CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
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.
11-7 NPV Profiles
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NPV profiles
Bloom’s: Application
Multiple Choice: Conceptual
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.
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
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.
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%.
11-7 NPV Profiles
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NPV profiles
Bloom’s: Application
Multiple Choice: Conceptual
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.
11-7 NPV Profiles
FOFM.BRIG.16.11.07 – NPV Profiles
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NPV profiles
Bloom’s: Application
Multiple Choice: Conceptual
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
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.
b.
c.
d.
e.
11-8 Payback Period
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Bloom’s: Analysis
Multiple Choice: Conceptual
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.
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NPV, IRR, and MIRR
Bloom’s: Analysis
11-8 Payback Period
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Bloom’s: Analysis
Multiple Choice: Conceptual
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
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.
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.
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NPV, IRR, and MIRR
Bloom’s: Analysis
Multiple Choice: Conceptual
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.
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NPV, IRR, and MIRR
Bloom’s: Comprehension
Multiple Choice: Conceptual
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.
Multiple Choice: Conceptual
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
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.
FOFM.BRIG.16.11.00 – Comprehensive
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NPV, IRR, and MIRR
Bloom’s: Comprehension
Multiple Choice: Conceptual
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.
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Ranking methods: NPV
Bloom’s: Comprehension
Multiple Choice: Conceptual
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
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
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.
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Miscellaneous concepts
Bloom’s: Comprehension
Multiple Choice: Conceptual
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.
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
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.
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NPV profiles
Bloom’s: Application
Multiple Choice: Conceptual
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.
11-7 NPV Profiles
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NPV profiles
Bloom’s: Application
Multiple Choice: Conceptual
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
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.
11-7 NPV Profiles
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NPV profiles
Bloom’s: Analysis
Multiple Choice: Conceptual
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.
CHAPTER 11—THE BASICS OF 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.
c
MODERATE/CHALLENGING
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
11-4 Multiple Internal Rates of Return
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Multiple IRRs
Bloom’s: Application
Multiple Choice: Conceptual
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.
Answer e is essentially the definition of the MIRR, hence it is correct.
11-6 Modified Internal Rate of Return (MIRR)
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Bloom’s: Comprehension
Multiple Choice: Conceptual
69. 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 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 the MIRR will be less than the IRR.
d.
If a project’s IRR is greater than its WACC, then the MIRR will be greater than the IRR.
e.
To find a project’s MIRR, we compound cash inflows at the IRR and then discount the terminal value back to t
= 0 at the WACC.
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
70. 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.
b.
If Project S has a positive NPV, Project L must also have a positive NPV.
c.
If the WACC falls, each project’s IRR will increase.
d.
If the WACC increases, each project’s IRR will decrease.
e.
If Projects S and L have the same NPV at the current WACC, 10%, then Project L, the one with the lower
IRR, would have a higher NPV if the WACC used to evaluate the projects declined.
11-7 NPV Profiles
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11-6 Modified Internal Rate of Return (MIRR)
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Bloom’s: Analysis
Multiple Choice: Conceptual
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
71. Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows
and are equally risky.
a.
If a project’s IRR is equal to its WACC, then, under all reasonable conditions, the project’s NPV must be
negative.
b.
If a project’s IRR is equal to its WACC, then under all reasonable conditions, the project’s IRR must be
negative.
c.
If a project’s IRR is equal to its WACC, then under all reasonable conditions the project’s NPV must be zero.
d.
There is no necessary relationship between a project’s IRR, its WACC, and its NPV.
e.
When evaluating mutually exclusive projects, those projects with relatively long lives will tend to have
relatively high NPVs when the cost of capital is relatively high.
c
CHALLENGING
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NPV profiles
Bloom’s: Analysis
Multiple Choice: Conceptual
72. A company is choosing between two projects. The larger project has an initial cost of $100,000, annual cash flows of
$30,000 for 5 years, and an IRR of 15.24%. The smaller project has an initial cost of $51,600, annual cash flows of
$16,000 for 5 years, and an IRR of 16.65%. The projects are equally risky. Which of the following statements is
CORRECT?
a.
