Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
89. 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
90. 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
b. False
91. Which of the following statements is CORRECT?
a. The discounted payback method recognizes all cash flows over a project’s life, and it also adjusts these cash flows
to account for the time value of money.
b. The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback
today.
c. The regular payback is useful as an indicator of a project’s liquidity because it gives managers an idea of how long
it will take to recover the funds invested in a project.
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
d. The regular payback does not consider cash flows beyond the payback year, but the discounted payback
overcomes this defect.
e. The regular payback method recognizes all cash flows over a project’s life.
92. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows,
with one outflow followed by a series of inflows.
a. One drawback of the regular payback for evaluating projects is that this method does not properly account for the
time value of money.
b. If a project’s payback is positive, then the project should be rejected because it must have a negative NPV.
c. The regular payback ignores cash flows beyond the payback period, but the discounted payback method
overcomes this problem.
d. If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or
less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will
cause its risk to increase over time.
e. The longer a project’s payback period, the more desirable the project is normally considered to be by this
criterion.
93. Which of the following statements is CORRECT?
a. One drawback of the regular payback is that this method does not take account of cash flows beyond the payback
period.
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
b. If a project’s payback is positive, then the project should be accepted because it must have a positive NPV.
c. The regular payback ignores cash flows beyond the payback period, but the discounted payback method
overcomes this problem.
d. One drawback of the discounted payback is that this method does not consider the time value of money, while the
regular payback overcomes this drawback.
e. The shorter a project’s payback period, the less desirable the project is normally considered to be by this criterion.
94. Which of the following statements is NOT a disadvantage of the regular payback method?
a. Ignores cash flows beyond the payback period.
b. Does not directly account for the time value of money.
c. Does not provide any indication regarding a project’s liquidity or risk.
d. Does not take account of differences in size among projects.
e. Lacks an objective, market-determined benchmark for making decisions.
95. Suppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4-
year payback regardless of economic conditions. Other things held constant, which of the following statements is most
likely to be true?
a. It will accept too many long-term projects and reject too many short-term projects (as judged by the NPV).
b. The firm will accept too many projects in all economic states because a 4-year payback is too low.
c. The firm will accept too few projects in all economic states because a 4-year payback is too high.
d. If the 4-year payback results in accepting just the right set of projects under average economic conditions, then
this payback will result in too few long-term projects when the economy is weak.
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
e. It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV).
96. Which of the following statements is CORRECT?
a. For mutually exclusive projects with normal cash flows, the NPV and MIRR methods can never conflict, but their
results could conflict with the discounted payback and the regular IRR methods.
b. Multiple IRRs can exist, but not multiple MIRRs. This is one reason some people favor the MIRR over the
regular IRR.
c. If a firm uses the discounted payback method with a required payback of 4 years, then it will accept more projects
than if it used a regular payback of 4 years.
d. The percentage difference between the MIRR and the IRR is equal to the project’s cost of capital.
e. The NPV, IRR, MIRR, and discounted payback (using a payback requirement of 3 years or less) methods always
lead to the same accept/reject decisions for independent projects.
97. Which of the following statements is CORRECT?
a. The discounted payback method eliminates all of the problems associated with the payback method.
b. When evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a
project’s acceptability.
c. To find the MIRR, we discount the TV at the IRR.
d. A project’s NPV profile must intersect the X-axis at the project’s cost of capital.
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
e. The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather
than a dollar amount, which the NPV method provides.
98. McGlothin 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
99. Garner Inc. is considering a project that has the following cash flow data. What is the project’s payback?
Year 0 1 2 3
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
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
100. Worthington 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
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
101. Poder 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
e. 2.85 years
102. Suzanne’s Cleaners is considering a project that has the following cash flow data. What is the project’s payback?
Year 0 1 2 3 4 5
Cash flows −$1,100 $300 $310 $320 $330 $340
a. 2.31 years
b. 2.56 years
c. 2.85 years
d. 3.16 years
e. 3.52 years
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
103. Craig’s Car Wash Inc. is considering a project that has the following cash flow and cost of capital (r) data. What is
the project’s discounted payback?
r = 10.00%
Year 0 1 2 3
Cash flows −$900 $500 $500 $500
a. 1.88 years
b. 2.09 years
c. 2.29 years
d. 2.52 years
e. 2.78 years
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
104. Shannon Co. is considering a project that has the following cash flow and cost of capital (r) data. What is the
project’s discounted payback?
r = 10.00%
Year 0 1 2 3 4
Cash flows −$950 $525 $485 $445 $405
a. 1.61 years
b. 1.79 years
c. 1.99 years
d. 2.22 years
e. 2.44 years
105. 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
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
106. 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
107. Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?
a. A project’s NPV increases as the cost of capital declines.
b. A project’s MIRR is unaffected by changes in the cost of capital.
c. A project’s regular payback increases as the cost of capital declines.
d. A project’s discounted payback increases as the cost of capital declines.
e. A project’s IRR increases as the cost of capital declines.
108. Which of the following statements is CORRECT?
a. The payback method is generally regarded by academics as being the best single method for evaluating capital
budgeting projects.
b. The discounted payback method is generally regarded by academics as being the best single method for
evaluating capital budgeting projects.
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
c. The net present value method (NPV) is generally regarded by academics as being the best single method for
evaluating capital budgeting projects.
d. The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single
method for evaluating capital budgeting projects.
e. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for
evaluating capital budgeting projects.