Question_TB10_12Dec_2nd
[i]. A capital investment’s internal rate of return
a. Changes when the cost of capital changes.
b. Is equal to the annual net cash flows divided by one half of the project’s cost when the cash flows are an annuity.
c. Must exceed the cost of capital in order for the firm to accept the investment.
d. Is similar to the yield to maturity on a bond.
e. Statements c and d are correct.
[ii]. Which of the following statements is most correct? The modified IRR (MIRR) method:
a. Always leads to the same ranking decision as NPV for independent projects.
b. Overcomes the problem of multiple internal rates of return.
c. Compounds cash flows at the cost of capital.
d. Overcomes the problems of cash flow timing and project size that lead to criticism of the regular IRR method.
e. Statements b and c are correct.
[iii]. Which of the following statements is correct?
a. Because discounted payback takes account of the cost of capital, a project’s discounted payback is normally shorter than its regular payback.
b. The NPV and IRR methods use the same basic equation, but in the NPV method the discount rate is specified and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found.
c. If the cost of capital is less than the crossover rate for two mutually exclusive projects’ NPV profiles, a NPV/IRR conflict will not occur.
d. If you are choosing between two projects that have the same life, and if their NPV profiles cross, then the smaller project will probably be the one with the steeper NPV profile.
e. If the cost of capital is relatively high, this will favor larger, longerterm projects over smaller, shorterterm alternatives because it is good to earn high rates on larger amounts over longer periods.
[iv]. When 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. Statements a and c are correct.
e. All of the statements above are correct.
[v]. A company estimates that its weighted average cost of capital (WACC) is 10 percent. Which of the following independent projects should the company accept?
a. Project A requires an upfront expenditure of $1,000,000 and generates a net present value of $3,200.
b. Project B has a modified internal rate of return of 9.5 percent.
c. Project C requires an upfront expenditure of $1,000,000 and generates a positive internal rate of return of 9.7 percent.
d. Project D has an internal rate of return of 9.5 percent.
e. None of the projects above should be accepted.
[vi]. Which of the following is most correct?
a. The NPV and IRR rules will always lead to the same decision in choosing between mutually exclusive projects, unless one or both of the projects are “nonnormal” in the sense of having only one change of sign in the cash flow stream.
b. The Modified Internal Rate of Return (MIRR) compounds cash outflows at the cost of capital.
c. Conflicts between NPV and IRR rules arise in choosing between two mutually exclusive projects (that each have normal cash flows) when the cost of capital exceeds the crossover rate (that is, the discount rate at which the NPV profiles cross).
d. The discounted payback method overcomes the problems that the payback method has with cash flows occurring after the payback period.
e. None of the statements above is correct.
[vii]. Which of the following statements is most correct?
a. The IRR method is appealing to some managers because it produces a rate of return upon which to base decisions rather than a dollar amount like the NPV method.
b. The discounted payback method solves all the problems associated with the payback method.
c. For independent projects, the decision to accept or reject will always be the same using either the IRR method or the NPV method.
d. Statements a and c are correct.
e. All of the statements above are correct.
[viii]. Which of the following statements is most correct?
a. One of the disadvantages of choosing between mutually exclusive projects on the basis of the discounted payback method is that you might choose the project with the faster payback period but with the lower total return.
b. Multiple IRRs can occur in cases when project cash flows are normal, but they are more common in cases where project cash flows are nonnormal.
c. When choosing between mutually exclusive projects, managers should accept all projects with IRRs greater than the weighted average cost of capital.
d. Statements a and b are correct.
e. All of the statements above are correct.
[ix]. Normal projects C and D are mutually exclusive. Project C has a higher net present value if the WACC is less than 12 percent, whereas Project D has a higher net present value if the WACC exceeds 12 percent. Which of the following statements is most correct?
a. Project D has a higher internal rate of return.
b. Project D is probably larger in scale than Project C.
c. Project C probably has a faster payback.
d. Statements a and c are correct.
e. All of the statements above are correct.
[x]. Your assistant has just completed an analysis of two mutually exclusive projects. You must now take her report to a board of directors meeting and present the alternatives for the board’s consideration. To help you with your presentation, your assistant also constructed a graph with NPV profiles for the two projects. However, she forgot to label the profiles, so you do not know which line applies to which project. Of the following statements regarding the profiles, which one is most reasonable?
a. If the two projects have the same investment cost, and if their NPV profiles cross once in the upper right quadrant, at a discount rate of 40 percent, this suggests that a NPV versus IRR conflict is not likely to exist.
b. If the two projects’ NPV profiles cross once, in the upper left quadrant, at a discount rate of minus 10 percent, then there will probably not be a NPV versus IRR conflict, irrespective of the relative sizes of the two projects, in any meaningful, practical sense (that is, a conflict that will affect the actual investment decision).
c. If one of the projects has a NPV profile that crosses the Xaxis twice, hence the project appears to have two IRRs, your assistant must have made a mistake.
d. Whenever a conflict between NPV and IRR exist, then, if the two projects have the same initial cost, the one with the steeper NPV profile probably has less rapid cash flows. However, if they have identical cash flow patterns, then the one with the steeper profile probably has the lower initial cost.
e. If the two projects both have a single outlay at t = 0, followed by a series of positive cash inflows, and if their NPV profiles cross in the lower left quadrant, then one of the projects should be accepted, and both would be accepted if they were not mutually exclusive.
