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CFIN4
Chapter 9 – Capital Budgeting Techniques
1. Beyond some point, a further increase in the size of the firm's total capital budget may lead to a decrease in the
NPVs of all the investments being considered.
a. True
b. False
2. The primary function of the capital budget is to forecast the funds required for future investments that must be raised
through external funding, that is, by selling stock or bonds.
a. True
b. False
3. One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a
rough measure of a project's liquidity and risk.
a. True
b. False
4. The modified IRR (MIRR) method has wide appeal to professors, but most business executives prefer the NPV
method to either the regular or modified IRR.
a. True
b. False
5. The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs) with
the present value of the cash inflows.
a. True
b. False
6. Under certain conditions, a particular project may have more than one IRR. One condition under which this situation
can occur is if, in addition to the initial investment at time = 0, a negative cash flow occurs at the end of the project's
life.
a. True
b. False
7. Other things held constant, an increase in the required rate of return will result in a decrease of a project's IRR.
a. True
b. False
8. The IRR of a project whose cash flows accrue relatively rapidly is more sensitive to changes in the discount rate
than is the IRR of a project whose cash flows come in more slowly.
a. True
b. False
CFIN4
Chapter 9 – Capital Budgeting Techniques
9. If a project's NPV exceeds the project's IRR, then the project should be accepted.
a. True
b. False
10. Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method
chooses the other, should generally be resolved in favor of the project with the higher NPV.
a. True
b. False
11. Although the payback method ignores the time value of money, relying solely on this capital budgeting method will
always lead to value maximizing decision.
a. True
b. False
12. Using the discounted payback method, a project should be accepted when the discounted payback is greater than the
projects expected life.
a. True
b. False
CFIN4
Chapter 9 – Capital Budgeting Techniques
13. A capital budgeting project is acceptable if the rate of return required for such a project is greater than the project's
internal rate of return.
a. True
b. False
14. The post-audit two main purposes are to improve forecasts and to improve operations.
a. True
b. False
15. Any capital budgeting investment rule should depend solely on forecasted cash flows and the opportunity rate of
return. The rule itself should not be affected by managers' tastes, the choice of accounting method, or the
profitability of other independent projects.
a. True
b. False
16. 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. At the current required rate of return, normal Projects S and L have identical NPVs. Now suppose interest
rates and money costs generally decline. Other things held constant, this change will cause L to become preferred to
S.
a. True
b. False
CFIN4
Chapter 9 – Capital Budgeting Techniques
17. When considering two mutually exclusive projects, the financial manager should always select that project whose
internal rate of return is the highest provided the projects have the same initial cost.
a. True
b. False
18. If the IRR of normal Project X is greater than the IRR of mutually exclusive Project Y (also normal), we can
conclude that the firm will select X rather than Y if X has a NPV > 0.
a. True
b. False
19. The main reason that the NPV method is regarded as being conceptually superior to IRR method for evaluating
mutually exclusive investments is that multiple IRRs may exist.
a. True
b. False
20. 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 required rate of return. 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
CFIN4
Chapter 9 – Capital Budgeting Techniques
21. In capital budgeting analyses, it is possible that NPV and IRR will both involve assuming reinvestment of the
project's cash flows at the same rate.
a. True
b. False
22. Small businesses probably make less use of the 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 those firms.
a. True
b. False
23. Effective capital budgeting can improve the timing of asset acquisition and the quality of assets purchased, thereby
providing an opportunity to purchase and install assets before they are needed.
a. True
b. False
24. An increase in the discount rate used in computing the NPV of a project will lower the value of the NPV for that
project.
a. True
b. False
CFIN4
Chapter 9 – Capital Budgeting Techniques
25. NPV and IRR will always lead to the same accept/reject decision for mutually exclusive projects.
a. True
b. False
26. The NPV method implicitly assumes that the rate at which cash flows can be reinvested is the required rate of
return, whereas the IRR method implies that the firm has the opportunity to reinvest at the project's IRR.
a. True
b. False
27. There exists an IRR solution for each time the direction of cash flows associated with project is interrupted.
a. True
b. False
28. The post-audit is a simple process in which actual results are compared to forecasted results and any discrepancy
indicates changes in factors that are completely under management's control.
a. True
b. False
CFIN4
Chapter 9 – Capital Budgeting Techniques
29. Which of the following capital budgeting methods might not consider the salvage value of a machine being
considered for purchase?
a. Internal rate of return.
b. Net present value.
c. Payback.
d. Discounted payback.
e. Answers c and d are both correct.
