Question 1

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.
A) $77.49
B) $81.56
C) $85.86
D) $90.15
E) $94.66

Accepted Answer

To calculate the NPV, we need to discount each cash flow at the WACC and sum them up.

Year 0 = -$870 (initial investment)
Year 1 = $330 / (1 + 0.075) = $308.14
Year 2 = $330 / (1 + 0.075)^2 = $286.55
Year 3 = $330 / (1 + 0.075)^3 = $266.25
Year 4 = $330 / (1 + 0.075)^4 = $247.11
Year 5 = $330 / (1 + 0.075)^5 = $229.03

NPV = -$870 + $308.14 + $286.55 + $266.25 + $247.11 + $229.03 = $85.86

Since the NPV is positive, the project should be accepted. Therefore, the best choice is C.

Question 2

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.

Accepted Answer

The answer of Projects S and L both have normal...

Question 3

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.

Accepted Answer

The project has a positive NPV, indicating that it will increase the firm's value. Although it has two IRRs, one of them is not relevant as it is negative and the other is excessively high, indicating a flaw in the cash flow estimation. Therefore, it is better to focus on the MIRR, which exceeds the WACC, indicating that the project's cash flows can generate a return greater than the cost of capital. It is recommended to explain this to the president to convince him to accept the project.

Question 4

Taggart Inc. is considering a project that has the following cash flow data. What is the project's payback?
A) 1.86 years
B) 2.07 years
C) 2.30 years
D) 2.53 years
E) 2.78 years

Accepted Answer

To calculate payback period, we need to add up the cash inflows until they equal the initial investment.

Year 1: $400,000
Year 2: $250,000
Year 3: $150,000
Year 4: $100,000
Year 5: $50,000

Cumulative cash flows:
Year 1: $400,000
Year 2: $650,000
Year 3: $800,000
Year 4: $900,000
Year 5: $950,000

The payback period is the third year since the cumulative cash flows equal the initial investment of $800,000 at that point.
Therefore, the project's payback period is 2.30 years (C).

Question 5

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.
A) 12.55%
B) 13.21%
C) 13.87%
D) 14.56%
E) 15.29%

Accepted Answer

The answer of Simms Corp. is considering a project that...

Question 6

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.

Accepted Answer

The answer of Which of the following statements is CORRECT?...

Question 7

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.

Accepted Answer

The answer of Westchester Corp. is considering two equally risky,...

Question 8

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.

Accepted Answer

The crossover rate is the discount rate at which the NPVs of two projects are equal. Since Project Y has a higher NPV at a WACC of 10% despite having a lower IRR than Project X, it must have a higher NPV at a discount rate greater than 10%. Therefore, the crossover rate must be greater than 10%, making choice B correct. The other choices are not necessarily true based on the given information.

Question 9

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.

Accepted Answer

The answer of Which of the following statements is CORRECT?...

Question 10

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.

Accepted Answer

The answer of Which of the following statements is CORRECT?...

Question 11

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.

Accepted Answer

The answer of Projects S and L are equally risky,...

Question 12

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.

Accepted Answer

The crossover rate is the rate at which the NPV profiles of two projects intersect. In the upper right quadrant, as assumed in the question, the NPV profile of Project A will be increasing at a decreasing rate, while the NPV profile of Project B will be increasing at an increasing rate. Therefore, there will be a crossover rate where both projects have the same NPV.

At the crossover rate, the IRR of both projects will be the same, which means that the NPV of Project B will be higher than the NPV of Project A if the WACC is less than the crossover rate. Conversely, the NPV of Project A will be higher than Project B if the WACC is greater than the crossover rate.

Since the WACC in this case is 10%, which is between the IRRs of both projects, we need to find the crossover rate to determine which project has a higher NPV. The crossover rate can be calculated as follows:

Crossover rate = IRR of Project A + ((NPV of Project A at WACC) / (NPV of Project B at WACC - NPV of Project A at WACC)) x (IRR of Project B - IRR of Project A)
Crossover rate = 15% + ((0 / (NPV of Project B at 10% - 0)) x (20% - 15%))
Crossover rate = 15%

Since the crossover rate is 15%, which is greater than 8%, Project B will have the higher NPV. Therefore, the correct answer is C.

Question 13

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%.

Accepted Answer

The answer of Projects A and B are mutually exclusive...

Question 14

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.
A) 9.43%
B) 9.91%
C) 10.40%
D) 10.92%
E) 11.47%

Accepted Answer

The answer of Thorley Inc. is considering a project that...

Question 15

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.
A) $265.65
B) $278.93
C) $292.88
D) $307.52
E) $322.90

Accepted Answer

The answer of Anderson Systems is considering a project that...

Question 16

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.
A) $105.89
B) $111.47
C) $117.33
D) $123.51
E) $130.01

Accepted Answer

The answer of Harry's Inc. is considering a project that...

Question 17

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.
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.

Accepted Answer

If the cost of capital is greater than the crossover rate (the discount rate at which the two projects have the same NPV), then the NPV profile of one project will always be higher than the IRR of the other project. Therefore, there will be no conflict between the two criteria and one project will rank higher by both. If the cost of capital is less than the crossover rate, then the IRR profile of one project will always be higher than the NPV of the other project, and the conflict will also not exist. Therefore, in both cases, there will be no conflict between the two criteria. Option A, D, and E are incorrect because they are either not related to the statement or do not correctly describe the conditions for conflicts between NPV and IRR.

Question 18

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.
A) 14.05%
B) 15.61%
C) 17.34%
D) 19.27%
E) 21.20%

Accepted Answer

To calculate IRR, we need to find the discount rate that makes the net present value (NPV) of the project's cash flows equal to zero. By using a financial calculator or spreadsheet, we find that the IRR for this project is 19.27%. Since this is higher than the company's WACC, the project should be accepted.

Question 19

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 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.

Accepted Answer

The statement is correct. The IRR method gives a percentage rate of return, which some managers may find more intuitive than a dollar amount provided by the NPV method.

Question 20

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-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.

Accepted Answer

The fact that the smaller project has a higher IRR means that it is more efficient in generating cash flows relative to its size. However, the larger project has a higher NPV at a zero discount rate, which implies that it generates higher total cash flows over the life of the project. At some discount rate, the NPV profiles of the two projects will cross, and the larger project will have a higher NPV beyond this crossover rate. Therefore, choice D is the correct answer. Choice A is incorrect because it assumes that the two projects are mutually exclusive, which is not necessarily true. Choice B is incorrect because it assumes that the NPV profiles of the two projects will not cross, which is also not true. Choice C is incorrect because it makes a generalization that is not always true.

Quiz 12: Capital Budgeting Mc Problems

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.

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?

Taggart Inc. is considering a project that has the following cash flow data. What is the project's payback?

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.

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.

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?

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.

Which of the following statements is CORRECT? Assume that all projects being considered have normal cash flows and are equally risky.

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?

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?

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.

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.

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.

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.

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.

Which of the following statements is CORRECT?