EASY Capital Budget: 1.

A firm should never undertake an investment if accepting the project would cause an increase in the firms cost of capital. FALSE PV of Cash Flows 2. Because present value refers to the value of cash flows that occur at different points in time, present values cannot be added to determine the value of a capital budgeting project. FALSE Ranking methods: 3. Given two mutually exclusive projects and a zero cost of capital, the payback method and NPV method of selecting investments will always lead to the same decision on which project to undertake. FALSE. Payback Period: 4. One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a rough measure of a projects liquidity and risk. TRUE NPV 5. Assuming that the total cash flows are equal, the NPV of a project whose cash flows accrue relatively rapidly is more sensitive to changes in the discount rate than is the NPV of a project whose cash flows come in more slowly. FALSE IRR 6. The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs) with the present value of the cash inflows. TRUE 7. Under certain conditions, particular projects may have more than one IRR. One condition under which this situation can occur is if, in addition to the initial investment at time = 0, a negative cash flow occurs at the end of the projects life. TRUE 8. Other things held constant, an increase in the cost of capital discount rate will result in a decrease in a projects IRR. FALSE IRR and NPV 9. If a projects NPV exceeds the projects IRR, then the project should be accepted. FALSE Multiple IRRs 10. The phenomenon called multiple internal rates of return arises when two or more mutually exclusive projects which have different lives are being compared. FALSE MIRR 11. The modified IRR (MIRR) method has wide appeal to professors, but most business executives prefer the NPV method to either the regular or MIRR. FALSE 12. The MIRR always leads to the same capital budgeting decisions as the NPV method. FALSE Mutually exclusive Projects 13. Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV. TRUE Reinvestment rate assumption 14. The NPV methods assumption that cash inflows are reinvested at the cost of capital is more reasonable than the IRRs assumption that cash flows are reinvested at the IRR. This makes the NPV method preferable to the IRR method. TRUE. Replacement Chain

15. The replacement chain, or common life, approach is applicable whether two projects with differing lives are mutually exclusive or independent. FALSE MEDIUM Ranking methods 16. Any capital budgeting investment rule should depend solely on forecasted cash flows and the opportunity cost of capital. The rule itself should not be affected by managers tastes, the choice of accounting method, or the profitability of other independent projects. TRUE 17. A decrease in the firms discount rate (r) will increase NPV, which could change the accept/reject decision for a potential project. However, such a change would have no impact on the projects IRR, hence on the accept/reject decision under the IRR method. FALSE Mutually exclusive projects 18. When considering two mutually exclusive projects, the financial manager should always select that project whose internal rate of return is the highest provided the project have the same initial cost. FALSE NPV 19. Normal projects Q and R have the same NPV when the discount rate is zerio. However, Project Q has larger early cash flows than R. Therefore, we know that at all discount rates greater than zero, project R will have a greater NPV than Q. FALSE 20. Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large cash flows late in its life. At the current cost of capital, normal projects S and L have identical NPVs. Now suppose interest rates and money costs generally decline. Other things held constant, this change will cause L to become preferred to S. TRUE IRR and NPV 21. If the IRR of normal Project X is greater than then IRR of mutually exclusive Project Y (also normal), we can conclude that the firm will select X rather than Y if X has a NPV > 0. FALSE NPV versus IRR 22. The main reason that the NPV method is regarded as being conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist. FALSE 23. The NPV and IRR methods, when used to evaluate an independent project, will lead to different accept/reject decisions unless the IRR is greater than the cost of capital. FALSE NPV profile 24. The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zerio. 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. FALSE Reinvestment rate assumption 25. In capital budgeting analyses, it is possible that NPV and IRR will both involve an assumption of reinvestment of the projects cash flows at the same rate. TRUE 26. Small businesses probably make less use of the DCF capital budgeting tecniques than large businesses. This may reflect a lack of knowledge on the part of small business firms managers, but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for those firms. TRUE

