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Exam 12: Capital Budgeting: Decision Criteria

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Question 31

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Florida Phosphate is considering a project which involves opening a new mine at a cost of $10,000,000 at t = 0. The project is expected to have operating cash flows of $5,000,000 at the end of each of the next 4 years. However, the facility will have to be repaired at a cost of $6,000,000 at the end of the second year. Thus, at the end of Year 2 there will be a $5,000,000 operating cash inflow and an outflow of -$6,000,000 for repairs. The company's cost of capital is 15 percent. What is the difference between the project's MIRR and its regular IRR?

A) 0.00%
B) 0.51%
C) 3.40%
D) 9.65%
E) 13.78%

F) A) and B)
G) A) and E)

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Question 32

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

A) The project with the higher NPV may not always be the project with the higher IRR.
B) The project with the higher NPV may not always be the project with the higher MIRR.
C) The project with the higher IRR may not always be the project with the higher MIRR.
D) All of the answers above are correct.
E) Answers a and c are correct.

F) A) and B)
G) All of the above

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Question 33

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The Seattle Corporation has been presented with an investment opportunity which will yield 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 Year 10. This investment will cost the firm $150,000 today, and the firm's cost of capital is 10 percent. Assume cash flows occur evenly during the year, 1/365th each day. What is the payback period for this investment?

Scott Corporation's new project calls for an investment of $10,000. It has an estimated life of 10 years. The IRR has been calculated to be 15 percent. If cash flows are evenly distributed and the tax rate is 40 percent, what is the annual before-tax cash flow each year? (Assume depreciation is a negligible amount.)

Which of the following statements is correct?

The post-audit is used to

Which of the following statements is most correct?

After getting her degree in marketing and working for 5 years for a large department store, Sally started her own specialty shop in a regional mall. Sally's current lease calls for payments of $1,000 at the end of each month for the next 60 months. Now the landlord offers Sally a new 5-year lease which calls for zero rent for 6 months, then rental payments of $1,050 at the end of each month for the next 54 months. Sally's cost of capital is 11 percent. By what absolute dollar amount would accepting the new lease change Sally's theoretical net worth? (Hint: The cost of capital per month is 11%/12 = 0.9166667%.)

A decrease in the firm's discount rate (r) will increase NPV, which could change the accept/reject decision for a potential project. However, such a change would have no impact on the project's IRR, hence on the accept/reject decision under the IRR method.

Although the replacement chain, or common life, approach is appealing for dealing with projects with different lives, it is not used in industry because there are no projects which meet the assumptions the method requires.

A firm should never undertake an investment if accepting the project would cause an increase in the firm's cost of capital.

Assume a project has normal cash flows (that is, the initial cash flow is negative, and all other cash flows are positive) . Which of the following statements is most correct?

The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zero. Also, the NPV of X is greater than the NPV of Y at the cost of capital. If the two projects are mutually exclusive, Project X should definitely be selected, and the investment made, provided we have confidence in the data. Put another way, it is impossible to draw NPV profiles that would suggest not accepting Project X.

A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept?

The modified IRR (MIRR) method has wide appeal to professors, but most business executives prefer the NPV method to either the regular or modified IRR.

Assume a project has normal cash flows (i.e., the initial cash flow is negative, and all other cash flows are positive) . Which of the following statements is most correct?

One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a rough measure of a project's liquidity and risk.

Mills Corp. is considering adopting one of two machines. Machine A requires an up-front expenditure at t = 0 of $450,000. Machine A has an expected life of two years, and will generate positive after-tax cash flows of $350,000 per year (all cash flows are realized at the end of the year) Alternatively, Machine B requires an expenditure of $1 million at t = 0. Machine B has an expected life of four years, and will generate positive after-tax cash flows of $350,000 per year (all cash flows are realized at year end) The cost of capital is 10 percent. What is the net present value (on an extended four-year life) of the better machine?

Haig Aircraft is considering a project which has an up-front cost paid today at t = 0. The project will generate positive cash flows of $60,000 a year at the end of each of the next five years. The project's NPV is $75,000 and the company's WACC is 10 percent. What is the project's simple, regular payback?

Project A has an internal rate of return (IRR) of 15 percent. Project B has an IRR of 14 percent. Both projects have a cost of capital of 12 percent. Which of the following statements is most correct?