CHAPTER 10—THE BASICS OF CAPITAL BUDGETING: EVALUATING CASH
FLOWS
TRUE/FALSE
1. A firm should never accept a project if its acceptance would lead to an increase in the firm’s cost of
capital (its WACC).
2. Because “present value” refers to the value of cash flows that occur at different points in time, a series
of present values of cash flows should not be summed to determine the value of a capital budgeting
project.
3. Assuming that their NPVs based on the firm’s cost of capital are equal, the NPV of a project whose
cash flows accrue relatively rapidly will be more sensitive to changes in the discount rate than the
NPV of a project whose cash flows come in later in its life.
4. A basic rule in capital budgeting is that if a project’s NPV exceeds its IRR, then the project should be
accepted.
5. Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks
one project higher but the IRR method ranks the other one first. In theory, such conflicts should be
resolved in favor of the project with the higher positive NPV.
6. Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks
one project higher but the IRR method ranks the other one first. In theory, such conflicts should be
resolved in favor of the project with the higher positive IRR.
7. The internal rate of return is that discount rate that equates the present value of the cash outflows (or
costs) with the present value of the cash inflows.
8. Other things held constant, an increase in the cost of capital will result in a decrease in a project’s IRR.
9. A project’s IRR is independent of the firm’s cost of capital. In other words, a project’s IRR doesn’t
change with a change in the firm’s cost of capital.
10. Under certain conditions, a project may have more than one IRR. One such condition is when, in
addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the
project’s life.
11. The phenomenon called “multiple internal rates of return” arises when two or more mutually exclusive
projects that have different lives are compared to one another.
12. The NPV method is based on the assumption that projects’ cash flows are reinvested at the project’s
risk-adjusted cost of capital.
13. The IRR method is based on the assumption that projects’ cash flows are reinvested at the project’s
risk-adjusted cost of capital.
14. The NPV method’s assumption that cash inflows are reinvested at the cost of capital is generally more
reasonable than the IRR’s assumption that cash flows are reinvested at the IRR. This is an important
reason why the NPV method is generally preferred over the IRR method.
15. 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.
16. 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.
17. 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.
18. One advantage of the payback method for evaluating potential investments is that it provides
information about a project’s liquidity and risk.
19. When considering two mutually exclusive projects, the firm should always select the project whose
internal rate of return is the highest, provided the projects have the same initial cost. This statement is
true regardless of whether the projects can be repeated or not.
20. 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.
21. 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.
22. The NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects,
will lead to different accept/reject decisions and thus capital budgets if the cost of capital at which the
projects’ NPV profiles cross is less than the projects’ cost of capital.
23. No conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but
mutually exclusive projects, if the projects’ cost of capital exceeds the rate at which the projects’ NPV
profiles cross.
24. Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large
cash flows late in its life. Neither has negative cash flows after Year 0, and at the current cost of
capital, the two projects have identical NPVs. Now suppose interest rates and money costs decline.
Other things held constant, this change will cause L to become preferred to S.
25. The regular payback method is deficient in that it does not take account of cash flows beyond the
payback period. The discounted payback method corrects this fault.
26. In theory, capital budgeting decisions should depend solely on forecasted cash flows and the
opportunity cost of capital. The decision criterion should not be affected by managers’ tastes, choice of
accounting method, or the profitability of other independent projects.
27. If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital, the
payback method and NPV method would always lead to the same decision on which project to
undertake.
28. An increase in the firm’s WACC will decrease projects’ NPVs, which could change the accept/reject
decision for any potential project. However, such a change would have no impact on projects’ IRRs.
Therefore, the accept/reject decision under the IRR method is independent of the cost of capital.
29. 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.
30. Normal Projects S and L have the same NPV when the discount rate is zero. However, Project S’s cash
flows come in faster than those of L. Therefore, we know that at any discount rate greater than zero, L
will have the higher NPV.
31. If the IRR of normal Project X is greater than the IRR of mutually exclusive (and also normal) Project
Y, we can conclude that the firm should always select X rather than Y if X has NPV > 0.
MULTIPLE CHOICE
32. Which of the following statements is CORRECT? Assume that the project being considered has
normal cash flows, with one outflow followed by a series of inflows.
a.
The lower the WACC used to calculate a project’s NPV, the lower the calculated NPV will
be.
b.
If a project’s NPV is less than zero, then its IRR must be less than the WACC.
c.