Since the smaller project has the higher IRR, the two projects’ NPV profiles cannot cross, and the smaller
project’s NPV will be higher at all positive values of WACC.
b.
Since the smaller project has the higher IRR, the two projects’ NPV profiles will cross, and the larger project
will look better based on the NPV at all positive values of WACC.
c.
If the company uses the NPV method, it will tend to favor smaller, shorter-term projects over larger, longer-
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NPV profiles
Bloom’s: Analysis
Multiple Choice: Conceptual
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
term projects, regardless of how high or low the WACC is.
d.
Since the smaller project has the higher IRR but the larger project has the higher NPV at a zero discount rate,
the two projects’ NPV profiles will cross, and the larger project will have the higher NPV if the WACC is less
than the crossover rate.
e.
Since the smaller project has the higher IRR and the larger NPV at a zero discount rate, the two projects’ NPV
profiles will cross, and the smaller project will look better if the WACC is less than the crossover rate.
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Bloom’s: Application
Multiple Choice: Conceptual
73. McCall Manufacturing has a WACC of 10%. The firm is considering two normal, equally risky, mutually exclusive,
but not repeatable projects. The two projects have the same investment costs, but Project A has an IRR of 15%, while
Project B has an IRR of 20%. Assuming the projects’ NPV profiles cross in the upper right quadrant, which of the
following statements is CORRECT?
a.
Each project must have a negative NPV.
b.
Since the projects are mutually exclusive, the firm should always select Project B.
c.
If the crossover rate is 8%, Project B will have the higher NPV.
d.
Only one project has a positive NPV.
e.
If the crossover rate is 8%, Project A will have the higher NPV.
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
11-7 NPV Profiles
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NPV profiles
Bloom’s: Application
Multiple Choice: Conceptual
74. Projects A and B are mutually exclusive and have normal cash flows. Project A has an IRR of 15% and B’s IRR is
20%. The company’s WACC is 12%, and at that rate Project A has the higher NPV. Which of the following statements is
CORRECT?
a.
The crossover rate for the two projects must be less than 12%.
b.
Assuming the timing pattern of the two projects’ cash flows is the same, Project B probably has a higher cost
(and larger scale).
c.
Assuming the two projects have the same scale, Project B probably has a faster payback than Project A.
d.
The crossover rate for the two projects must be 12%.
e.
Since B has the higher IRR, then it must also have the higher NPV if the crossover rate is less than the WACC
of 12%.
c
CHALLENGING
11-7 NPV Profiles
FOFM.BRIG.16.11.07 – NPV Profiles
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NPV profiles
Bloom’s: Application
Multiple Choice: Conceptual
75. Anderson Systems is considering a project that has the following cash flow and WACC data. What is the project’s
NPV? Note that if a project’s projected NPV is negative, it should be rejected.
WACC:
9.00%
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
Year
0
1
2
3
Cash flows
−$1,000
$500
$500
$500
a.
$265.65
b.
$278.93
c.
$292.88
d.
$307.52
e.
$322.90
a
EASY
11-2 Net Present Value (NPV)
FOFM.BRIG.16.11.02 – Net Present Value (NPV)
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NPV
Bloom’s: Analysis
Multiple Choice: Problem
76. Tuttle Enterprises is considering a project that has the following cash flow and WACC data. What is the project’s
NPV? Note that if a project’s projected NPV is negative, it should be rejected.
WACC:
11.00%
Year
0
1
2
3
4
Cash flows
−$1,000
$350
$350
$350
$350
a.
$77.49
b.
$81.56
c.
$85.86
d.
$90.15
e.
$94.66
c
EASY
11-2 Net Present Value (NPV)
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NPV
Bloom’s: Analysis
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
77. Harry’s Inc. is considering a project that has the following cash flow and WACC data. What is the project’s NPV?
Note that if a project’s projected NPV is negative, it should be rejected.
