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Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
60. Martin Manufacturing is considering two normal, equally risky, mutually exclusive, but not repeatable projects.
Martin's cost of capital is 10%. 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.
Since the projects are mutually exclusive, the firm should always select Project B.
b.
If the crossover rate is 8%, Project B will have the higher NPV.
c.
Only one project has a positive NPV.
d.
If the crossover rate is 8%, Project A will have the higher NPV.
e.
Each project must have a negative NPV.
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
61. 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 cost of capital is 12%, and at that rate Project A has the higher NPV. Which of the following
statements is CORRECT?
a.
Assuming the timing pattern of the two projects' cash flows is the same, Project B probably has a higher cost
(and larger scale).
b.
Assuming the two projects have the same scale, Project B probably has a faster payback than Project A.
c.
The crossover rate for the two projects must be 12%.
d.
Since B has the higher IRR, then it must also have the higher NPV if the crossover rate is less than the cost of
capital of 12%.
e.
The crossover rate for the two projects must be less than 12%.
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
62. Hart Corp. is considering a project that has the following cash flow data. What is the project's IRR? Note that a
project's IRR can be less than the cost of capital 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%
63. Spence Company is considering a project that has the following cash flow data. What is the project's IRR? Note that a
project's IRR can be less than the cost of capital 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%
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
64. Nichols Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a
project's IRR can be less than the cost of capital 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%
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
65. Kiley Electronics is considering a project that has the following cash flow data. What is the project's IRR? Note that a
project's IRR can be less than the cost of capital (and even negative), in which case it will be rejected.
Year
0
1
2
3
Cash flows
−$1,100
$450
$470
$490
a.
9.70%
b.
10.78%
c.
11.98%
d.
13.31%
e.
14.64%
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
66. Modern Refurbishing Inc. is considering a project that has the following cash flow data. What is the project's IRR?
Note that a project's IRR can be less than the cost of capital (and even negative), in which case it will be rejected.
Year
0
1
2
3
4
Cash flows
−$850
$300
$290
$280
$270
a.
13.13%
b.
14.44%
c.
15.89%
d.
17.48%
e.
19.22%
67. Pet World is considering a project that has the following cash flow data. What is the project's IRR? Note that a
project's IRR can be less than the cost of capital (and even negative), in which case it will be rejected.
Year
0
1
2
3
4
5
Cash flows
−$9,500
$2,000
$2,025
$2,050
$2,075
$2,100
a.
2.08%
b.
2.31%
c.
2.57%
d.
2.82%
e.
3.10%
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
68. Current Design Co. is considering two mutually exclusive, equally risky, and not repeatable projects, S and L. Their
cash flows are shown below. The CEO believes the IRR is the best selection criterion, while the CFO advocates the NPV.
If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if
any, value will be forgone, i.e., what's the chosen NPV versus the maximum possible NPV? Note that (1) "true value" is
measured by NPV, and (2) under some conditions the choice of IRR vs. NPV will have no effect on the value gained or
lost.
r:
7.50%
Year
0
1
2
3
4
CFS
−$1,100
$550
$600
$100
$100
CFL
−$2,700
$650
$725
$800
$1,400
a.
$138.10
b.
$149.21
c.
$160.31
d.
$171.42
e.
$182.52
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
69. Murray Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually
exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV
method. You were hired to advise Murray on the best procedure. If the wrong decision criterion is used, how much
potential value would Murray lose?
r:
6.00%
Year
0
1
2
3
4
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
CFS
−$1,025
$380
$380
$380
$380
CFL
−$2,150
$765
$765
$765
$765
a.
$188.68
b.
$198.61
c.
$209.07
d.
$219.52
e.
$230.49
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
70. Projects S and L, whose cash flows are shown below, are mutually exclusive, equally risky, and not repeatable.
Hooper Inc. is considering which of these two projects to undertake. If the decision is made by choosing the project with
the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the
IRR will not cause any value to be lost because the project with the higher IRR will also have the higher NPV, so no value
will be lost if the IRR method is used.
r:
10.25%
Year
0
1
2
3
4
CFS
−$2,050
$750
$760
$770
$780
CFL
−$4,300
$1,500
$1,518
$1,536
$1,554
a.
$134.79
b.
$141.89
c.
$149.36
d.
$164.29
e.
$205.36
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
71. Markman & Sons is considering Projects S and L. These projects are mutually exclusive, equally risky, and not
repeatable and their cash flows are shown below. If the decision is made by choosing the project with the higher IRR, how
much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause
any value to be lost because the project with the higher IRR will also have the higher NPV, i.e., no conflict will exist.
r:
10.00%
Year
0
1
2
3
4
CFS
−$1,025
$650
$450
$250
$50
CFL
−$1,025
$100
$300
$500
$700
a.
$5.47
b.
$6.02
c.
$6.62
d.
$7.29
e.
$7.82
IRRL
15.66%
IRRS
19.86%
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
72. Carolina Company is considering Projects S and L, whose cash flows are shown below. These projects are mutually
exclusive, equally risky, and are not repeatable. If the decision is made by choosing the project with the higher IRR, how
much value will be forgone? Note that under some conditions choosing projects on the basis of the IRR will cause $0.00
value to be lost.
r:
7.75%
Year
0
1
2
3
4
CFS
−$1,050
$675
$650
CFL
−$1,050
$360
$360
$360
$360
a.
$11.45
b.
$12.72
c.
$14.63
d.
$16.82
e.
$19.35
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
73. Silverman Co. is considering Projects S and L, whose cash flows are shown below. These projects are mutually
exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the higher MIRR rather
than the one with the higher NPV, how much value will be forgone? Note that under some conditions choosing projects
on the basis of the MIRR will cause $0.00 value to be lost.
r:
8.75%
Year
0
1
2
3
4
CFS
−$1,100
$375
$375
$375
$375
CFL
−$2,200
$725
$725
$725
$725
a.
$32.12
b.
$35.33
c.
$38.87
d.
$40.15
e.
$42.16
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
74. Farmer Co. is considering Projects S and L, whose cash flows are shown below. These projects are mutually
exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the shorter payback,
some value may be forgone. How much value will be lost in this instance? Note that under some conditions choosing
projects on the basis of the shorter payback will not cause value to be lost.
r =
10.25%
Year
0
1
2
3
4
CFS
−$950
$500
$800
$0
$0
CFL
−$2,100
$400
$800
$800
$1,000
a.
$24.14
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
b.
$26.82
c.
$29.80
d.
$33.11
e.
$36.42
75. Langton Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually
exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO
advocates the MIRR. If the decision is made by choosing the project with the higher IRR rather than the one with the
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
higher MIRR, how much, if any, value will be forgone. In other words, what's the NPV of the chosen project versus the
maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of
IRR vs. MIRR will have no effect on the value lost.
r =
7.00%
Year
0
1
2
3
4
CFS
−$1,100
$550
$600
$100
$100
CFL
−$2,750
$725
$725
$800
$1,400
a.
$185.90
b.
$197.01
c.
$208.11
d.
$219.22
e.
$230.32
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
76. 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
77. 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
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
78. 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
79. 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
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
80. 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 cost of capital.
a.
True
b.
False
81. 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
less than the projects' cost of capital.
a.
True
b.
False
Ch 10 The Basics of Capital Budgeting: Evaluating Cash Flows
82. No 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 exceeds the rate at which the projects' NPV profiles cross.
a.
True
b.
False
83. 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.