If a project’s NPV is greater than zero, then its IRR must be less than zero.
d.
The NPV of a relatively low-risk project should be found using a relatively high WACC.
e.
A project’s NPV is found by compounding the cash inflows at the IRR to find the terminal
value (TV), then discounting the TV at the WACC.
33. Which of the following statements is CORRECT?
a.
One defect of the IRR method versus the NPV is that the IRR does not take account of the
time value of money.
b.
One defect of the IRR method versus the NPV is that the IRR does not take account of the
cost of capital.
c.
One defect of the IRR method versus the NPV is that the IRR 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 versus the NPV is that the IRR does not take proper account
of differences in the sizes of projects.
e.
One defect of the IRR method versus the NPV is that the IRR does not take account of
cash flows over a project’s full life.
34. Which of the following statements is CORRECT? Assume that the project being considered has
normal cash flows, with one outflow followed by a series of inflows.
a.
A project’s regular IRR is found by discounting the cash inflows at the WACC to find the
present value (PV), then compounding this PV to find the IRR.
b.
If a project’s IRR is greater than the WACC, then its NPV must be negative.
c.
To find a project’s IRR, we must solve for the discount rate that causes the PV of the
inflows to equal the PV of the project’s costs.
d.
To find a project’s IRR, we must find a discount rate that is equal to the WACC.
e.
A project’s regular IRR is found by compounding the cash inflows at the WACC to find
the terminal value (TV), then discounting this TV at the WACC.
35. Which of the following statements is CORRECT? Assume that the project being considered has
normal cash flows, with one outflow followed by a series of inflows.
a.
A project’s regular IRR is found by compounding the cash inflows at the WACC to find
the present value (PV), then discounting the TV to find the IRR.
b.
If a project’s IRR is smaller than the WACC, then its NPV will be positive.
c.
A project’s IRR is the discount rate that causes the PV of the inflows to equal the project’s
cost.
d.
If a project’s IRR is positive, then its NPV must also be positive.
e.
A project’s regular IRR is found by compounding the initial cost at the WACC to find the
terminal value (TV), then discounting the TV at the WACC.
36. Which of the following statements is CORRECT?
a.
If a project has “normal” cash flows, then its MIRR must be positive.
b.
If a project has “normal” cash flows, then it will have exactly two real IRRs.
c.
The definition of “normal” cash flows is that the cash flow stream has one or more
negative cash flows followed by a stream of positive cash flows and then one negative
cash flow at the end of the project’s life.
d.
If a project has “normal” cash flows, then it can have only one real IRR, whereas a project
with “nonnormal” cash flows might have more than one real IRR.
e.
If a project has “normal” cash flows, then its IRR must be positive.
37. Which of the following statements is CORRECT?
a.
Projects with “normal” cash flows can have two or more real IRRs.
b.
Projects with “normal” cash flows must have two changes in the sign of the cash flows,
e.g., from negative to positive to negative. If there are more than two sign changes, then
the cash flow stream is “nonnormal.”
c.
The “multiple IRR problem” can arise if a project’s cash flows are “normal.”
d.
Projects with “nonnormal” cash flows are almost never encountered in the real world.
e.
Projects with “normal” cash flows can have only one real IRR.
38. Which of the following statements is CORRECT?
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.
39. Which of the following statements is CORRECT?
a.
The discounted payback method recognizes all cash flows over a project’s life, and it also
adjusts these cash flows to account for the time value of money.
b.
The regular payback method was, years ago, widely used, but virtually no companies even
calculate the payback today.
c.
The regular payback is useful as an indicator of a project’s liquidity because it gives
managers an idea of how long it will take to recover the funds invested in a project.
d.
The regular payback does not consider cash flows beyond the payback year, but the
discounted payback overcomes this defect.
e.
The regular payback method recognizes all cash flows over a project’s life.
40. Which of the following statements is CORRECT? Assume that the project being considered has
normal cash flows, with one outflow followed by a series of inflows.
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.
41. Which of the following statements is CORRECT?
a.
One drawback of the regular payback is that this method does not take account of cash
flows beyond the payback period.
b.
If a project’s payback is positive, then the project should be accepted because it must have
a positive NPV.
c.
The regular payback ignores cash flows beyond the payback period, but the discounted
payback method overcomes this problem.
d.
One drawback of the discounted payback is that this method does not consider the time
value of money, while the regular payback overcomes this drawback.
e.
The shorter a project’s payback period, the less desirable the project is normally
considered to be by this criterion.