30. Assume a project has normal cash flows (i.e., initial cash flow is negative, and all other cash flows are positive).
Which of the following statements is most correct?
a. All else equal, a project's IRR increases as the required rate of return declines.
b. All else equal, a project's NPV increases as the required rate of return declines.
c. All else equal, a project's IRR is unaffected by changes in the required rate of return.
d. Answers a and b are both correct.
e. Answers b and c are both correct.
31. A major disadvantage of the payback period method is it
a. Is useless as a risk indicator.
b. Ignores cash flows beyond the payback period.
c. Does not directly account for the time value of money.
d. All of the above are correct.
e. Only answers b and c are correct.
CFIN4
Chapter 9 – Capital Budgeting Techniques
32. If the calculated NPV is negative, then which of the following must be true? The discount rate used is
a. Equal to the internal rate of return.
b. Too high.
c. Greater than the internal rate of return.
d. Too low.
e. Less than the internal rate of return.
33. Projects A and B have the same expected lives and initial cash outflows. However, one project's cash flows are
larger in the early years, while the other project has larger cash flows in the later years. The two NPV profiles are
given below:
Which of the following statements is correct?
a. Project A has the smaller cash flows in the later years.
b. Project A has the larger cash flows in the later years.
c. We require information on the required rate of return in order to determine which project has larger early cash
flows.
d. The NPV profile graph is inconsistent with the statement made in the problem.
e. None of the above statements is correct.
CFIN4
Chapter 9 – Capital Budgeting Techniques
34. Which of the following statements is correct?
a. The NPV method assumes that cash flows will be reinvested at the required rate of return 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 required rate of return while the IRR
method assumes reinvestment at the risk-free rate.
d. The NPV method does not consider the inflation premium.
e. The IRR method does not consider all relevant cash flows, and particularly cash flows beyond the payback
period.
35. Which of the following is not a rationale for using the NPV method in capital budgeting?
a. An NPV of zero signifies that the project's cash flows are just sufficient to repay the invested capital and to
provide the required rate of return on that capital.
b. A project whose NPV is positive will increase the value of the firm if that project is accepted.
c. A project is considered acceptable if it has a positive NPV.
d. A project is not considered acceptable if it has a negative NPV.
e. All of the above are true.
36. The involves comparing the actual results with those predicted by the project's sponsors and explaining why
any differences occur.
a. discounted payback
b. internal rate of return
c. post-audit
d. net present value
e. economic value added
CFIN4
Chapter 9 – Capital Budgeting Techniques
37. The present value of the expected net cash inflows for a project will most likely exceed the present value of the
expected net profit after tax for the same project because
a. Income is reduced by taxes paid, but cash flow is not.
b. There is a greater probability of realizing the projected cash flow than the forecasted income.
c. Income is reduced by dividends paid, but cash flow is not.
d. Income is reduced by depreciation charges, but cash flow is not.
e. Cash flow reflects any change in net working capital, but sales do not.
38. Which of the following statements is correct?
a. Because discounted payback takes account of the required rate of return, 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 required rate of return 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 which 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 required rate of return is relatively high, this will favor larger, longer-term projects over smaller, shorter-
term alternatives because it is good to earn high rates on larger amounts over longer periods.
CFIN4
Chapter 9 – Capital Budgeting Techniques
39. Which of the following statements is correct?
a. The discounted payback is generally shorter than the regular payback.
b. Any type of project might have multiple rates of return if the IRR is sufficiently high.
c. The NPV and IRR methods can lead to conflicting and accept/reject decisions only if (1) mutually exclusive
projects are being evaluated and (2) if the projects' NPV profiles cross at a rate less than the firm's cost of
capital.
d. The NPV and IRR methods can lead to conflicting accept/reject decisions only if (1) mutually exclusive
projects are being evaluated and (2) if the projects' NPV profiles cross at a rate greater than the firm's cost of
capital.
e. None of the above is a correct statement.
40. Which of the following statements is false?
a. The NPV will be positive if the IRR is less than the required rate of return.
b. If the multiple IRR problem does not exist, any independent project acceptable by the NPV method will also
be acceptable by the IRR method.
c. When IRR = r (the required rate of return), NPV = 0.
d. The IRR can be positive even if the NPV is negative.
e. The NPV method is not affected by the multiple IRR problem.