27. Although the replacement chain, or common life, approach is appealing for dealing with projects with different lives, it is not used in industry because there are no projects which meet the assumptions the method requires. FALSE 28. Extending projects with different lives to a common life for comparison purposes, while theoretically appealing, should be done only if there is a high probability that the projects will actually be replicated beyond their initial lives. TRUE EASY 29. Assume a project has normal cash flows (i.e., the initial cash flow isnegative, and all other cash flows are positive). Which of thefollowing statements is most correct? a. a. All else equal, a project's IRR increases as the cost of capitaldeclines. b. b. All else equal, a project's NPV increases as the cost of capitaldeclines. c. c. All else equal, a project's MIRR is unaffected by changes in thecost of capital. d. d. Answers a and b are correct.e. Answers b and c are correct. 30. Which of the following statements is most correct? a. a. The NPV method assumes that cash flows will be reinvested at thecost of capital while the IRR method assumes reinvestment at theIRR. b. b. The NPV method assumes that cash flows will be reinvested at therisk free rate while the IRR method assumes reinvestment at the IRR. c. c. The NPV method assumes that cash flows will be reinvested at thecost of capital while the IRR method assumes reinvestment at therisk-free rate. d. d. The NPV method does not consider the inflation premium. e. e. The IRR method does not consider all relevant cash flows, and particularly cash flows beyond the payback period. 31. A major disadvantage of the payback period method is that it a. Is useless as a risk indicator. b. b. Ignores cash flows beyond the payback period. c. c. Does not directly account for the time value of money. d. d. All of the answers above are correct. e. e. Only answers b and c are correct. 32. Graph problem 33. Which of the following statements is most correct? a. a. If a projects internal rate of return (IRR) exceeds the cost ofcapital, then the projects net present value (NPV) must bepositive. b. b. If Project A has a higher IRR than Project B, then Project A mustalso have a higher NPV. c. c. The IRR calculation implicitly assumes that all cash flows arereinvested at a rate of return equal to the cost of capital. d. d. Answers a and c are correct. e. e. None of the answers above is correct. 34. Project A has an internal rate of return (IRR) of 15 percent. ProjectB has an IRR of 14 percent. Both projects have a cost of capital of 12percent. Which of the following statements is most correct? a. a. Both projects have a positive net present value (NPV). b. b. Project A must have a higher NPV than Project B. c. c. If the cost of capital were less than 12 percent, Project B wouldhave a higher IRR than Project A. d. d. Statements a and c are correct.

35.

36. 37.

