Chapter 11: Capital Budgeting True/False Page 391
(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
We point out to our students that some of the questions can best be analyzed by sketching out a
NPV profile graph and then thinking about the question in relation to the graph.
Note that there is some overlap between the T/F and the multiple choice questions, as
some T/F statements are used in the MC questions. See the preface for information on the
AACSB letter indicators (F, M, etc.) on the subject lines.
Multiple Choice: 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).
a. True
b. False
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.
a. True
b. False
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.
a. True
b. False
4. A basic rule in capital budgeting is that if a project’s NPV exceeds
its IRR, then the project should be accepted.
a. True
b. False
5. Conflicts between two mutually exclusive projects occasionally occur,
where the NPV method ranks one project higher but the IRR method puts
the other one first. In theory, such conflicts should be resolved in
favor of the project with the higher NPV.
CHAPTER 11
THE BASICS OF CAPITAL BUDGETING
Page 392 True/False Chapter 11: Capital Budgeting
a. True
b. False
6. Conflicts between two mutually exclusive projects occasionally occur,
where the NPV method ranks one project higher but the IRR method puts
the other one first. In theory, such conflicts should be resolved in
favor of the project with the higher IRR.
a. True
b. False
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.
a. True
b. False
8. Other things held constant, an increase in the cost of capital will
result in a decrease in a project’s IRR.
a. True
b. False
9. 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.
a. True
b. False
10. The phenomenon called “multiple internal rates of return” arises when
two or more mutually exclusive projects that have different lives are
being compared.
a. True
b. False
11. The NPV method is based on the assumption that projects’ cash flows are
reinvested at the project’s risk-adjusted cost of capital.
a. True
b. False
12. The IRR method is based on the assumption that projects’ cash flows are
reinvested at the project’s risk-adjusted cost of capital.
Chapter 11: Capital Budgeting True/False Page 393
a. True
b. False
13. 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.
a. True
b. False
14. 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.
a. True
b. False
15. 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.
a. True
b. False
16. 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.
a. True
b. False
17. One advantage of the payback method for evaluating potential
investments is that it provides information about a project’s liquidity
and risk.
a. True
b. False
18. 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.
a. True
Page 394 True/False Chapter 11: Capital Budgeting
b. False
19. 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.
a. True
b. False
20. 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
costs of capital.
a. True
b. False
21. 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 greater than the crossover rate.
a. True
b. False
22. A 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 is less than the rate at which the projects’
NPV profiles cross.
a. True
b. False
23. 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.
a. True
b. False
24. 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.
a. True
Chapter 11: Capital Budgeting True/False Page 395
b. False
25. 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.
a. True
b. False
26. 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.
a. True
b. False
27. Small businesses make less use of DCF capital budgeting techniques than
large businesses. This may reflect a lack of knowledge on the part of
small firms’ managers, but it may also reflect a rational conclusion
that the costs of using DCF analysis outweigh the benefits of these
methods for very small firms.
a. True
b. False
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.
a. True
b. False
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.
a. True
b. False
Page 396 M/C Problems Chapter 11: Capital Budgeting
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.
a. True
b. False
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.
a. True
b. False
Multiple Choice: Conceptual
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. 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.
b. The lower the WACC used to calculate it, the lower the calculated
NPV will be.
c. If a project’s NPV is less than zero, then its IRR must be less than
the WACC.
d. If a project’s NPV is greater than zero, then its IRR must be less
than zero.
e. The NPV of a relatively low-risk project should be found using a
relatively high WACC.
33. Which of the following statements is CORRECT?
a. One defect of the IRR method is that it does not take account of
cash flows over a project’s full life.
b. One defect of the IRR method is that it does not take account of the
time value of money.
c. One defect of the IRR method is that it does not take account of the
cost of capital.
d. 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.
e. 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.
Chapter 11: Capital Budgeting M/C Problems Page 397
34. 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 cash flows over a project’s full life.
b. One defect of the IRR method versus the NPV is that the IRR does not
take account of the time value of money.
c. One defect of the IRR method versus the NPV is that the IRR does not
take account of the cost of capital.
d. 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.
e. 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.
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 terminal value (TV), then discounting this TV
at the WACC.
b. 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.
c. If a project’s IRR is greater than the WACC, then its NPV must be
negative.
d. 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.
e. To find a project’s IRR, we must find a discount rate that is equal
to the WACC.
36. 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 initial cost at
the WACC to find the terminal value (TV), then discounting the TV at
the WACC.
b. 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.
c. If a project’s IRR is smaller than the WACC, then its NPV will be
positive.
d. A project’s IRR is the discount rate that causes the PV of the
inflows to equal the project’s cost.
e. If a project’s IRR is positive, then its NPV must also be positive.