41. Assume that you are comparing two mutually exclusive projects. Which of the following statements is most correct?
a. The NPV and IRR rules will always lead to the same decision unless one or both of the projects are "non-
conventional" in the sense of having only one change of sign in the cash flow stream, i.e., one or more initial
cash outflows (the investment) followed by a series of cash inflows.
b. If a conflict exists between the NPV and the IRR, the conflict can always be eliminated by dropping the IRR
and replacing it with the payback period.
c. There will be a meaningful (as opposed to irrelevant) conflict only if the projects' NPV profiles cross, and
even then, only if the required rate of return is to the left of (or lower than) the discount rate at which the
crossover occurs.
d. Statements a, b, and c are all true.
e. None of the above is a correct statement.
42. Two mutually exclusive projects each have a cost of $10,000. The total, undiscounted cash flows from Project L are
$15,000, while the undiscounted cash flows from Project S total $13,000. Their NPV profiles cross at a discount rate
of 10 percent. Which of the following statements best describes this situation?
a. The NPV and IRR methods will select the same project if the required rate of return is greater than 10
percent; for example, 18 percent.
b. The NPV and IRR methods will select the same project if the cost of capital is less than 10 percent; for
example, 8 percent.
c. To determine if a ranking conflict will occur between the two projects the required rate of return is needed as
well as an additional piece of information.
d. Project L should be selected at any required rate of return, because it has a higher IRR.
e. Project S should be selected at any required rate of return, because it has a higher IRR.
CFIN4
Chapter 9 – Capital Budgeting Techniques
43. The internal rate of return of a capital investment
a. Changes when the required rate of return 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 required rate of return in order for the firm to accept the investment.
d. Is similar to the yield to maturity bond.
e. Answers c and d are both correct.
44. Which of the following statements is correct?
a. In general, the NPVs of riskier cash flows should be found using relatively high discount rates. However, if a
cash flow is negative, it should be evaluated using a low discount rate.
b. If a project has only costs (no revenues) as would certain environmental projects, then the project is likely to
have two regular IRRs.
c. If the NPV and IRR methods give conflicting rankings for two mutually exclusive projects, the payback period
should be used to choose the project that should be purchased.
d. It is better to use the NPV method to evaluate independent projects, but for mutually exclusive projects,
especially if projects vary greatly in size, the IRR method is better.
e. None of the above is a correct statement.
CFIN4
Chapter 9 – Capital Budgeting Techniques
45. Two firms evaluated the same capital budgeting project to determine whether to purchase it. The CFO of Anchor
Weights Corporation (AWC) reported that she determined that the project's internal rate of return equals 9 percent,
and she recommended that the project be purchased. The CFO of Sectional Spas Incorporated (SSI) simply reported
that the project was unacceptable to his firm when he evaluated it using one of the capital budgeting techniques that
considers the time value of money. Given this information, which of the following statements is correct?
a. The net present value of the project must be positive for both firms.
b. If the SSI's CFO computes the IRR for the project, he will find that it is less than 9 percent for his company.
c. AWC's CFO must have used the traditional payback period method to evaluate the project.
d. If the project is acceptable (unacceptable) to one firm, it must be acceptable (unacceptable) to both firms. As
a result, one of the CFOs made a mistake when evaluating the project.
e. SSI's must have a required rate of return that is greater than 9 percent.
46. When Richard evaluated a capital budgeting project, a new machine needed to manufacture inventory using his
firm's required rate of return, he discovered that the project's net present value (NPV) is negative. Based on this
information, which of the following must be correct?
a. The project's internal rate of return is also negative.
b. The project's discounted payback period is greater than its economic life.
c. As long as the new machine's initial investment outlay is fairly low, the firm should purchase if it is used to
replace an older machine that is required to produce inventory.
d. The project's traditional payback period must be greater than the maximum payback period that the firm has
established.
e. Two or more of these scenarios must be correct.
CFIN4
Chapter 9 – Capital Budgeting Techniques
47. Tara is evaluating two mutually exclusive capital budgeting projects that have the following characteristics:
Cash Flows
Year
Project Q
Project R
0
$(4,000)
$(4,000)
1
0
3,500
2
5,000
1,100
IRR
11.8%
12.0%
If the firm's required rate of return (r) is 10 percent, which project should be purchased?
a. Both projects should be purchased, because the IRRs for both projects exceed the firm's required rate of
return.
b. Neither project should be accepted, because the IRRs for both projects exceed the firm's required rate of
return.
c. Project Q should be accepted, because its net present value (NPV) is higher than Project R's NPV.
d. Project R should be accepted, because its net present value (NPV) is higher than Project Q's NPV.
e. None of the above is a correct answer.
