Question 1

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)The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.
B)If a project's NPV is greater than zero, then its IRR must be less than the WACC.
C)If a project's NPV is greater than zero, then its IRR must be less than zero.
D)The NPVs of relatively risky projects should be found using relatively low WACCs.

Accepted Answer

The correct statement is that the higher the WACC (Weighted Average Cost of Capital) used to calculate the NPV (Net Present Value), the lower the calculated NPV will be. This is because a higher WACC reflects a higher opportunity cost of investment, which in turn reduces the relative attractiveness of the project's cash flows. The other statements are not correct. B is incorrect because the IRR (Internal Rate of Return) and WACC are not necessarily directly related, and a positive NPV only implies that the project's cash flows exceed its costs at the given discount rate. C is incorrect because a positive NPV implies that the project's IRR is greater than the discount rate, not less than zero. D is incorrect because higher risks require higher WACCs to reflect the cost of capital that investors demand for taking on more uncertain cash flows.

Question 2

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.

Accepted Answer

Even if the firm has a zero cost of capital, the time value of money should still be considered in investment decisions. The payback method only considers the time it takes to recover the initial investment, while the NPV method takes into account the time value of money by discounting future cash flows back to their present value. Therefore, the two methods may lead to different decisions on which project to undertake.

Question 3

Which of the following statements is correct?
A)The IRR is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
B)The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
C)The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
D)The NPV is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

Accepted Answer

The NPV (Net Present Value) is generally considered the best method for evaluating capital budgeting projects among academics and finance professionals because it takes into account the time value of money, accounts for all expected cash flows, and uses a realistic discount rate. The IRR (Internal Rate of Return) and payback method are also commonly used, but they have limitations and can lead to incorrect decisions, especially when cash flows are uneven or the discount rate is not appropriate. The discounted payback method is an improvement over the regular payback method, but it still ignores the cost of capital and the long-term profitability of the project. Therefore, the NPV should be preferred over the other methods whenever possible.

Question 4

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)The lower the WACC used to calculate it, the lower the calculated NPV will be.
B)If a project's NPV is less than zero, then its IRR must be less than the WACC.
C)If a project's NPV is greater than zero, then its IRR must be less than zero.
D)The NPV of a relatively low risk project should be found using a relatively high WACC.

Accepted Answer

If a project's NPV is less than zero, it means that the present value of its cash inflows is less than the present value of its cash outflows, so its IRR must be less than the WACC. This is because the WACC represents the cost of capital, so if the IRR is less than the WACC, the project is not generating a return greater than its cost of capital and is therefore not profitable. A project's NPV is calculated using the WACC, so statement A is incorrect. Statement C is also incorrect; if a project's NPV is greater than zero, it means that its cash inflows are greater than its cash outflows, so its IRR must be greater than the WACC. Statement D is incorrect because a low-risk project should have a lower WACC, not a higher one, which would make its NPV higher.

Question 5

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)The longer a project's payback period, the more desirable the project is normally considered to be by this criterion.
B)One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.
C)If a project's payback is positive, then the project should be rejected because it must have a negative NPV.
D)The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.

Accepted Answer

The payback criterion does not consider the time value of money. This means that future cash flows are not discounted to their present value, which can result in incorrect project evaluations. Therefore, option B is the correct statement. Options A and C are incorrect since a longer payback period is generally considered less desirable and a positive payback does not necessarily mean a negative NPV. Option D is partially correct but does not address the entire issue with the payback method.

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)If Project A has a higher IRR than Project B, then Project A must have the lower NPV.
B)If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.
C)The IRR calculation implicitly assumes that all cash flows are reinvested at the WACC.
D)If a project has normal cash flows and its IRR exceeds its WACC, then the project's NPV must be positive.

Accepted Answer

If a project has normal cash flows (i.e. one outflow followed by a series of inflows) and its IRR exceeds its WACC, then the project's NPV must be positive. This is because the IRR represents the discount rate at which the project's cash inflows equal its outflows, so any discount rate lower than the IRR will result in a positive NPV. The other statements are incorrect: A is false because a higher IRR indicates a higher expected return, which would result in a higher NPV, not a lower one; B is also false for the same reason; and C is incorrect because the IRR calculation assumes that cash inflows are reinvested at the IRR, not the WACC.

