Module 10 FINANCE
Which of the following statements is CORRECT? The project's regular payback increases as the WACC declines. The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects. The project's IRR increases as the WACC declines. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
Which of the following statements is FALSE? The payback rule is reliable because it considers the time value of money and depends on the cost of capital. The payback period is a useful indicator of the risk and liquidity of a project. For most investment opportunities expenses occur initially and cash is received later. Fifty percent of firms surveyed reported using the payback rule for making decisions.
The payback rule is reliable because it considers the time value of money and depends on the cost of capital.
Which of the following statements is FALSE? The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea. There is always one internal rate of return (IRR) for an investment opportunity. In general, there can be as many internal rates of return (IRRs) as the number of times the project's cash flows change sign over time. A net present value (NPV) will always exist for an investment opportunity.
There is always one internal rate of return (IRR) for an investment opportunity.
A decrease in the firm's discount rate (r, or WACC) will increase NPV of a project with normal cash flows, which could change the accept/reject decision for any independent project under the NPV method. However, since such a change would have no impact on the project's IRR, the accept/reject decision of the independent project under the IRR method does not depend on the cost of capital.
false
All else constant, an increase in the cost of capital will result in a decrease in a project's IRR.
false
Assuming that their NPVs based on the firm's cost of capital are equal, the NPV of a project whose cash flows accrue relatively rapidly will be more sensitive to changes in the discount rate than the NPV of a project whose cash flows come in later in its life.
false
Internal rate of return (IRR) can reliably be used to choose between mutually exclusive projects.
false
Suppose there are two mutually exclusive projects — Project X and Project Y — with normal cash flows. If the IRR of Project X is greater than the IRR of Project Y, we can conclude that the firm should select X rather than Y if X has NPV > 0.
false
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 of 10%. If the two projects are mutually exclusive, Project X will be selected over Project Y at all discount rates (at which NPV of X is positive).
false
The internal rate of return (IRR) rule will agree with the Net Present Value rule even when positive cash flows precede negative cash flows.
false
Which of the following is NOT a limitation of the payback period rule?
it is difficult to calculate
A firm is considering several mutually exclusive investment opportunities. The best way to choose between them is which of the following?
net present value
The cash flows for three projects are shown below. The cost of capital is 7.5%. If an investor decided to take projects with a payback period two years or less, which of these projects would he take?
none of these investments
Which of the following decision rules is best defined as the amount of time it takes to pay back the initial investment?
payback period
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 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. If a project's IRR is greater than the WACC, then its NPV must be negative. To find a project's IRR, we must find a discount rate that is equal to the WACC. 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.
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.
One advantage of the payback method for evaluating potential investments is that it provides some information about a project's liquidity and risk.
true
The NPV method's assumption that cash inflows are reinvested at the cost of capital is more reasonable than the IRR's assumption that cash flows are reinvested at the IRR.
true
The payback rule is based on the idea that an opportunity that pays back its initial investment quickly is a worthwhile opportunity.
true
Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project's life.
true
When different investment rules give conflicting answers, then decisions should be based on the Net Present Value rule, as it is the most reliable and accurate decision rule.
true
The owner of a hair salon spends $1,000,000 to renovate its premises, believing that this will increase her future cash flow. She constructs the graph below, which shows the net present value (NPV) as a function of the discount rate. At what discount rate does her decision to renovate become untenable?
3.3%
Which of the following situations can lead to IRR giving a different decision than NPV for mutually exclusive projects?
All of the above can lead to IRR giving a different decision than 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. If Project A has a higher IRR than Project B, then Project A must have the lower NPV. The IRR calculation implicitly assumes that all cash flows are reinvested at the WACC. The IRR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business. If a project has normal cash flows and its IRR exceeds its WACC, then the project's NPV must be positive. If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.
If a project has normal cash flows and its IRR exceeds its WACC, then the project's NPV must be positive.
Which of the following statements is FALSE for normal projects (i.e., projects with normal cash flows)?
If the cost of capital estimate is more than the internal rate of return (IRR), the net present value (NPV) will be positive.
Which of the following is NOT a limitation of the payback rule?
It is difficult to calculate
Which of the following statements is CORRECT? If a project is independent, then it cannot have multiple IRRs. Multiple IRRs can only occur if the signs of the cash flows change more than once. If two projects are mutually exclusive, then they are likely to have multiple IRRs. If a project has two IRRs, then the smaller one is the one that is most relevant, and it should be accepted and relied upon. For a project to have more than one IRR, then both IRRs must be greater than the WACC.
Multiple IRRs can only occur if the signs of the cash flows change more than once.
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.
One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.
Which of the following statements is CORRECT? 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 sign changes, then the cash flow stream is "non-normal." Projects with "normal" cash flows can have only one IRR. Projects with "non-normal" cash flows are never encountered in the real world. The "multiple IRR problem" can arise if a project's cash flows are "normal." Projects with "normal" cash flows can have two or more real IRRs.
Projects with "normal" cash flows can have only one IRR.