42. Assume a project has normal cash flows. All else equal, which of the following statements is
CORRECT?
a.
A project’s NPV increases as the WACC declines.
b.
A project’s MIRR is unaffected by changes in the WACC.
c.
A project’s regular payback increases as the WACC declines.
d.
A project’s discounted payback increases as the WACC declines.
e.
A project’s IRR increases as the WACC declines.
43. Which of the following statements is CORRECT?
a.
The payback method is generally regarded by academics as being the best single method
for evaluating capital budgeting projects.
b.
The discounted payback method is generally regarded by academics as being the best
single method for evaluating capital budgeting projects.
c.
The net present value method (NPV) is generally regarded by academics as being the best
single method for evaluating capital budgeting projects.
d.
The modified internal rate of return method (MIRR) is generally regarded by academics as
being the best single method for evaluating capital budgeting projects.
e.
The internal rate of return method (IRR) is generally regarded by academics as being the
best single method for evaluating capital budgeting projects.
44. Which of the following statements is CORRECT?
a.
The NPV profile graph for a normal project will generally have a positive (upward) slope
as the life of the project increases.
b.
An NPV profile graph is designed to give decision makers an idea about how a project’s
risk varies with its life.
c.
An NPV profile graph is designed to give decision makers an idea about how a project’s
contribution to the firm’s value varies with the cost of capital.
d.
We cannot draw a project’s NPV profile unless we know the appropriate WACC for use in
evaluating the project’s NPV.
e.
An NPV profile graph shows how a project’s payback varies as the cost of capital changes.
45. Which of the following statements is CORRECT? Assume that the project being considered has
normal cash flows, with one outflow followed by a series of inflows.
a.
The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.
b.
If a project’s NPV is greater than zero, then its IRR must be less than the WACC.
c.
If a project’s NPV is greater than zero, then its IRR must be less than zero.
d.
The NPVs of relatively risky projects should be found using relatively low WACCs.
e.
A project’s NPV is generally found by compounding the cash inflows at the WACC to find
the terminal value (TV), then discounting the TV at the IRR to find its PV.
46. Which of the following statements is CORRECT?
a.
If the cost of capital declines, this lowers a project’s NPV.
b.
The NPV method is regarded by most academics as being the best indicator of a project’s
profitability; hence, most academics recommend that firms use only this one method.
c.
A project’s NPV depends on the total amount of cash flows the project produces, but
because the cash flows are discounted at the WACC, it does not matter if the cash flows
occur early or late in the project’s life.
d.
The NPV and IRR methods may give different recommendations regarding which of two
mutually exclusive projects should be accepted, but they always give the same
recommendation regarding the acceptability of a normal, independent project.
e.
The NPV method was once the favorite of academics and business executives, but today
most authorities regard the MIRR as being the best indicator of a project’s profitability.
47. Which of the following statements is CORRECT? Assume that the project being considered has
normal cash flows, with one outflow followed by a series of inflows.
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 WACC.
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 WACC, 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.
48. Which of the following statements is CORRECT?
a.
If two projects are mutually exclusive, then they are likely to have multiple IRRs.
b.
If a project is independent, then it cannot have multiple IRRs.
c.
Multiple IRRs can occur only if the signs of the cash flows change more than once.
d.
If a project has two IRRs, then the smaller one is the one that is most relevant, and it
should be accepted and relied upon.
e.
For a project to have more than one IRR, then both IRRs must be greater than the WACC.
49. Which of the following statements is CORRECT?
a.
The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the
IRR method assumes reinvestment at the IRR.
b.
The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR
method assumes reinvestment at the risk-free rate.
c.
The NPV method does not consider all relevant cash flows, particularly cash flows beyond
the payback period.
d.
The IRR method does not consider all relevant cash flows, particularly cash flows beyond
the payback period.
e.
The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR
method assumes reinvestment at the IRR.
50. Projects A and B have identical expected lives and identical initial cash outflows (costs). However,
most of one project’s cash flows come in the early years, while most of the other project’s cash flows
occur in the later years. The two NPV profiles are given below:
Which of the following statements is CORRECT?
a.
More of Project B’s cash flows occur in the later years.
b.
We must have information on the cost of capital in order to determine which project has
the larger early cash flows.
c.
The NPV profile graph is inconsistent with the statement made in the problem.
d.
The crossover rate, i.e., the rate at which Projects A and B have the same NPV, is greater
than either project’s IRR.
e.