Question 7

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 regular IRR is found by compounding the initial cost at the WACC to find the terminal value (TV), then discounting the TV at the WACC.
B)A project's regular IRR is found by compounding the cash inflows at the WACC to find the present value (PV), then discounting to find the IRR.
C)If a project's IRR is smaller than the WACC, then its NPV will be positive.
D)A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost.

Accepted Answer

The IRR is the discount rate at which the project's cash inflows equal the initial outflow, so the PV of the inflows minus the initial outflow is zero. Therefore, the IRR is the discount rate that causes the PV of the inflows to equal the initial cost.

Question 8

Which statement regarding payback is true?
A)The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion.
B)One drawback of the payback criterion for evaluating projects is that this method does not take account of cash flows beyond the payback period.
C)If a project's payback is positive, then the project should be accepted because it must have a positive NPV.
D)The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.

Accepted Answer

The statement that "One drawback of the payback criterion for evaluating projects is that this method does not take account of cash flows beyond the payback period" is true. A shorter payback period is generally considered more desirable, making statement A incorrect. C is false because a positive payback period only means that the initial investment has been returned and does not necessarily indicate a positive NPV. While statement D is partially true, the discounted payback method still has limitations in accurately evaluating projects that have longer-term cash flows.

Question 9

Which statement regarding normal cash flows is correct?
A)Projects with normal cash flows can have only one real IRR.
B)Projects with normal cash flows can have two or more real IRRs.
C)The "multiple IRR problem" can arise if a project's cash flows are normal.
D)Projects with non-normal cash flows are almost never encountered in the real world.

Accepted Answer

Normal cash flows involve an initial outlay followed by a series of positive cash inflows, which means there can only be one sign change in the cash flow stream. This characteristic ensures that there can only be one real Internal Rate of Return (IRR), as the IRR is found by solving the equation where the net present value equals zero, and the existence of a single sign change guarantees only one real root to this equation.

Question 10

Which statement regarding normal cash flows is correct?
A)If a project has normal cash flows, then its IRR must be positive.
B)If a project has normal cash flows, then its MIRR must be positive.
C)If a project has normal cash flows, then it will have exactly two real IRRs.
D)If a project has normal cash flows, then it can have only one real IRR, whereas a project with non-normal cash flows might have more than one real IRR.

Accepted Answer

Normal cash flows involve an initial outlay followed by a series of positive cash inflows, which means the project can have only one real IRR. Non-normal cash flows, which involve sign changes in the cash flow stream more than once, can result in multiple IRRs.

Question 11

Which statement about an NPV profile graph is true?
A)An NPV profile graph shows how a project's payback varies as the cost of capital changes.
B)The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases.
C)An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life.
D)An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital.

Accepted Answer

An NPV profile graph is designed to show how a project's contribution to the firm's value varies with the cost of capital. It plots the NPV of a project against different discount rates (cost of capital), giving decision makers an idea of how sensitive the project's value is to changes in the cost of capital. The slope of the graph can be positive or negative depending on the nature of the project's cash flows.

Question 12

Which statement regarding the IRR method is correct?
A)One defect of the IRR method is that it does not take account of cash flows over a project's full life.
B)One defect of the IRR method is that it does not take account of the time value of money.
C)One defect of the IRR method is that it does not take account of the cost of capital.
D)One defect of the IRR method is that it does not assume that the cash flows to be received from a project can be reinvested at a rate other than the IRR itself.

Accepted Answer

The IRR method assumes that all cash flows generated by the project can be reinvested at the internal rate of return itself, which may not always be realistic or achievable in practice. This is a known limitation of the IRR method.

Question 13

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 cost of capital.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.

Accepted Answer

While Project X has a higher IRR and NPV at a specific cost of capital, NPV profiles could intersect, meaning that for different costs of capital, Project Y might have a higher NPV, suggesting situations where Project Y could be preferred over Project X.

Question 14

Theoretically speaking,hard capital rationing does not exist.

Accepted Answer

Hard capital rationing is the situation where a firm cannot raise funds at any cost or faces external constraints such as legal regulations. However, in theory, a firm can raise funds from different sources such as debt, equity, or internal funds, and there are no external constraints on the availability of funds. Therefore, theoretically speaking, hard capital rationing does not exist.

Question 15

Which statement regarding payback is true?
A)The regular payback method recognizes all cash flows over a project's life.
B)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.
C)The regular payback method was widely used years ago, but virtually no companies even calculate the payback today.
D)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.