37. Which of the following statements is CORRECT?
a. If a project has “normal” cash flows, then its IRR must be positive.
Page 398 M/C Problems Chapter 11: Capital Budgeting
b. If a project has “normal” cash flows, then its MIRR must be
positive.
c. If a project has “normal” cash flows, then it will have exactly two
real IRRs.
d. 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.
e. 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.
Chapter 11: Capital Budgeting M/C Problems Page 399
38. Which of the following statements is CORRECT?
a. Projects with “normal” cash flows can have only one real IRR.
b. Projects with “normal” cash flows can have two or more real IRRs.
c. 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.”
d. The “multiple IRR problem” can arise if a project’s cash flows are
“normal.”
e. Projects with “nonnormal” cash flows are almost never encountered in
the real world.
39. Which of the following statements is CORRECT?
a. The regular payback method recognizes all cash flows over a
project’s life.
b. 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.
c. The regular payback method was, years ago, widely used, but
virtually no companies even calculate the payback today.
d. 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.
e. The regular payback does not consider cash flows beyond the payback
year, but the discounted payback overcomes this defect.
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. The longer a project’s payback period, the more desirable the
project is normally considered to be by this criterion.
b. One drawback of the payback criterion for evaluating projects is
that this method does not properly account for the time value of
money.
c. If a project’s payback is positive, then the project should be
rejected because it must have a negative NPV.
d. The regular payback ignores cash flows beyond the payback period,
but the discounted payback method overcomes this problem.
e. 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.
Page 400 M/C Problems Chapter 11: Capital Budgeting
41. Which of the following statements is CORRECT?
a. The shorter a project’s payback period, the less desirable the
project is normally considered to be by this criterion.
b. One drawback of the payback criterion is that this method does not
take account of cash flows beyond the payback period.
c. If a project’s payback is positive, then the project should be
accepted because it must have a positive NPV.
d. The regular payback ignores cash flows beyond the payback period,
but the discounted payback method overcomes this problem.
e. 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.
42. Assume a project has normal cash flows. All else equal, which of the
following statements is CORRECT?
a. A project’s IRR increases as the WACC declines.
b. A project’s NPV increases as the WACC declines.
c. A project’s MIRR is unaffected by changes in the WACC.
d. A project’s regular payback increases as the WACC declines.
e. A project’s discounted payback increases as the WACC declines.
43. Which of the following statements is CORRECT?
a. The internal rate of return method (IRR) is generally regarded by
academics as being the best single method for evaluating capital
budgeting projects.
b. The payback method is generally regarded by academics as being the
best single method for evaluating capital budgeting projects.
c. The discounted payback method is generally regarded by academics as
being the best single method for evaluating capital budgeting
projects.
d. The net present value method (NPV) is generally regarded by
academics as being the best single method for evaluating capital
budgeting projects.
e. The modified internal rate of return method (MIRR) 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. An NPV profile graph shows how a project’s payback varies as the
cost of capital changes.
b. The NPV profile graph for a normal project will generally have a
positive (upward) slope as the life of the project increases.
c. An NPV profile graph is designed to give decision makers an idea
about how a project’s risk varies with its life.
d. 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.
Chapter 11: Capital Budgeting M/C Problems Page 401
e. We cannot draw a project’s NPV profile unless we know the
appropriate WACC for use in evaluating the project’s NPV.
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. 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.
b. The higher the WACC used to calculate the NPV, the lower the
calculated NPV will be.
c. If a project’s NPV is greater than zero, then its IRR must be less
than the WACC.
d. If a project’s NPV is greater than zero, then its IRR must be less
than zero.
e. The NPVs of relatively risky projects should be found using
relatively low WACCs.
46. Which of the following statements is CORRECT?
a. For a project to have more than one IRR, then both IRRs must be
greater than the WACC.
b. If two projects are mutually exclusive, then they are likely to have
multiple IRRs.
c. If a project is independent, then it cannot have multiple IRRs.
d. Multiple IRRs can only occur if the signs of the cash flows change
more than once.
e. 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.
47. Which of the following statements is CORRECT?
a. The NPV method assumes that cash flows will be reinvested at the
WACC, while the IRR method assumes reinvestment at the IRR.
b. The NPV method assumes that cash flows will be reinvested at the
risk-free rate, while the IRR method assumes reinvestment at the
IRR.
c. The NPV method assumes that cash flows will be reinvested at the
WACC, while the IRR method assumes reinvestment at the risk-free
rate.
d. The NPV method does not consider all relevant cash flows,
particularly cash flows beyond the payback period.
e. The IRR method does not consider all relevant cash flows,
particularly cash flows beyond the payback period.
