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

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Question 31

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Small businesses make less use of DCF capital budgeting techniques than large businesses. This may reflect a lack of knowledge on the part of small firms' managers, but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for very small firms.

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Question 32

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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.

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Question 33

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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. 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.

Which of the following statements best describes the IRR method?

In theory, 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.

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?

Flint Fruits is considering two equally risky, mutually exclusive projects, Projects A and B, that have the following cash flows: At what WACC would the two projects have the same NPV?

Rentz Recreation Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative) , in which case it will be rejected.

Mountain Fresh Water Company is considering two mutually exclusive machines. Machine A has an up-front cost of $100,000 (CF0 = -100,000) , and it produces positive after-tax cash inflows of $40,000 a year at the end of each of the next six years. Machine B has an up-front cost of $50,000(CF0 = - 50,000) , and it produces after-tax cash inflows of $30,000 a year at the end of the next three years. The Company's cost of capital is 10.5%. Based on the equivalent annual annuity, which machine will be chosen?

A firm should never undertake an investment if accepting the project would lead to an increase in the firm's cost of capital.

Which of the following statements is correct?

Edmondson Electric Systems is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's projected NPV is negative, it should be rejected.

The primary reason that the NPV method is conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist.

Which of the following statements is correct? Assume that the project being considered has normal cash flows, with one cash outflow at t = 0 followed by a series of positive cash flows.

Bey Bikes is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?

Van Auken Inc. is considering a project that has the following cash flows: The company's WACC is 10%. What are the project's payback, IRR, and NPV?

Which of the following statements is correct?

Theoretically speaking, hard capital rationing does not exist.

Barry Company is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected.

The IRR is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows.