Finance Exam 3
a.A project's NPV increases as the WACC declines.
Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? a.A project's NPV increases as the WACC declines. b.A project's MIRR is unaffected by changes in the WACC. c.A project's regular payback increases as the WACC declines. d.A project's discounted payback increases as the WACC declines. e.A project's IRR increases as the WACC declines.
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.
Clifford 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 $50,000, annual cash flows of $16,000 for 5 years, and an IRR of 16.63%. 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 will cross, and the larger project will look better based on the NPV at all positive values of WACC. b. 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. 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 smaller project will look better if the WACC is less than the crossover rate. e. 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.
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.
Consider 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. If Project S has a positive NPV, Project L must also have a positive NPV. b. If the WACC falls, each project's IRR will increase. c. If the WACC increases, each project's IRR will decrease. 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. e. Project S must have a higher NPV than Project L.
a.The crossover rate must be greater than 10%.
Consider two projects, X and Y. 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 greater than 10%. b.If the WACC is 8%, Project X will have the higher NPV. c.If the WACC is 18%, Project Y will have the higher NPV. d.Project X is larger in the sense that it has the higher initial cost. e.The crossover rate must be less than 10%.
a. Since the projects are mutually exclusive, the firm should always select Project B.
Martin Manufacturing is considering two normal, equally risky, mutually exclusive, but not repeatable projects. Martin's WACC is 10%. 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. Since the projects are mutually exclusive, the firm should always select Project B. b. If the crossover rate is 8%, Project B will have the higher NPV. c. Only one project has a positive NPV. d. If the crossover rate is 8%, Project A will have the higher NPV. e. Each project must have a negative NPV.
b. Assuming the two projects have the same scale, Project B probably has a faster payback than Project A.
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. Assuming the timing pattern of the two projects' cash flows is the same, Project B probably has a higher cost (and larger scale). b. Assuming the two projects have the same scale, Project B probably has a faster payback than Project A. c. The crossover rate for the two projects must be 12%. d. 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%. e. The crossover rate for the two projects must be less than 12%.
a. Project L.
Projects S and L are both normal projects with an initial cost of $10,000, followed by a series of positive cash inflows. Project S's undiscounted net cash flows total $20,000, while L's total undiscounted flows are $30,000. At a WACC of 10%, the two projects have identical NPVs. Which project's NPV is more sensitive to changes in the WACC? a. Project L. b. Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital. c. Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal. d The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs. e. Project S.
If the WACC is 10%, both projects will have positive NPVs.
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 6%, Project S will have the higher NPV. b.If the WACC is 13%, Project S will have the lower NPV. c.If the WACC is 10%, both projects will have a negative NPV. d.Project S's NPV is more sensitive to changes in WACC than Project L's. e.If the WACC is 10%, both projects will have positive NPVs.
When IRR>WACC then NPV >0, if IRR<Wacc then NPV<0 if IRR=WACC then NPV = 0
There is a very clear relationship between IRR, WACC and NPV. When IRR>WACC then NPV >0, if IRR<Wacc then NPV<0 if IRR=WACC then NPV = 0
e.Projects with "normal" cash flows can have only one real IRR.
Which of the following statements is CORRECT? a.Projects with "normal" cash flows can have two or more real IRRs. b.Projects with "normal" cash flows must have two changes in the sign of the cash flows, e.g., from negative to positive to negative. If there are more than two sign changes, then the cash flow stream is "nonnormal." c.The "multiple IRR problem" can arise if a project's cash flows are "normal." d.Projects with "nonnormal" cash flows are almost never encountered in the real world. e.Projects with "normal" cash flows can have only one real IRR.
e.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.
Which of the following statements is CORRECT? a.The discounted payback method eliminates all of the problems associated with the payback method. b.When evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a project's acceptability. c.To find the MIRR, we discount the TV at the IRR. d.A project's NPV profile must intersect the X-axis at the project's WACC. e.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.
a.To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the WACC to find the PV.
Which of the following statements is CORRECT? a.To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the WACC to find the PV. b.The NPV and IRR methods both assume that cash flows can be reinvested at the WACC. However, the MIRR method assumes reinvestment at the MIRR itself. c.If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the higher IRR probably has more of its cash flows coming in the later years. d.If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years. e.For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR.
e. The NPV method was once the favorite of academics and business executives, but today most authorities regard the MIRR as being the best indicator of a project's profitability
Which of the following statements is CORRECT? a. If the cost of capital declines, this lowers a project's NPV. 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. e. The NPV method was once the favorite of academics and business executives, but today most authorities regard the MIRR as being the best indicator of a project's profitability
e. The NPV, IRR, MIRR, and discounted payback (using a payback requirement of 3 years or less) methods always lead to the same accept/reject decisions for independent projects.
