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Chapter 9 – Capital Budgeting Techniques
58. A college intern working at Anderson Paints evaluated potential investments that is, capital budgeting
projects using the firm’s average required rate of return (WACC), and he produced the following report for the
capital budgeting manager:
Project
NPV
IRR
Risk
LOM
$1,500
12.5%
High
QUE
0
11.0
Low
YUP
800
9.5
Average
DOG
(450)
10.0
Low
The capital budgeting manager usually considers the risks associated with capital budgeting projects before making
her final decision. If a project has a risk that is different from average, she adjusts the average required rate of
return by adding or subtracting 2 percentage points. If the four projected listed above are independent, which one(s)
should the capital budgeting manager recommend be purchased?
a. Project LOM only, because it has both the highest NPV and the higher IRR.
b. Projects LOM, QUE, and YUP, because they all have positive NPVs and their IRRs.
c. Projects DOG and QUE, because their IRRs are greater than their risk-adjusted discount he projects returns
are higher than the rates of return that capital budgeting manager uses to evaluate them.
d. Projects QUE, YUP, and DOG, because their IRRs are greater than their risk-adjusted discount rates that
is, the projects returns are higher than the rates of return that capital budgeting manager uses to evaluate
them.
e. There is not enough information to answer this question, because the firm’s average required rate of return
cannot be determined.
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Chapter 9 – Capital Budgeting Techniques
59. The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30,000
per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10. This investment will
cost the firm $150,000 today, and the firm’s required rate of return 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
60. You have recently accepted a one–year employment term by a firm. The firm has given you the option of receiving
your salary as a lump sum value of $30,000 at the end of the year or as 12 monthly payments of $2,400 starting one
month after you start work. If your relevant discount rate is 2 percent per month, then which salary options would
you prefer? (Ignore taxes, risk, and consumption needs.) Choose the best answer.
a. The lump sum payment, since it has the larger future value.
b. Monthly payments, since you do not have to wait so long to receive your money.
c. Either one, since they have the same present value.
d. The lump sum payment, since it has the larger present value.
e. Monthly payments, since it has the larger present value.
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Chapter 9 – Capital Budgeting Techniques
61. Two projects being considered are mutually exclusive and have the following cash flows:
Year
Project B
0
−$50,000
1
0
2
0
3
0
4
0
5
99,500
If the required rate of return on these projects is 10 percent, which would be chosen and why?
a. Project B because of higher NPV.
b. Project B because of higher IRR.
c. Project A because of higher NPV.
d. Project A because of higher IRR.
e. Neither, because both have IRRs less than the cost of capital.
62. The capital budgeting director of Sparrow Corporation is evaluating a project which costs $200,000, is expected to
last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year. If the firm’s required
rate of return 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%
63. 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 of the 20 years. Find the internal rate of return to the nearest whole percentage point.
a. 9%
b. 7%
c. 5%
d. 3%
e. 11%
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Chapter 9 – Capital Budgeting Techniques
64. Michigan Mattress Company is considering the purchase of land and the construction of a new plant. The land, which
be bought immediately (at t = 0), has a cost of $100,000 and the building, which would be erected at the end of the fir
= 1), would cost $500,000. It is estimated that the firm’s after-tax cash flow will be increased by $100,000 starting at
of the second year, and that this incremental flow would increase at a 10 percent rate annually over the next 10 year
the approximate payback period?
a. 2 years
b. 4 years
c. 6 years
d. 8 years
e. 10 years
65. The Seattle Corporation has been presented with an investment opportunity which will yield end of year 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 required rate of return is 10 percent. What is the NPV
for this investment?
a. $135,984
b. $18,023
c. $219,045
d. $51,138
e. $92,146
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Chapter 9 – Capital Budgeting Techniques
66. You are considering the purchase of an investment that would pay you $5,000 per year for Years 1-5, $3,000 per
year for Years 6-8, and $2,000 per year for Years 9 and 10. If you require a 14 percent rate of return, and the cash
flows occur at the end of each year, then how much should you be willing to pay for this investment?
a. $15,819.27
b. $21,937.26
c. $32,415.85
d. $38,000.00
e. $52,815.71
67. Two projects being considered by a firm are mutually exclusive and have the following projected cash flows:
Year
Project B
0
($100,000)
1
0
2
0
3
133,000
Based only on the information given, which of the two projects would be preferred, and why?
a. Project A, because it has a shorter payback period.
b. Project B, because it has a higher IRR.
c. Indifferent, because the projects have equal IRRs.
d. Include both in the capital budget, since the sum of the cash inflows exceeds the initial investment in both
cases.
e. Choose neither, since their NPVs are negative.