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e. e. Statements a, b, and c are correct. The post-audit is used to a. a. Improve cash flow forecasts. b. b. Stimulate management to improve operations and bring results intoline with forecasts. c. c. Eliminate potentially profitable but risky projects. d. d. All of the answers above are correct.e. Answers a and b are correct. Didnt translate well Project A has an IRR of 15 percent. Project B has an IRR of 18percent. Both projects have the same risk. Which of the followingstatements is most correct? a. a. If the WACC is 10 percent, both projects will have a positive NPV,and the NPV of Project B will exceed the NPV of Project A. b. b. If the WACC is 15 percent, the NPV of Project B will exceed the NPVof Project A. c. c. If the WACC is less than 18 percent, Project B will always have ashorter payback than Project A. d. d. If the WACC is greater than 18 percent, Project B will always have ashorter payback than Project A. e. e. If the WACC increases, the IRR of both projects will decline. A project has an up-front cost of $100,000. The projects WACC is 12percent and its net present value is $10,000. Which of the followingstatements is most correct? a. a. The project should be rejected since its return is less than theWACC. b. b. The projects internal rate of return is greater than 12 percent. c. c. The projects modified internal rate of return is less than 12percent. d. d. All of the above answers are correct.e. None of the above answers is correct. Projects L and S each have an initial cost of $10,000, followed by a series of positive cash inflows. Project L has total, undiscounted cash inflows of $16,000, while S has total undiscounted inflows of$15,000. Further, at a discount rate of 10 percent, the two projects have identical NPVs. Which project's NPV will be more sensitive to changes in the discount rate? (Hint: Projects with steeper NPV profiles are more sensitive to discount rate changes.) a. a. Project S. b. b. Project L. c. c. Both projects are equally sensitive to changes in the discount rate since their NPVs are equal at all costs of capital. d. d. Neither project is sensitive to changes in the discount rate, since both have NPV profiles which are horizontal. e. e. The solution cannot be determined unless the timing of the cashflows is known. Two mutually exclusive projects each have a cost of $10,000. The total, undiscounted cash flows from Project L are $15,000, while the undiscounted cash flows from Project S total $13,000. Their NPVprofiles cross at a discount rate of 10 percent. Which of the following statements best describes this situation? a. a. The NPV and IRR methods will select the same project if the cost of capital is greater than 10 percent; for example, 18 percent. b. b. The NPV and IRR methods will select the same project if the cost of capital is less than 10 percent; for example, 8 percent. c. c. To determine if a ranking conflict will occur between the two projects the cost of capital is needed as well as an additional piece of information. d. d. Project L should be selected at any cost of capital, because it hasa higher IRR. e. e. Project S should be selected at any cost of capital, because it hasa higher IRR. Assume that you are comparing two mutually exclusive projects. Whichof the following statements is most correct?

42.

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a. a. The NPV and IRR rules will always lead to the same decision unlessone or both of the projects are "non-normal" in the sense of havingonly one change of sign in the cash flow stream, i.e., one or moreinitial cash outflows (the investment) followed by a series of cashinflows. b. b. If a conflict exists between the NPV and the IRR, the conflict canalways be eliminated by dropping the IRR and replacing it with theMIRR. c. c. There will be a meaningful (as opposed to irrelevant) conflict onlyif the projects' NPV profiles cross, and even then, only if the costof capital is to the left of (or lower than) the discount rate atwhich the crossover occurs. d. d. Statements a, b, and c are true. Which of the following statements is incorrect? a. a. Assuming a project has normal cash flows, the NPV will be positiveif the IRR is less than the cost of capital.b. If the multiple IRR problem does not exist, any independent project acceptable by the NPV method will also be acceptable by the IRRmethod.c. If IRR = r (the cost of capital), then NPV = 0.d. NPV can be negative if the IRR is positive.e. The NPV method is not affected by the multiple IRR problem. Which of the following statements is most correct? a. a. If a project with normal cash flows has an IRR which exceeds thecost of capital, then the project must have a positive NPV. b. b. If the IRR of Project A exceeds the IRR of Project B, then Project Amust also have a higher NPV. c. c. The modified internal rate of return (MIRR) can never exceed theIRR.d. Answers a and c are correct.e. None of the answers above is correct. Which of the following statements is most correct?a. The MIRR method will always arrive at the same conclusion as the NPVmethod.b. The MIRR method can overcome the multiple IRR problem, while the NPVmethod cannot.c. The MIRR method uses a more reasonable assumption about reinvestmentrates than the IRR method.d. Statements a and c are correct.e. All of the above statements are correct. Assume a project has normal cash flows (that is, the initial cash flowis negative, and all other cash flows are positive). Which of thefollowing statements is most correct?a. All else equal, a project's IRR increases as the cost of capitaldeclines.b. All else equal, a project's NPV increases as the cost of capitaldeclines.c. All else equal, a project's MIRR is unaffected by changes in thecost of capital.d. Answers a and b are correct.e. Answers b and c are correct. Project X has an internal rate of return of 20 percent. Project Y hasan internal rate of return of 15 percent. Both projects have apositive net present value. Which of the following statements is mostcorrect?a. Project X must have a higher net present value than Project Y.b. If the two projects have the same WACC, Project X must have a highernet present value.c. Project X must have a shorter payback than Project Y.d. Both answers b and c are correct.e. None of the above answers is correct. The internal rate of return of a capital investmenta. Changes when the cost of capital changes.b. Is equal to the annual net cash flows divided by one half of theproject's cost when the cash flows are an annuity.c. Must exceed the cost of capital in order for the firm to accept theinvestment.d. Is similar to the yield to maturity on a bond.e. Answers c and d are correct. Which of the following statements is most correct? The modified IRR(MIRR) method:a. Always leads to the same ranking decision as NPV for independentprojects.b. Overcomes the problem of multiple rates of return.c. Compounds cash flows at the cost of capital.d. Overcomes the problems of cash flow timing and project size thatlead to criticism of the regular IRR method.e. Answers b and c are correct. Which of the following statements is correct?a. Because discounted payback takes account of the cost of capital, aproject's discounted payback is normally shorter than its regularpayback.b. The NPV and IRR methods use the same basic equation, but in the NPVmethod the discount rate is specified and the equation is solved forNPV, while in the IRR method the NPV is set equal to zero and thediscount rate is found.c. If the cost of capital is less than the crossover rate for twomutually exclusive projects' NPV profiles, a NPV/IRR conflict willnot occur.d. If you are choosing between two projects which have the same life,and if their NPV profiles cross, then the smaller project willprobably be the one with the steeper NPV profile.e. If the cost of capital is relatively high, this will favor larger,longer-term projects over smaller, shorter-term alternatives becauseit is good to earn high rates on larger amounts over longer periods.