CFIN4
Chapter 9 – Capital Budgeting Techniques
48. Union Atlantic Corporation, which has a required rate of return equal to 14 percent, is evaluating a capital budgeting
project that has the following characteristics:
Year
Cash Flows
0
$(170,000)
1
60,750
2
60,750
3
60,750
4
60,750
Union Atlantic's capital budgeting manager has determined that the project's net present value is $7,008. According
to this information, which of the following statements is correct?
a. The project's internal rate of return (IRR) must be greater than 14 percent.
b. The project's discounted payback must be less that its economic life.
c. The project should be purchased by Union Atlantic.
d. All of these statements are correct.
e. None of these statements is correct.
49. The importance of capital budgeting decisions is due to all of the following factors except for:
a. the impact of a capital budgeting decision is long term; the firm looses some decision-making flexibility when
capital projects are purchased.
b. effective capital budgeting can improve the timing of asset acquisition and the quality of assets purchased.
c. the acquisition of fixed assets typically involves substantial expenditures, and before a firm spends a large
amount of money, it must have the funds available.
d. capital budgeting techniques overcome the problems with error in forecasts for asset requirements and
projected sales, we will still be able to determine if we should fund the project.
e. all of the above are factors that make capital budgeting important.
CFIN4
Chapter 9 – Capital Budgeting Techniques
50. The advantage of the payback period over other capital budgeting techniques is that
a. it is the simplest and oldest formal model to evaluate capital budgeting model.
b. it directly accounts for the time value of money.
c. it ignores cash flows beyond the payback period.
d. it always leads to decisions that maximize the value of the firm.
e. it incorporates risk into the discount rate used to solve the payback period.
51. If the NPV form a project is positive it must be that
a. the discounted payback period is longer than the useful life of the project.
b. the internal rate of return is lower than the discount used.
c. the project is not acceptable on a risk adjusted basis.
d. this project is preferred to any other mutually exclusive project.
e. accepting the project increases the value of the firm.
52. Discounted payback's primary advantage over traditional payback is that
a. discounted payback considers cash flows that occur after the discounted payback period.
b. discounted payback is always shorter than traditional payback making more projects acceptable.
c. discounted payback does consider the time value of money.
d. discounted payback will let you accept projects whose discounted payback period is longer than the useful of
the project.
e. all of the above are true.
CFIN4
Chapter 9 – Capital Budgeting Techniques
53. Which of the following statements concerning the internal rate of return is false?
a. The internal rate of return for a capital budgeting project is the same for all firms regardless of their cost of
capital.
b. A project is acceptable long as the project's internal rate of return is greater than the hurdle rate for the
project.
c. The internal rate of return is dependent on the timing of the cash flows.
d. A project with a positive internal rate of return will always increase the value of the firm if the project is
accepted.
e. You do not need to know the required rate of return to solve for the internal rate of return.
54. Net present value is preferred to internal rate of return for capital budgeting decisions because
a. the internal rate of return does not allow you to determine if the project is acceptable.
b. the net present value is the only method that allows you to determine which independent project is acceptable.
c. the net present value allows you to compare mutually exclusive projects.
d. the internal rate of return for a project is different for each firm.
e. NPV contains information about a projects "safety margin" which is not inherent in IRR.
55. All of the following factors can complicate the post-audit process except
a. each element of the cash flow forecast is subject to uncertainty.
b. projects sometimes fail to meet expectations for reasons beyond the control of operating executives.
c. it is often difficult to separate the operating results of one investment from those of a larger system.
d. executives who were responsible for a given decision might have moved on by the time the time the results of
the long term project are known.
e. the most successful firms, on average, are the ones that put the least emphasis on the post-audit.
CFIN4
Chapter 9 – Capital Budgeting Techniques
56. Benefits of the post-audit include all of the following except
a. when decision makers are forced to compare their projections to actual outcomes, there is a tendency to
improve.
b. conscious or unconscious biases are removed.
c. negative NPV projects are identified before they begin.
d. forecasts are improved.
e. all of the above are benefits of the post-audit.
57. 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 which will affect the actual investment
decision).
c. If one of the projects has a NPV profile which crosses the X-axis 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.
