For
more course tutorials visit
1. Which of the following
statements is CORRECT?
a. The internal rate of return
method (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 net present value method
(NPV) is generally regarded by academics as being the best single method for
evaluating capital budgeting projects.
e. The modified internal rate of
return method (MIRR) is generally regarded by academics as being the best
single method for evaluating capital budgeting projects.
2. Projects A and B have
identical expected lives and identical initial cash outflows (costs). However,
most of one project’s cash flows come in the early years, while most of the
other project’s cash flows occur in the later years. The two NPV profiles are
given below:
Which of the following statements
is CORRECT?
a. More of Project A’s cash flows
occur in the later years.
b. More of Project B’s cash flows
occur in the later years.
c. We must have information on
the cost of capital in order to determine which project has the larger early
cash flows.
d. The NPV profile graph is
inconsistent with the statement made in the problem.
e. The crossover rate, i.e., the
rate at which Projects A and B have the same NPV, is greater than either
project’s IRR.
3. Suppose a firm relies
exclusively on the payback method when making capital budgeting decisions, and
it sets a 4-year payback regardless of economic conditions. Other things held
constant, which of the following statements is most likely to be true?
a. It will accept too many
short-term projects and reject too many long-term projects (as judged by the
NPV).
b. It will accept too many
long-term projects and reject too many short-term projects (as judged by the
NPV).
c. The firm will accept too many
projects in all economic states because a 4-year payback is too low.
d. The firm will accept too few
projects in all economic states because a 4-year payback is too high.
e. If the 4-year payback results
in accepting just the right set of projects under average economic conditions,
then this payback will result in too few long-term projects when the economy is
weak.
4. 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 the firm’s
value will increase if the project is accepted.
d. You should recommend that the
project be rejected. Although its NPV is positive 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.
5. A firm 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 the
firm on the best procedure. If the wrong decision criterion is used, how much
potential value would the firm lose?
WACC: 6.00%
Year 0 1 2 3 4
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
No comments:
Post a Comment