Accepted Answer

The regular payback method calculates the amount of time it takes to recover the initial investment, making it a useful indicator of a project's liquidity. The other statements are incorrect - the regular payback method only recognizes cash flows up to the point of payback, and while the discounted payback method adjusts for time value of money, it may not recognize all cash flows over a project's life. Additionally, while the regular payback method may not be as commonly used today, it is still a relevant tool for some companies.

Question 16

Normal Projects Q and R have the same NPV when the discount rate is zero.However,Project Q's cash flows come in faster than those of R.Therefore,we know that at any discount rate greater than zero,R will have a higher NPV than Q.

Accepted Answer

The statement is incorrect. If Q's cash flows are coming in faster, it means that Q has a shorter payback period and a higher internal rate of return (IRR) than R. Therefore, at discount rates lower than IRR, Q will have a higher NPV than R. However, at discount rates higher than IRR, R will have a higher NPV than Q. It cannot be concluded that R will always have a higher NPV than Q at any discount rate greater than zero without additional information about their respective IRRs.

Question 17

Which of the following statements is correct?
A)The NPV method assumes that cash flows will be reinvested at the WACC, 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 WACC, while the IRR method assumes reinvestment at the risk-free rate.
D)The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period.

Accepted Answer

The NPV method assumes that cash flows will be reinvested at the weighted average cost of capital (WACC), while the IRR method assumes reinvestment at the internal rate of return (IRR). This assumption is a key difference between the two methods and can lead to different project evaluations.

Question 18

Which statement about the NPV is true?
A)The NPV method was once the favourite of academics and business executives, but today most authorities regard the MIRR as being the best indicator of a project's profitability.
B)The NPV method is regarded by most academics as being the best indicator of a project's profitability; hence, most academics recommend that firms use only this one method.
C)A project's NPV depends on the total amount of cash flows the project produces, but because the cash flows are discounted at the WACC, it does not matter if the cash flows occur early or late in the project's life.
D)The NPV and IRR methods may give different recommendations regarding which of two mutually exclusive projects should be accepted, but they always give the same recommendation regarding the acceptability of a normal, independent project.

Accepted Answer

The answer of Which statement about the NPV is true?
A)The...

Question 19

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 regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR.
B)If a project's IRR is greater than the WACC, then its NPV must be negative.
C)To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs.
D)To find a project's IRR, we must find a discount rate that is equal to the WACC.

Accepted Answer

The correct statement is that to find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs. This is because the IRR is the rate that sets the NPV of the project to zero, meaning the present value of inflows equals the present value of outflows (or costs). Option A describes the calculation of the regular payback period, not the regular IRR. Option B is incorrect since if the IRR is greater than the WACC, then the project's NPV would be positive. Option D is also incorrect since the IRR is not necessarily equal to the WACC; they may be different depending on the project's risk profile.

Question 20

Assume a project has normal cash flows.All else being equal,which of the following statements is correct?
A)The project's IRR increases as the WACC declines.
B)The project's NPV increases as the WACC declines.
C)The project's MIRR is unaffected by changes in the WACC.
D)The project's regular payback increases as the WACC declines.

Accepted Answer

When the WACC (Weighted Average Cost of Capital) declines, the discount rate used to calculate the NPV decreases, which leads to an increase in the project's NPV. The IRR (Internal Rate of Return) could stay the same or decrease with a decrease in the discount rate. MIRR (Modified Internal Rate of Return) also changes with changes in WACC. The regular payback period is also unaffected by WACC changes.

Quiz 10: The Basics of Capital Budgeting: Evaluating Cash Flows

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.

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.

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 outflow followed by a series of inflows.

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.

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.

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.

Which statement regarding payback is true?

Which statement regarding normal cash flows is correct?

Which statement regarding normal cash flows is correct?

Which statement about an NPV profile graph is true?

Which statement regarding the IRR method is correct?

Theoretically speaking,hard capital rationing does not exist.

Which statement regarding payback is true?

Normal Projects Q and R have the same NPV when the discount rate is zero.However,Project Q's cash flows come in faster than those of R.Therefore,we know that at any discount rate greater than zero,R will have a higher NPV than Q.

Which of the following statements is correct?

Which statement about the NPV is true?

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.

Assume a project has normal cash flows.All else being equal,which of the following statements is correct?