Page 402 M/C Problems Chapter 11: Capital Budgeting
48. 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
have the lower NPV.
b. If Project A has a higher IRR than Project B, then Project A must
also have a higher NPV.
c. The IRR calculation implicitly assumes that all cash flows are
reinvested at the WACC.
d. The IRR calculation implicitly assumes that cash flows are withdrawn
from the business rather than being reinvested in the business.
e. If a project has normal cash flows and its IRR exceeds its WACC,
then the project’s NPV must be positive.
49. Assume that the economy is in a mild recession, and as a result
interest rates and money costs generally are relatively low. The WACC
for two mutually exclusive projects that are being considered is 8%.
Project S has an IRR of 20% while Project L’s IRR is 15%. The projects
have the same NPV at the 8% current WACC. However, you believe that
the economy is about to recover, and 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 reject both projects because they will both have negative
NPVs under the new conditions.
b. 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.
c. You should recommend Project L, because at the new WACC it will have
the higher NPV.
d. You should recommend Project S, because at the new WACC it will have
the higher NPV.
e. You should recommend Project L because it will have the higher IRR
at the new WACC.
Chapter 11: Capital Budgeting M/C Problems Page 403
50. Assume that the economy is enjoying a strong boom, and as a result
interest rates and money costs generally are relatively high. The WACC
for two mutually exclusive projects that are being considered is 12%.
Project S has an IRR of 20% while Project L’s IRR is 15%. The projects
have the same NPV at the 12% current WACC. However, you believe that
the economy will soon fall into a mild recession, and 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 reject both projects because they will both have negative
NPVs under the new conditions.
b. 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.
c. You should recommend Project L, because at the new WACC it will have
the higher NPV.
d. You should recommend Project S, because at the new WACC it will have
the higher NPV.
e. You should recommend Project L because it will have both a higher
IRR and a higher NPV under the new conditions.
51. Which of the following statements is CORRECT?
a. 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.
b. If the cost of capital declines, this lowers a project’s NPV.
c. 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 and disregard other
methods.
d. 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.
e. 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.
Page 404 M/C Problems Chapter 11: Capital Budgeting
52. 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 A’s cash flows occur in the later years.
b. More of Project B’s cash flows occur in the later years.
c. We must have information on the cost of capital in order to
determine which project has the larger early cash flows.
d. The NPV profile graph is inconsistent with the statement made in the
problem.
e. The crossover rate, i.e., the rate at which Projects A and B have
the same NPV, is greater than either project’s IRR.
53. Projects S and L both have 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 S.
b. Project L.
c. Both projects are equally sensitive to changes in the WACC since
their NPVs are equal at all costs of capital.
d. Neither project is sensitive to changes in the discount rate, since
both have NPV profiles that are horizontal.
e. The solution cannot be determined because the problem gives us no
information that can be used to determine the projects’ relative IRRs.
54. Projects C and D are mutually exclusive and have normal cash flows.
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 probably has a higher IRR.
b. Project D is probably larger in scale than Project C.
Chapter 11: Capital Budgeting M/C Problems Page 405
c. Project C probably has a faster payback.
d. Project C probably has a higher IRR.
e. The crossover rate between the two projects is below 12%.
55. 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 short-term projects and reject too many
long-term projects (as judged by the NPV).
b. It will accept too many long-term projects and reject too many
short-term projects (as judged by the NPV).
c. The firm will accept too many projects in all economic states
because a 4–year payback is too low.
d. The firm will accept too few projects in all economic states because
a 4-year payback is too high.
e. 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.
56. Four of the following statements are truly disadvantages of the regular
payback method, but one is not a disadvantage of this method. Which
one is NOT a disadvantage of the payback method?
a. Lacks an objective, market-determined benchmark for making
decisions.
b. Ignores cash flows beyond the payback period.
c. Does not directly account for the time value of money.
d. Does not provide any indication regarding a project’s liquidity or
risk.
e. Does not take account of differences in size among projects.
57. Which of the following statements is CORRECT?
a. If a project with normal cash flows has an IRR greater than the
WACC, the project must also have a positive NPV.
b. If Project A’s IRR exceeds Project B’s, then A must have the higher
NPV.
c. A project’s MIRR can never exceed its IRR.
d. If a project with normal cash flows has an IRR less than the WACC,
the project must have a positive NPV.
e. If the NPV is negative, the IRR must also be negative.
58. Which of the following statements is CORRECT?
a. The MIRR and NPV decision criteria can never conflict.
b. The IRR method can never be subject to the multiple IRR problem,
while the MIRR method can be.
Page 406 M/C Problems Chapter 11: Capital Budgeting
c. 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.
d. The higher the WACC, the shorter the discounted payback period.
e. The MIRR method assumes that cash flows are reinvested at the
crossover rate.