[xi]. Which of the following statements is most correct?
a. When dealing with independent projects, discounted payback (using a payback requirement of 3 or less years), NPV, IRR, and modified IRR always lead to the same accept/reject decisions for a given project.
b. When dealing with mutually exclusive projects, the NPV and modified IRR methods always rank projects the same, but those rankings can conflict with rankings produced by the discounted payback and the regular IRR methods.
c. Multiple rates of return are possible with the regular IRR method but not with the modified IRR method, and this fact is one reason given by the textbook for favoring MIRR (or modified IRR) over IRR.
d. Statements a and c are correct.
e. None of the statements above is correct.
[xii]. Which of the following statements is correct?
a. There can never be a conflict between NPV and IRR decisions if the decision is related to a normal, independent project, that is, NPV will never indicate acceptance if IRR indicates rejection.
b. To find the MIRR, we first compound CFs at the regular IRR to find the TV, and then we discount the TV at the cost of capital to find the PV.
c. The NPV and IRR methods both assume that cash flows are reinvested at the cost of capital. However, the MIRR method assumes reinvestment at the MIRR itself.
d. If you are choosing between two projects that have the same cost, and if their NPV profiles cross, then the project with the higher IRR probably has more of its cash flows coming in the later years.
e. A change in the cost of capital would normally change both a project’s NPV and its IRR.
[xiii]. Project A has an internal rate of return of 18 percent, while Project B has an internal rate of return of 16 percent. However, if the company’s cost of capital (WACC) is 12 percent, Project B has a higher net present value. Which of the following statements is most correct?
a. The crossover rate for the two projects is less than 12 percent.
b. Assuming the timing of the two projects is the same, Project A is probably of larger scale than Project B.
c. Assuming that the two projects have the same scale, Project A probably has a faster payback than Project B.
d. Statements a and b are correct.
e. Statements b and c are correct.
[xiv]. The Seattle Corporation has been presented with an investment opportunity that 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?
a. 5.23 years
b. 4.86 years
c. 4.00 years
d. 6.12 years
e. 4.35 years
[xv]. Coughlin Motors is considering a project with the following expected cash flows:
Project
Year Cash Flow
0 $700 million
1 200 million
2 370 million
3 225 million
4 700 million
The project’s WACC is 10 percent. What is the project’s discounted payback?
a. 3.15 years
b. 4.09 years
c. 1.62 years
d. 2.58 years
e. 3.09 years
[xvi]. A project has the following cash flows:
Project
Year Cash Flow
0 $3,000
1 1,000
2 1,000
3 1,000
4 1,000
Its cost of capital is 10 percent. What is the project’s discounted payback period?
a. 3.00 years
b. 3.30 years
c. 3.52 years
d. 3.75 years
e. 4.75 years
[xvii]. Project A has a 10 percent cost of capital and the following cash flows:
Project A
Year Cash Flow
0 $300
1 100
2 150
3 200
4 50
What is Project A’s discounted payback?
a. 2.25 years
b. 2.36 years
c. 2.43 years
d. 2.50 years
e. 2.57 years
[xviii]. As the director of capital budgeting for Denver Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:
Project X Project Z
Year Cash Flow Cash Flow
0 $100,000 $100,000
1 50,000 10,000
2 40,000 30,000
3 30,000 40,000
4 10,000 60,000
If Denver’s cost of capital is 15 percent, which project would you choose?
a. Neither project.
b. Project X, since it has the higher IRR.
c. Project Z, since it has the higher NPV.
d. Project X, since it has the higher NPV.
e. Project Z, since it has the higher IRR.
[xix]. Two projects being considered are mutually exclusive and have the following projected cash flows:
Project A Project B
Year Cash Flow Cash Flow
0 $50,000 $50,000
1 15,625 0
2 15,625 0
3 15,625 0
4 15,625 0
5 15,625 99,500
If the required rate of return on these projects is 10 percent, which would be chosen and why?
a. Project B because it has the higher NPV.
b. Project B because it has the higher IRR.
c. Project A because it has the higher NPV.
d. Project A because it has the higher IRR.
e. Neither, because both have IRRs less than the cost of capital.