68. Two fellow financial analysts are evaluating a project with the following net cash flows:
Year Cash Flow
0 $−10,000
1 100,000
2 −100,000
One analyst says that the project has an IRR of between 12 and 13%. The other analyst calculates an IRR of just
under 800%, but fears his calculator’s battery is low and may have caused an error. You agree to settle the dispute
by analyzing the project cash flows. Which statement best describes the IRR for this project?
a. There is a single IRR of approximately 12.7 percent.
b. This project has no IRR, because the NPV profile does not cross the X axis.
c. There are multiple IRRs of approximately 12.7 percent and 787 percent.
d. This project has two imaginary IRRs.
e. There are an infinite number of IRRs between 12.5 percent and 790 percent that can define the IRR for this
project.
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Chapter 9 – Capital Budgeting Techniques
69. Two projects being considered are mutually exclusive and have the following projected cash flows:
Year
Project B
0
−$ 50,000
1
0
2
0
3
0
4
0
5
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%
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Chapter 9 – Capital Budgeting Techniques
d. 20.0%
e. The NPV profiles of these two projects do not cross.
70. In comparing two mutually exclusive projects of equal size and equal life, which of the following statements is most
correct?
a. The project with the higher NPV may not always be the project with the higher IRR.
b. The project with the higher NPV may not always be the project with the higher MIRR.
c. The project with the higher IRR may not always be the project with the higher MIRR.
d. All of the above answers are correct.
e. Answers a and c are both correct.
71. Which of the following statements is correct?
a. One can find the “cross-over rate,“ or the discount rate at which two normal projects have the same NPV, by
finding the IRR of the differences in the projects‘ yearly cash flows.
b. If you calculate a project’s MIRR and find it to be the same as the regular IRR, you can be sure you made a
mistake.
c. If a project’s IRR is less than its required rate of return, then the discounted payback period will be less than
the regular payback period.
d. If a project has a cash outflow at t = 0 followed by a single cash inflow at t = 10, then the MIRR will be less
than the regular IRR.
e. If a project has a cash outflow at t = 0 followed by a single cash inflow at t = 10, then the MIRR will be
greater than the regular IRR.
72. Which of the following 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 rates of return.
c. Compounds cash flows at the required rate of return.
d. Overcomes the problem of cash flow timing and the problem of project size that leads to criticism of the
regular IRR method.
e. Answers b and c are both correct.
73. The modified IRR (MIRR) is normally
a. Less than the regular IRR if IRR > r.
b. Greater than the regular IRR if IRR > r.
c. Equal to the regular IRR if IRR = r.
d. Answers a and c are both correct.
e. Answers b and c are both correct.
74. Which of the following statements is 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, b and c are all false.
75. 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, i.e., 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 required rate of return to find the PV.
c. The NPV and IRR methods both assume that cash flows are reinvested at the required rate of return.
However, the MIRR method assumes reinvestment at the MIRR itself.
d. If you are choosing between two projects which 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 required rate of return would normally change both a project’s NPV and its IRR.
76. Which of the following statements is correct?
a. The modified internal rate of return (MIRR) of a project increases as the discount rate increases.
b. The internal rate of return (IRR) of a project increases as the required rate of return increases.
c. Both IRR and MIRR can produce the multiple rates of return.
d. When comparing two projects, the project with the higher IRR will also have the higher MIRR.
e. Both a and c are correct.
77. Alyeska Salmon Inc., a large salmon canning firm operating out of Valdez, Alaska, has a new automated production
line project it is considering. The project has a cost of $275,000 and is expected to provide after-tax annual cash
flows of $73,306 for eight years. The firm’s management is uncomfortable with the IRR reinvestment assumption
and prefers the modified IRR approach. You have calculated a required rate of return for the firm of 12 percent.
What is the project’s MIRR?
a. 15.0%
b. 14.0%
c. 12.0%
d. 16.0%
e. 17.0%
78. Below are the returns of Nulook Cosmetics and the “market” over a three-year period:
Year
Nulook
Market
1
8%
6%
2
9%
9%
3 32% 22%
Nulook finances internally using only retained earnings, and it uses the Capital Asset Pricing Model with a historical
beta to determine its required rate of return. Currently, the risk-free rate is 7 percent, and the estimated market risk
premium is 6 percent. Nulook is evaluating a project which has a cost today of $2,028 and will provide estimated
cash inflows of $1,000 at the end of the next 3 years. What is this project‘s MIRR?
a. 12.4%
b. 16.0%
c. 17.5%
d. 20.0%
e. 22.9%
79. Project A has a cost of $1,000, and it will produce end–of–year net cash inflows of $500 per year for 3 years. The
project’s required rate of return is 10 percent. What is the difference between the project’s IRR and its MIRR?
a. 3.88%
b. 4.31%
c. 5.09%
d. 5.75%
e. 6.21%
80. Project X has a cost of $30,000 at t = 0, and it is expected to produce a uniform cash flow stream for 7 years, i.e.,
the CF’s are the same in Years 1 through 7, and it has a regular IRR of 14 percent. The required rate of return for
the project is 12 percent. What is the project’s modified IRR (MIRR)?
a. 11.87%
b. 12.42%