50. In comparing two mutually exclusive projects of equal size and equallife, which of the following statements is most correct?a. The project with the higher NPV may not always be the project withthe higher IRR.b. The project with the higher NPV may not always be the project withthe higher MIRR.c. The project with the higher IRR may not always be the project withthe higher MIRR.d. All of the answers above are correct.e. Answers a and c are correct. 51. Which of the following is most correct?a. The NPV and IRR rules will always lead to the same decision inchoosing between mutually exclusive projects, unless one or both ofthe projects are non-normal in the sense of having only one changeof sign in the cash flow stream.b. The Modified Internal Rate of Return (MIRR) compounds cash outflowsat the cost of capital.c. Conflicts between NPV and IRR rules arise in choosing between twomutually exclusive projects (that each have normal cash flows) whenthe cost of capital exceeds the crossover point (that is, the pointat which the NPV profiles cross).d. The discounted payback method overcomes the problems that thepayback method has with cash flows occurring after the paybackperiod.e. None of the statements above is correct. 52. Which of the following statements is most correct?a. The IRR method is appealing to some managers because it produces arate of return upon which to base decisions rather than a dollaramount like the NPV method.b. The discounted payback method solves all the problems associatedwith the payback method.c. For independent projects, the decision to accept or reject willalways be the same using either the IRR method or the NPV method.d. All of the statements above are correct.e. Statements a and c are correct. 53. Which of the following statements is most correct?a. One of the disadvantages of choosing between mutually exclusiveprojects on the basis of the discounted payback method is that youmight choose the project with the faster payback period but with thelower total return.b. Multiple IRRs can occur in cases when project cash flows are normal,but they are more common in cases where project cash flows arenonnormal.c. When choosing between mutually exclusive projects, managers shouldaccept all projects with IRRs greater than the weighted average costof capital.d. All of the statements above are correct.e. Two of the statements above are correct. 54. Normal projects C and D are mutually exclusive. Project C has a highernet present value if the WACC is less than 12 percent, whereas ProjectD has a higher net present value if the WACC exceeds 12 percent. Bothprojects have a positive NPV if the WACC is 12 percent. Which of thefollowing statements is most correct?a. Project D has a higher internal rate of return.b. Project D is probably larger in scale than Project C.c. Project C probably has a faster payback.d. All of the statements above are correct.e. Answers a and c are correct. 55. A company estimates that its weighted average cost of capital (WACC) is10 percent. Which of the following independent projects should thecompany accept?a. Project A requires an up-front expenditure of $1,000,000 andgenerates a net present value of $3,200.b. Project B has a modified internal rate of return of 9.5 percent.c. Project C requires an up-front expenditure of $1,000,000 andgenerates a positive internal rate of return of 9.7 percent.d. Project D has an internal rate of return of 9.5 percent.e. None of the projects above should be accepted. 56. Your assistant has just completed an analysis of two mutually exclusiveprojects. You must now take her report to a board of directors meetingand present the alternatives for the board's consideration. To helpyou with your presentation, your assistant also constructed a graphwith NPV profiles for the two projects. However, she forgot to labelthe profiles, so you do not know which line applies to which project.Of the following statements regarding the profiles, which one is most reasonable? a. a. If the two projects have the same investment cost, and if their NPVprofiles cross once in the upper right quadrant, at a discount rateof 40 percent, this suggests that a NPV versus IRR conflict is notlikely to exist.b. If the two projects' NPV profiles cross once, in the upper leftquadrant, at a discount rate of minus 10 percent, then there willprobably not be a NPV versus IRR conflict, irrespective of therelative sizes of the two projects, in any meaningful, practicalsense (that is, a conflict which will affect the actual investmentdecision).c. If one of the projects has a NPV profile which crosses the X-axis twice, hence the project appears to have two IRRs, your assistantmust have made a mistake.d. Whenever a conflict between NPV and IRR exist, then, if the twoprojects have the same initial cost, the one with the steeper NPVprofile probably has less rapid cash flows. However, if they haveidentical cash flow patterns, then the one with the steeper profile probably has the lower initial cost.e. If the two projects both have a single outlay at t = 0, followed bya series of positive cash inflows, and if their NPV profiles crossin the lower left quadrant, then one of the projects should beaccepted, and both would be accepted if they were not mutually exclusive.