[xx]. The capital budgeting director of Sparrow Corporation is evaluating a project that costs $200,000, is expected to last for 10 years and produce aftertax cash flows, including depreciation, of $44,503 per year. If the firm’s cost of capital is 14 percent and its tax rate is 40 percent, what is the project’s IRR?
a. 8%
b. 14%
c. 18%
d. 5%
e. 12%
[xxi]. An insurance firm agrees to pay you $3,310 at the end of 20 years if you pay premiums of $100 per year at the end of each year for 20 years. Find the internal rate of return to the nearest whole percentage point.
a. 9%
b. 7%
c. 5%
d. 3%
e. 11%
[xxii]. Oak Furnishings is considering a project that has an upfront cost and a series of positive cash flows. The project’s estimated cash flows are summarized below:
Project
Year Cash Flow
0 ?
1 $500 million
2 300 million
3 400 million
4 600 million
The project has a regular payback of 2.25 years. What is the project’s internal rate of return (IRR)?
a. 23.1%
b. 143.9%
c. 17.7%
d. 33.5%
e. 41.0%
[xxiii]. A company is analyzing two mutually exclusive projects, S and L, whose cash flows are shown below:

   
S 1,100 1,000 350 50
L 1,100 0 300 1,500
The company’s cost of capital is 12 percent, and it can obtain an unlimited amount of capital at that cost. What is the regular IRR (not MIRR) of the better project, that is, the project that the company should choose if it wants to maximize its stock price?
a. 12.00%
b. 15.53%
c. 18.62%
d. 19.08%
e. 20.46%
[xxiv]. Your company is choosing between the following nonrepeatable, equally risky, mutually exclusive projects with the cash flows shown below. Your cost of capital is 10 percent. How much value will your firm sacrifice if it selects the project with the higher IRR?

   
1,000 500 500 500

     
2,000 668.76 668.76 668.76 668.76 668.76
a. $243.43
b. $291.70
c. $332.50
d. $481.15
e. $535.13
[xxv]. Green Grocers is deciding among two mutually exclusive projects. The two projects have the following cash flows:
Project A Project B
Year Cash Flow Cash Flow
0 $50,000 $30,000
1 10,000 6,000
2 15,000 12,000
3 40,000 18,000
4 20,000 12,000
The company’s weighted average cost of capital is 10 percent (WACC = 10%). What is the net present value (NPV) of the project with the highest internal rate of return (IRR)?
a. $ 7,090
b. $ 8,360
c. $11,450
d. $12,510
e. $15,200
[xxvi]. Projects X and Y have the following expected net cash flows:
Project X Project Y
Year Cash Flow Cash Flow
0 $500,000 $500,000
1 250,000 350,000
2 250,000 350,000
3 250,000
Assume that both projects have a 10 percent cost of capital. What is the net present value (NPV) of the project that has the highest IRR?
a. $ 13,626.35
b. $ 16,959.00
c. $ 62,050.62
d. $107,438.02
e. $121,713.00
[xxvii]. Braun Industries is considering an investment project that has the following cash flows:
Year Cash Flow
0 $1,000
1 400
2 300
3 500
4 400
The company’s WACC is 10 percent. What is the project’s payback, internal rate of return (IRR), and net present value (NPV)?
a. Payback = 2.4, IRR = 10.00%, NPV = $600.
b. Payback = 2.4, IRR = 21.22%, NPV = $260.
c. Payback = 2.6, IRR = 21.22%, NPV = $300.
d. Payback = 2.6, IRR = 21.22%, NPV = $260.
e. Payback = 2.6, IRR = 24.12%, NPV = $300.
[xxviii]. Two projects being considered are mutually exclusive and have the following projected cash flows:
Project A Project B
Year Cash Flow Cash Flow
0 $50,000 $ 50,000
1 15,990 0
2 15,990 0
3 15,990 0
4 15,990 0
5 15,990 100,560
At what rate (approximately) do the NPV profiles of Projects A and B cross?
a. 6.5%
b. 11.5%
c. 16.5%
d. 20.0%
e. The NPV profiles of these two projects do not cross.
[xxix]. Hudson Hotels is considering two mutually exclusive projects, Project A and Project B. The cash flows from the projects are summarized below:
Project A Project B
Year Cash Flow Cash Flow
0 $100,000 $200,000
1 25,000 50,000
2 25,000 50,000
3 50,000 80,000
4 50,000 100,000
The two projects have the same risk. At what cost of capital would the two projects have the same net present value (NPV)?
a. 2.86%
b. 13.04%
c. 15.90%
d. 10.03%
e. 24.45%
[xxx]. Cowher Co. is considering two mutually exclusive projects, Project X and Project Y. The projects are equally risky and have the following expected cash flows:
Project X Project Y
Year Cash Flow Cash Flow
0 $3,700 million $3,200 million
1 1,400 million 900 million
2 1,070 million 1,000 million
3 1,125 million 1,135 million
4 700 million 720 million
At what cost of capital would the two projects have the same net present value (NPV)?
a. 8.07%
b. 45.80%
c. 70.39%
d. 6.90%
e. Cannot be determined.

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Solution: Question_TB10_12Dec_2nd  Answer