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

A) One defect of the IRR method is that it does not take account of the time value of money.
B) One defect of the IRR method is that it does not take account of the cost of capital.
C) One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future.
D) One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself,and that assumption is often not valid.
E) One defect of the IRR method is that it does not take account of cash flows over a project's full life.

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A) If the cost of capital is 6%,Project S will have the higher NPV.
B) If the cost of capital is 13%,Project S will have the lower NPV.
C) If the cost of capital is 10%,both projects will have a negative NPV.
D) Project S's NPV is more sensitive to changes in cost of capital than Project L's.
E) If the cost of capital is 10%,both projects will have positive NPVs.

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A) A project's NPV increases as the cost of capital declines.
B) A project's MIRR is unaffected by changes in the cost of capital.
C) A project's regular payback increases as the cost of capital declines.
D) A project's discounted payback increases as the cost of capital declines.
E) A project's IRR increases as the cost of capital declines.

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A) One drawback of the regular payback for evaluating projects is that this method does not properly account for the time value of money.
B) If a project's payback is positive,then the project should be rejected because it must have a negative NPV.
C) The regular payback ignores cash flows beyond the payback period,but the discounted payback method overcomes this problem.
D) If a company uses the same payback requirement to evaluate all projects,say it requires a payback of 4 years or less,then the company will tend to reject projects with relatively short lives and accept long-lived projects,and this will cause its risk to increase over time.
E) The longer a project's payback period,the more desirable the project is normally considered to be by this criterion.

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A) 1.42 years
B) 1.58 years
C) 1.75 years
D) 1.93 years
E) 2.12 years

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A) The discounted payback method eliminates all of the problems associated with the payback method.
B) When evaluating independent projects,the NPV and IRR methods often yield conflicting results regarding a project's acceptability.
C) To find the MIRR,we discount the TV at the IRR.
D) A project's NPV profile must intersect the X-axis at the project's cost of capital.
E) The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount,which the NPV method provides.

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A) 1.61 years
B) 1.79 years
C) 1.99 years
D) 2.22 years
E) 2.44 years

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A) You should recommend that the project be rejected because,although its NPV is positive,it has an IRR that is less than the cost of capital.
B) You should recommend that the project be accepted because (1) its NPV is positive and (2) although it has two IRRs,in this case it would be better to focus on the MIRR,which exceeds the cost of capital.You should explain this to the president and tell him that the firm's value will increase if the project is accepted.
C) You should recommend that the project be rejected.Although its NPV is positive it has two IRRs,one of which is less than the cost of capital,which indicates that the firm's value will decline if the project is accepted.
D) You should recommend that the project be rejected because,although its NPV is positive,its MIRR is less than the cost of capital,and that indicates that the firm's value will decline if it is accepted.
E) You should recommend that the project be rejected because its NPV is negative and its IRR is less than the cost of capital.

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A) If Project A has a higher IRR than Project B,then Project A must also have a higher NPV.
B) The IRR calculation implicitly assumes that all cash flows are reinvested at the cost of capital.
C) The IRR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business.
D) If a project has normal cash flows and its IRR exceeds its cost of capital,then the project's NPV must be positive.
E) If Project A has a higher IRR than Project B,then Project A must have the lower NPV.

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A) You should delay a decision until you have more information on the projects,even if this means that a competitor might come in and capture this market.
B) You should recommend Project R,because at the new cost of capital it will have the higher NPV.
C) You should recommend Project K,because at the new cost of capital it will have the higher NPV.
D) You should recommend Project K because it has the higher IRR and will continue to have the higher IRR even at the new cost of capital.
E) You should reject both projects because they will both have negative NPVs under the new conditions.

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A) One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the cost of capital,whereas IRR assumes that cash flows are reinvested at the IRR.The NPV assumption is generally more appropriate.
B) One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project's full life whereas MIRR does not.
C) One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows.
D) Since cash flows under the IRR and MIRR are both discounted at the same rate (the cost of capital) ,these two methods always rank mutually exclusive projects in the same order.
E) One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project's full life whereas IRR does not.

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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%.

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