57. Which of the following statements is most correct?a. When dealing with Independent projects, discounted payback (using apayback requirement of 3 or less years), NPV, IRR, and modified IRRalways lead to the same accept/reject decisions for a given project.b. When dealing with mutually exclusive projects, the NPV and modifiedIRR methods always rank projects the same, but those rankings canconflict with rankings produced by the discounted payback and theregular IRR methods.c. Multiple rates of return are possible with the regular IRR methodbut not with the modified IRR method, and this fact is one reasongiven by the textbook for favoring MIRR (or modified IRR) over IRR.d. Statements a, b, and c are false.e. Statements a and c are true. 58. Which of the following statements is correct?a. There can never be a conflict between NPV and IRR decisions if thedecision is related to a normal, independent project, i.e., NPV willnever indicate acceptance if IRR indicates rejection.b. To find the MIRR, we first compound CFs at the regular IRR to findthe TV, and then we discount the TV at the cost of capital to findthe PV.c. The NPV and IRR methods both assume that cash flows are reinvestedat the cost of capital. However, the MIRR method assumesreinvestment at the MIRR itself.d. If you are choosing between two projects which have the same cost,and if their NPV profiles cross, then the project with the higher IRR probably has more of its cash flows coming in the later years.e. A change in the cost of capital would normally change both aproject's NPV and its IRR. 59. Project A has an internal rate of return of 18 percent, while Project Bhas an internal rate of return of 16 percent. However, if thecompanys cost of capital (WACC) is 12 percent, Project B has a highernet present value. Which of the following statements is most correct?a. The crossover rate for the two projects is less than 12 percent.b. Assuming the timing of the two projects is the same, Project A isprobably of larger scale than Project B.c. Assuming that the two projects have the same scale, Project Aprobably has a faster payback than Project B.d. Answers a and b are correct.e. Answers b and c are correct. 60. The Seattle Corporation has been presented with an investmentopportunity which will yield cash flows of $30,000 per year in Years 1through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year10. This investment will cost the firm $150,000 today, and the firm'scost of capital is 10 percent. Assume cash flows occur evenly duringthe year, 1/365th each day. What is the payback period for thisinvestment?a. 5.23 yearsb. 4.86 yearsc. 4.00 yearsd. 6.12 yearse. 4.35 years 61. 62. 63. Michigan Mattress Company is considering the purchase of land and theconstruction of a new plant. The land, which would be boughtimmediately (at t = 0), has a cost of $100,000 and the building, whichwould be erected at the end of the first year (t = 1), would cost$500,000. It is estimated that the firm's after-tax cash flow will beincreased by $100,000 starting at the end of the second year, and thatthis incremental flow would increase at a 10 percent rate annually overthe next 10 years. What is the approximate payback period?a. 2 yearsb. 4 yearsc. 6 yearsd. 8 yearse. 10 years 64. Haig Aircraft is considering a project which has an up-front cost paidtoday at t = 0. The project will generate positive cash flows of$60,000 a year at the end of each of the next five years. Theprojects NPV is $75,000 and the companys WACC is 10 percent. Whatis the projects simple, regular payback?a. 3.22 yearsb. 1.56 yearsc. 2.54 yearsd. 2.35 yearse. 4.16 years 65. Lloyd Enterprises has a project which has the following cash flows: Year/ Cashflow a. O CF -200,000 1 CF 50,000 2 CF 100,000 3 CF 150,000 4 CF 40,000 5 CF 25,000 b. The cost of capital is 10% what is the projects discounted payback? i. a. 1.8763 years ii. b. 2.0000 years iii. c. 2.3333 years iv. d. 2.4793 years v. e. 2.6380 years 66. 67. 68. The Seattle Corporation has been presented with an investmentopportunity which will yield end-of-year cash flows of $30,000 per yearin Years 1 through 4, $35,000 per year in Years 5 through 9, and$40,000 in Year 10. This

