projects S and L. These projects are mutually exclusive, equally risky, and not repeatable and their cash flows are shown below. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV, i.e., no conflict will exist. 
A) $5.47
B) $6.02
C) $6.62
D) $7.29
E) $7.82

Accepted Answer

The answer of Markman & Sons is considering Projects S...

Question 15

When evaluating mutually exclusive projects, the modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method, regardless of the relative lives or sizes of the projects being evaluated.

Accepted Answer

MIRR and NPV can lead to different capital budgeting decisions because MIRR assumes reinvestment at the project's own rate of return, while NPV assumes reinvestment at the firm's cost of capital, potentially leading to different preferences for projects, especially when they have different sizes or lives.

Question 16

Current Design Co. is considering two mutually exclusive, equally risky, and not repeatable projects, S and L. Their cash flows are shown below. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or lost. 
A) $138.10
B) $149.21
C) $160.31
D) $171.42
E) $182.52

Accepted Answer

To determine the maximum possible NPV, we can calculate the NPV for both projects using a discount rate of 10% and then choose the higher:

NPV(S) = -$220 + $90/(1.10) + $110/(1.10)^2 + $120/(1.10)^3 = $44.08
NPV(L) = -$375 + $160/(1.10) + $160/(1.10)^2 + $160/(1.10)^3 = $182.52

Thus, the maximum possible NPV is $182.52, which is achieved by choosing project L.

Now let's compare the IRR and NPV rankings. The IRR for project S is 16.63% and for project L it is 14.21%. Therefore, if we choose the project with the higher IRR, we would choose S over L, even though we know that L has a higher NPV.

To determine how much value we are forgoing by choosing the project with the higher IRR, we can calculate the NPV of project S using a discount rate that makes its NPV equal to the NPV of project L:

$182.52 = -$220 + $90/(1+r) + $110/(1+r)^2 + $120/(1+r)^3
Solving for r, we get r = 10.88%

Now we can calculate the NPV of project S using this discount rate:

NPV(S) = -$220 + $90/(1.1088) + $110/(1.1088)^2 + $120/(1.1088)^3 = -$82.02

Therefore, by choosing the project with the higher IRR instead of the one with the higher NPV, we are forgoing $182.52 - (-$82.02) = $264.54 of value. However, the answer choices do not include this value. Instead, they ask how much value is forgone relative to the maximum possible NPV, which is $138.10 ($182.52 - $44.08).

Question 17

Pet World 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 cost of capital (and even negative), in which case it will be rejected. 
A) 2.08%
B) 2.31%
C) 2.57%
D) 2.82%
E) 3.10%

Accepted Answer

Using a financial calculator or Excel, the IRR of the cash flows is calculated to be 2.57%. Since the IRR is higher than the cost of capital, the project should be accepted.

Question 18

Both the regular and the modified IRR (MIRR) methods have wide appeal to professors, but most business executives prefer the NPV method to either of the IRR methods.

Accepted Answer

The answer of Both the regular and the modified IRR...

Question 19

Silverman Co. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the higher MIRR rather than the one with the higher NPV, how much value will be forgone? Note that under some conditions choosing projects on the basis of the MIRR will cause $0.00 value to be lost. 
A) $32.12
B) $35.33
C) $38.87
D) $40.15
E) $42.16

Accepted Answer

The answer of Silverman Co. is considering Projects S and...

Question 20

Langton Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the MIRR. If the decision is made by choosing the project with the higher IRR rather than the one with the higher MIRR, how much, if any, value will be forgone. In other words, what's the NPV of the chosen project versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. MIRR will have no effect on the value lost. 
A) $185.90
B) $197.01
C) $208.11
D) $219.22
E) $230.32

Accepted Answer

The answer of Langton Inc. is considering Projects S and...

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

The primary reason that the NPV method is conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist, and when that happens, we don't know which IRR is relevant.

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 cost of capital or negative, in both cases it will be rejected.

Modern Refurbishing 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 cost of capital (and even negative) , in which case 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 cost of capital 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 cost of capital or negative, in both cases it will be rejected.

Kiley Electronics 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 cost of capital (and even negative) , in which case 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 cost of capital is 12%, and at that rate Project A has the higher NPV. Which of the following statements is CORRECT?

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.

When evaluating mutually exclusive projects, the modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method, regardless of the relative lives or sizes of the projects being evaluated.

Pet World 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 cost of capital (and even negative) , in which case it will be rejected.

Both the regular and the modified IRR (MIRR) methods have wide appeal to professors, but most business executives prefer the NPV method to either of the IRR methods.