Which of the following statements is CORRECT? a.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. b.Multiple IRRs can exist, but not multiple MIRRs. This is one reason some people favor the MIRR over the regular IRR. c.If a firm uses the discounted payback method with a required payback of 4 years, then it will accept more projects than if it used a regular payback of 4 years. d.The percentage difference between the MIRR and the IRR is equal to the project's WACC. e.The NPV, IRR, MIRR, and discounted payback (using a payback requirement of 3 years or less) methods always lead to the same accept/reject decisions for independent projects.
d.If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR.
Which of the following statements is CORRECT? a.If a project has "normal" cash flows, then its MIRR must be positive. b.If a project has "normal" cash flows, then it will have exactly two real IRRs. c.The definition of "normal" cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project's life. d.If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR. e.If a project has "normal" cash flows, then its IRR must be positive
a.One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV assumption is generally more appropriate.
Which of the following statements is CORRECT? a.One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR. The NPV assumption is generally more appropriate. b.One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project's full life whereas MIRR does not. c.One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows. d.Since cash flows under the IRR and MIRR are both discounted at the same rate (the WACC), these two methods always rank mutually exclusive projects in the same order. e.One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project's full life whereas IRR does not.
a.One drawback of the regular payback is that this method does not take account of cash flows beyond the payback period.
Which of the following statements is CORRECT? a.One drawback of the regular payback is that this method does not take account of cash flows beyond the payback period. b.If a project's payback is positive, then the project should be accepted because it must have a positive NPV. c.The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. d.One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback. e.The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion.
b.One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.
Which of the following statements is CORRECT? a.The IRR method can never be subject to the multiple IRR problem, while the MIRR method can be. b.One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption. c.The higher the WACC, the shorter the discounted payback period. d.The MIRR method assumes that cash flows are reinvested at the crossover rate. e.The MIRR and NPV decision criteria can never conflict.
c.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
Which of the following statements is CORRECT? a.The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases. b.An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life. c.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. d.We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV. e.An NPV profile graph shows how a project's payback varies as the cost of capital changes.
b. If a project's IRR is equal to its WACC, then under all reasonable conditions the project's NPV must be zero.
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 IRR must be negative. b. If a project's IRR is equal to its WACC, then under all reasonable conditions the project's NPV must be zero. c. There is no necessary relationship between a project's IRR, its WACC, and its NPV. d. 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. e. If a project's IRR is equal to its WACC, then, under all reasonable conditions, the project's NPV must be negative.
a. If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.
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 also have a higher NPV. b. The IRR calculation implicitly assumes that all cash flows are reinvested at the WACC. c. The IRR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business. d. If a project has normal cash flows and its IRR exceeds its WACC, then the project's NPV must be positive. e. If Project A has a higher IRR than Project B, then Project A must have the lower NPV.
a .A project's MIRR is always less than its regular IRR.
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 less than its regular IRR. b.If a project's IRR is greater than its WACC, then the MIRR will be less than the IRR. c.If a project's IRR is greater than its WACC, then the MIRR will be greater than the IRR. d.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. e.A project's MIRR is always greater than its regular IRR.
a. The higher the WACC used to calculate the NPV, the lower the calculated NPV will be.
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. e. A project's NPV is generally found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting the TV at the IRR to find its PV.
b. If a project's NPV is less than zero, then its IRR must be less than the WACC.
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 a project's NPV, 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. e. A project's NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC.
c.A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost.
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 cash inflows at the WACC to find the present value (PV), then discounting the TV to find the IRR. b.If a project's IRR is smaller than the WACC, then its NPV will be positive. c.A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost. d.If a project's IRR is positive, then its NPV must also be positive. e.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
e.A project's regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC.
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. e.A project's regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC.
b.If a project's payback is positive, then the project should be rejected because it must have a negative NPV.
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.One drawback of the regular payback for evaluating projects is that this method does not properly account for the time value of money. b.If a project's payback is positive, then the project should be rejected because it must have a negative NPV. c.The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. d.If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time. e.The longer a project's payback period, the more desirable the project is normally considered to be by this criterion.
a.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. The same project will rank higher by both criteria.
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 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. The same project will rank higher by both criteria. b.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. The same 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. e.If the two projects' NPV profiles do not cross, then there will be a sharp conflict as to which one should be selected.
b.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.
You are on the staff of O'Hara Inc. The CFO believes project acceptance should be based on the NPV, but Andrew O'Hara, 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, although its NPV is positive, it has an IRR that is less than the WACC. b.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. c.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. d.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. e.You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.