WACC:
10.25%
Year
0
1
2
3
4
5
Cash flows
−$1,000
$300
$300
$300
$300
$300
a.
$105.89
b.
$111.47
c.
$117.33
d.
$123.51
e.
$130.01
e
EASY
11-2 Net Present Value (NPV)
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NPV
Bloom’s: Analysis
Multiple Choice: Problem
78. Simms Corp. is considering a project that has the following cash flow data. What is the project’s IRR? Note that a
project’s projected IRR can be less than the WACC or negative, in both cases it will be rejected.
Year
0
1
2
3
Cash flows
−$1,000
$425
$425
$425
a.
12.55%
b.
13.21%
c.
13.87%
d.
14.56%
e.
15.29%
EASY
11-3 Internal Rate of Return (IRR)
FOFM.BRIG.16.11.03 – Internal Rate of Return (IRR)
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
Multiple Choice: Problem
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
79. Warr Company is considering a project that has the following cash flow data. What is the project’s IRR? Note that a
project’s projected IRR can be less than the WACC or negative, in both cases it will be rejected.
Year
0
1
2
3
4
Cash flows
−$1,050
$400
$400
$400
$400
a.
14.05%
b.
15.61%
c.
17.34%
d.
19.27%
e.
21.20%
EASY
11-3 Internal Rate of Return (IRR)
FOFM.BRIG.16.11.03 – Internal Rate of Return (IRR)
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
Bloom’s: Analysis
Multiple Choice: Problem
80. Thorley Inc. is considering a project that has the following cash flow data. What is the project’s IRR? Note that a
project’s projected IRR can be less than the WACC or negative, in both cases it will be rejected.
Year
0
1
2
3
4
5
Cash flows
−$1,250
$325
$325
$325
$325
$325
a.
9.43%
b.
9.91%
c.
10.40%
d.
10.92%
e.
11.47%
a
EASY
11-3 Internal Rate of Return (IRR)
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
Bloom’s: Analysis
Multiple Choice: Problem
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
81. Taggart Inc. is considering a project that has the following cash flow data. What is the project’s payback?
Year
0
1
2
3
Cash flows
−$1,150
$500
$500
$500
a.
1.86 years
b.
2.07 years
c.
2.30 years
d.
2.53 years
e.
2.78 years
11-8 Payback Period
FOFM.BRIG.16.11.08 – Payback Period
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
Bloom’s: Analysis
Multiple Choice: Problem
82. Resnick Inc. is considering a project that has the following cash flow data. What is the project’s payback?
Year
0
1
2
3
Cash flows
−$350
$200
$200
$200
a.
1.42 years
b.
1.58 years
c.
1.75 years
d.
1.93 years
e.
2.12 years
FOFM.BRIG.16.11.03 – Internal Rate of Return (IRR)
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
Bloom’s: Analysis
Multiple Choice: Problem
CHAPTER 11—THE BASICS OF CAPITAL BUDGETING
83. Susmel Inc. is considering a project that has the following cash flow data. What is the project’s payback?
Year
0
1
2
3
Cash flows
−$500
$150
$200
$300
a.
2.03 years
b.
2.25 years
c.
2.50 years
d.
2.75 years
e.
3.03 years
11-8 Payback Period
FOFM.BRIG.16.11.08 – Payback Period
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
Bloom’s: Analysis
Multiple Choice: Problem
84. Mansi Inc. is considering a project that has the following cash flow data. What is the project’s payback?
Year
0
1
2
3
Cash flows
−$750
$300
$325
$350
a.
1.91 years
b.
2.12 years
c.
2.36 years
d.
2.59 years
11-8 Payback Period
FOFM.BRIG.16.11.08 – Payback Period
United States – BUSPROG.FOFM.BRIG.16.03 – Analytic skills
United States – OH – DISC.FOFM.BRIG.16.03 – Capital budgeting and cost of capital
Bloom’s: Analysis
Multiple Choice: Problem