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

A) For a project to have more than one IRR, both IRRs must be greater than the WACC.
B) If two projects are mutually exclusive, then they are likely to have multiple IRRs.
C) If a project is independent, then it cannot have multiple IRRs.
D) Multiple IRRs can occur only if the signs of the cash flows change more than once.

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A) For independent projects, the NPV, IRR, MIRR, and discounted payback (using a payback requirement of three years or less) methods always lead to the same accept/reject decisions for a given project.
B) 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.
C) Multiple IRRs can exist, but not multiple MIRRs. This is one reason some people favour the MIRR over the regular IRR.
D) If a firm uses the discounted payback method with a required payback of four years, then it will accept more projects than if it used as its cutoff criterion a regular payback of four years.

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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.

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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.

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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) 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.
D) 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 larger smaller project will look better if the WACC is less than the crossover rate.

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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.

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A) Project S must have a higher NPV than Project L.
B) If Project S has a positive NPV, then Project L must also have a positive NPV.
C) If the WACC falls, then each project's IRR will increase.
D) 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.

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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 9%, Project B's NPV will be higher than Project A's.

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A) If the two projects' NPV profiles do not cross in the upper right quadrant, 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) For a conflict to exist between NPV and IRR, the initial investment cost of one project must exceed the cost of the other.
D) 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.

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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.

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A) Project S
B) Project L
C) Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital.
D) Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal.

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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.

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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.

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