investment will cost the firm $150,000 today,and the firm's cost of capital is 10 percent. What is the NPV for thisinvestment?a. $135,984b. $ 18,023c. $219,045d. $ 51,138e. $ 92,146 69. You are considering the purchase of an investment that would pay you$5,000 per year for Years 1-5, $3,000 per year for Years 6-8, and$2,000 per year for Years 9 and 10. If you require a 14 percent rateof return, and the cash flows occur at the end of each year, then howmuch should you be willing to pay for this investment?a. $15,819.27 b. $21,937.26 c. $32,415.85 d. $38,000.00 e. $52,815.71 70. 71. Alyeska Salmon Inc., a large salmon canning firm operating out ofValdez, Alaska, has a new automated production line project it isconsidering. The project has a cost of $275,000 and is expected toprovide after-tax annual cash flows of $73,306 for eight years. Thefirm's management is uncomfortable with the IRR reinvestment assumptionand prefers the modified IRR approach. You have calculated a cost ofcapital for the firm of 12 percent. What is the project's MIRR?a. 15.0%b. 14.0%c. 12.0%d. 16.0%e. 17.0% 72. 73. Scott Corporation's new project calls for an investment of $10,000. Ithas an estimated life of 10 years. The IRR has been calculated to be15 percent. If cash flows are evenly distributed and the tax rate is40 percent, what is the annual before-tax cash flow each year? (Assumedepreciation is a negligible amount.)a. $1,993b. $3,321c. $1,500d. $4,983e. $5,019

The corporate valuation model cannot be used unless a company doesnt pay dividends. Free cash flows should be discounted at the firms weighted average cost of capital to find its operations. Value-based management focuses on sales growth, profitability, capital requirements, the weighted average cost of capital and the dividend growth rate. Two important issues in corporate governance are 1 the rules that cover the boards ability to fire the CEO and 2 the rules that over the CEOs ability to remove members of the board.