More of Project A’s cash flows occur in the later years.
51. Projects S and L are both normal projects with an initial cost of $10,000, followed by a series of
positive cash inflows. Project S’s undiscounted net cash flows total $20,000, while L’s total
undiscounted flows are $30,000. At a WACC of 10%, the two projects have identical NPVs. Which
project’s NPV is more sensitive to changes in the WACC?
a.
Project L.
b.
Both projects are equally sensitive to changes in the WACC since their NPVs are equal at
all costs of capital.
c.
Neither project is sensitive to changes in the discount rate, since both have NPV profiles
that are horizontal.
d.
The solution cannot be determined because the problem gives us no information that can
be used to determine the projects’ relative IRRs.
e.
Project S.
52. Projects C and D both have normal cash flows and are mutually exclusive. Project C has a higher NPV
if the WACC is less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%.
Which of the following statements is CORRECT?
a.
Project D is probably larger in scale than Project C.
b.
Project C probably has a faster payback.
c.
Project C probably has a higher IRR.
d.
The crossover rate between the two projects is below 12%.
e.
Project D probably has a higher IRR.
53. The WACC for two mutually exclusive projects that are being considered is 8%. Project K has an IRR
of 20% while Project R’s IRR is 15%. The projects have the same NPV at the 8% current WACC.
However, you believe that money costs and thus your WACC will also increase. You also think that
the projects will not be funded until the WACC has increased, and their cash flows will not be affected
by the change in economic conditions. Under these conditions, which of the following statements is
CORRECT?
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 WACC it will have the higher NPV.
c.
You should recommend Project K, because at the new WACC 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 WACC.
e.
You should reject both projects because they will both have negative NPVs under the new
conditions.
54. The WACC for two mutually exclusive projects that are being considered is 12%. Project K has an
IRR of 20% while Project R’s IRR is 15%. The projects have the same NPV at the 12% current
WACC. Interest rates are currently high. However, you believe that money costs and thus your WACC
will soon decline. You also think that the projects will not be funded until the WACC has decreased,
and their cash flows will not be affected by the change in economic conditions. Under these
conditions, which of the following statements is CORRECT?
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 WACC it will have the higher NPV.
c.
You should recommend Project K, because at the new WACC it will have the higher
NPV.
d.
You should recommend Project R because it will have both a higher IRR and a higher
NPV under the new conditions.
e.
You should reject both projects because they will both have negative NPVs under the new
conditions.
55. Which of the following statements is NOT a disadvantage of the regular payback method?
a.
Ignores cash flows beyond the payback period.
b.
Does not directly account for the time value of money.
c.
Does not provide any indication regarding a project’s liquidity or risk.
d.
Does not take account of differences in size among projects.
e.
Lacks an objective, market-determined benchmark for making decisions.
56. Suppose a firm relies exclusively on the payback method when making capital budgeting decisions,
and it sets a 4-year payback regardless of economic conditions. Other things held constant, which of
the following statements is most likely to be true?
a.
It will accept too many long-term projects and reject too many short-term projects (as
judged by the NPV).
b.
The firm will accept too many projects in all economic states because a 4-year payback is
too low.
c.
The firm will accept too few projects in all economic states because a 4-year payback is
too high.
d.
If the 4-year payback results in accepting just the right set of projects under average
economic conditions, then this payback will result in too few long-term projects when the
economy is weak.
e.
It will accept too many short-term projects and reject too many long-term projects (as
judged by the NPV).
57. Which of the following statements is CORRECT?
a.
If Project A’s IRR exceeds Project B’s, then A must have the higher NPV.
b.
A project’s MIRR can never exceed its IRR.
c.
If a project with normal cash flows has an IRR less than the WACC, the project must have
a positive NPV.
d.
If the NPV is negative, the IRR must also be negative.
e.
If a project with normal cash flows has an IRR greater than the WACC, the project must
also have a positive NPV.
58. Which of the following statements is CORRECT?
a.
The IRR method can never be subject to the multiple IRR problem, while the MIRR
method can be.
b.
One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on
a generally more reasonable reinvestment rate assumption.
c.
The higher the WACC, the shorter the discounted payback period.
d.
The MIRR method assumes that cash flows are reinvested at the crossover rate.
e.
The MIRR and NPV decision criteria can never conflict.
59. Which of the following statements is CORRECT?
a.