Chapter 11: Capital Budgeting M/C Problems Page 407
59. Which of the following statements is CORRECT?
a. 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.
b. 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.
c. Multiple IRRs can exist, but not multiple MIRRs. This is one reason
some people favor the MIRR over the regular IRR.
d. 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.
e. The percentage difference between the MIRR and the IRR is equal to
the project’s WACC.
60. Which of the following statements is CORRECT?
a. For a project with normal cash flows, any change in the WACC will
change both the NPV and the IRR.
b. 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.
c. 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.
d. 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.
e. 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.
61. Which of the following statements is CORRECT?
a. 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.
b. 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.
c. 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.
d. One advantage of the NPV over the MIRR method is that NPV discounts
cash flows whereas the MIRR is based on undiscounted cash flows.
e. 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.
Page 408 M/C Problems Chapter 11: Capital Budgeting
62. Which of the following statements is CORRECT?
a. 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.
b. The discounted payback method eliminates all of the problems
associated with the payback method.
c. When evaluating independent projects, the NPV and IRR methods often
yield conflicting results regarding a project’s acceptability.
d. To find the MIRR, we discount the TV at the IRR.
e. A project’s NPV profile must intersect the X–axis at the project’s
WACC.
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 10%, both projects will have positive NPVs.
b. If the WACC is 6%, Project S will have the higher NPV.
c. If the WACC is 13%, Project S will have the lower NPV.
d. If the WACC is 10%, both projects will have a negative NPV.
e. Project S’s NPV is more sensitive to changes in WACC than Project
L’s.
64. Westchester 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 13%, Project A’s NPV will be higher than Project B’s.
b. If the WACC is 9%, Project A’s NPV will be higher than Project B’s.
c. If the WACC is 6%, Project B’s NPV will be higher than Project A’s.
d. If the WACC is greater than 14%, Project A’s IRR will exceed Project
B’s.
e. If the WACC is 9%, Project B’s NPV will be higher than Project A’s.
Chapter 11: Capital Budgeting M/C Problems Page 409
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 two projects’ NPV profiles do not cross, then there will be a
sharp conflict as to which one should be selected.
b. 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. One project will rank higher by both criteria.
c. 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. One project will rank higher by both criteria.
d. For a conflict to exist between NPV and IRR, the initial investment
cost of one project must exceed the cost of the other.
e. 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.
66. 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 less than 10%.
b. The crossover rate must be greater than 10%.
c. If the WACC is 8%, Project X will have the higher NPV.
d. If the WACC is 18%, Project Y will have the higher NPV.
e. Project X is larger in the sense that it has the higher initial
cost.
Page 410 M/C Problems Chapter 11: Capital Budgeting
67. You are on the staff of Camden Inc. The CFO believes project
acceptance should be based on the NPV, but Steve Camden, the president,
insists that no project should be accepted unless its IRR exceeds the
project’s risk–adjusted WACC. Now you must make a recommendation on a
project that has a cost of $15,000 and two cash flows: $110,000 at the
end of Year 1 and -$100,000 at the end of Year 2. The president and
the CFO both agree that the appropriate WACC for this project is 10%.
At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and
one at 527%, and a MIRR of 11.32%. Which of the following statements
best describes your optimal recommendation, i.e., the analysis and
recommendation that is best for the company and least likely to get you
in trouble with either the CFO or the president?
a. You should recommend that the project be rejected because its NPV is
negative and its IRR is less than the WACC.
b. You should recommend that the project be rejected because, although
its NPV is positive, it has an IRR that is less than the WACC.
c. 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 WACC. You
should explain this to the president and tell him that that the
firm’s value will increase if the project is accepted.
d. You should recommend that the project be rejected because (1) its
NPV is positive and (2) it has two IRRs, one of which is less than
the WACC, which indicates that the firm’s value will decline if the
project is accepted.
e. You should recommend that the project be rejected because, although
its NPV is positive, its MIRR is less than the WACC, and that
indicates that the firm’s value will decline if it is accepted.
68. Which of the following statements is CORRECT? Assume that the project
being considered has normal cash flows, with one cash outflow at t = 0
followed by a series of positive cash flows.
a. A project’s MIRR is always greater than its regular IRR.
b. A project’s MIRR is always less than its regular IRR.
c. If a project’s IRR is greater than its WACC, then its MIRR will be
greater than the IRR.
d. To find a project’s MIRR, we compound cash inflows at the regular
IRR and then find the discount rate that causes the PV of the
terminal value to equal the initial cost.
e. To find a project’s MIRR, the textbook procedure compounds cash
inflows at the WACC and then finds the discount rate that causes the
PV of the terminal value to equal the initial cost.
69. Projects S and L both have normal cash flows, and the projects have the
same risk, hence both are evaluated with the same WACC, 10%. However,
S has a higher IRR than L. Which of the following statements is
CORRECT?
a. Project S must have a higher NPV than Project L.