For mutually exclusive projects with normal cash flows, the NPV and MIRR methods can
never conflict, but their results could conflict with the discounted payback and the regular
IRR methods.
b.
Multiple IRRs can exist, but not multiple MIRRs. This is one reason some people favor
the MIRR over the regular IRR.
c.
If a firm uses the discounted payback method with a required payback of 4 years, then it
will accept more projects than if it used a regular payback of 4 years.
d.
The percentage difference between the MIRR and the IRR is equal to the project’s WACC.
e.
The NPV, IRR, MIRR, and discounted payback (using a payback requirement of 3 years
or less) methods always lead to the same accept/reject decisions for independent projects.
60. Which of the following statements is CORRECT?
a.
To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and
then we discount the TV at the WACC to find the PV.
b.
The NPV and IRR methods both assume that cash flows can be reinvested at the WACC.
However, the MIRR method assumes reinvestment at the MIRR itself.
c.
If two projects have the same cost, and if their NPV profiles cross in the upper right
quadrant, then the project with the higher IRR probably has more of its cash flows coming
in the later years.
d.
If two projects have the same cost, and if their NPV profiles cross in the upper right
quadrant, then the project with the lower IRR probably has more of its cash flows coming
in the later years.
e.
For a project with normal cash flows, any change in the WACC will change both the NPV
and the IRR.
61. Which of the following statements is CORRECT?
a.
One advantage of the NPV over the IRR is that NPV assumes that cash flows will be
reinvested at the WACC, 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
WACC), 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.
62. Which of the following statements is CORRECT?
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 WACC.
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.
63. Projects S and L are equally risky, mutually exclusive, and have normal cash flows. Project S has an
IRR of 15%, while Project L’s IRR is 12%. The two projects have the same NPV when the WACC is
7%. Which of the following statements is CORRECT?
a.
If the WACC is 6%, Project S will have the higher NPV.
b.
If the WACC is 13%, Project S will have the lower NPV.
c.
If the WACC is 10%, both projects will have a negative NPV.
d.
Project S’s NPV is more sensitive to changes in WACC than Project L’s.
e.
If the WACC is 10%, both projects will have positive NPVs.
64. Lancaster Corp. is considering two equally risky, mutually exclusive projects, both of which have
normal cash flows. Project A has an IRR of 11%, while Project B’s IRR is 14%. When the WACC is
8%, the projects have the same NPV. Given this information, which of the following statements is
CORRECT?
a.
If the WACC is 9%, Project A’s NPV will be higher than Project B’s.
b.
If the WACC is 6%, Project B’s NPV will be higher than Project A’s.
c.
If the WACC is greater than 14%, Project A’s IRR will exceed Project B’s.
d.
If the WACC is 9%, Project B’s NPV will be higher than Project A’s.
e.
If the WACC is 13%, Project A’s NPV will be higher than Project B’s.
65. You are considering two mutually exclusive, equally risky, projects. Both have IRRs that exceed the
WACC. Which of the following statements is CORRECT? Assume that the projects have normal cash
flows, with one outflow followed by a series of inflows.
a.
If the cost of capital is greater than the crossover rate, then the IRR and the NPV criteria
will not result in a conflict between the projects. The same project will rank higher by both
criteria.
b.
If the cost of capital is less than the crossover rate, then the IRR and the NPV criteria will
not result in a conflict between the projects. The same project will rank higher by both
criteria.
c.
For a conflict to exist between NPV and IRR, the initial investment cost of one project
must exceed the cost of the other.
d.
For a conflict to exist between NPV and IRR, one project must have an increasing stream
of cash flows over time while the other has a decreasing stream. If both sets of cash flows
are increasing or decreasing, then it would be impossible for a conflict to exist, even if one
project is larger than the other.
e.
If the two projects’ NPV profiles do not cross, then there will be a sharp conflict as to
which one should be selected.
66. Consider two projects, X and Y. Project X’s IRR is 19% and Project Y’s IRR is 17%. The projects have
the same risk and the same lives, and each has constant cash flows during each year of their lives. If
the WACC is 10%, Project Y has a higher NPV than X. Given this information, which of the following
statements is CORRECT?
a.
The crossover rate must be greater than 10%.
b.
If the WACC is 8%, Project X will have the higher NPV.
c.
If the WACC is 18%, Project Y will have the higher NPV.
d.
Project X is larger in the sense that it has the higher initial cost.
e.
The crossover rate must be less than 10%.