Q&A Hero

Q: The internal rate of return of a capital investment a. Changes when the required rate of return changes. b. Is equal to the annual net cash flows divided by one half of the project's cost when the cash flows are an annuity. c. Must exceed the required rate of return in order for the firm to accept the investment. d. Is similar to the yield to maturity on a bond. e. Answers c and d are both correct.

Q: Assume that you are comparing two mutually exclusive projects. Which of the following statements is most correct? a. The NPV and IRR rules will always lead to the same decision unless one or both of the projects are "non-conventional" in the sense of having only one change of sign in the cash flow stream, i.e., one or more initial cash outflows (the investment) followed by a series of cash inflows. b. If a conflict exists between the NPV and the IRR, the conflict can always be eliminated by dropping the IRR and replacing it with the payback period. c. There will be a meaningful (as opposed to irrelevant) conflict only if the projects' NPV profiles cross, and even then, only if the required rate of return is to the left of (or lower than) the discount rate at which the crossover occurs. d. Statements a, b, and c are all true. e. None of the above is a correct statement.

Q: Which of the following statements is correct? a. Large costs occur at the end of nuclear power plants' lives because these plants have to be closed down, and shutdown costs are high due to the difficulty of handling radioactive materials. For this reason, it is possible that a nuclear plant project could have two IRRs. b. If the Federal Reserve Board lowered interest rates, this would, other things held constant, tend to favor short-term as opposed to long-term projects. c. For NPV versus IRR ranking conflicts to occur, the projects under consideration must have NPV profiles which cross one another. Crossing profiles can occur only if the two projects differ in the size of the required investment outlay. d. All of the above statements are false.

Q: Which of the following statements is false? a. The NPV will be positive if the IRR is less than the required rate of return. b. If the multiple IRR problem does not exist, any independent project acceptable by the NPV method will also be acceptable by the IRR method. c. When IRR = r (the required rate of return), NPV = 0. d. The IRR can be positive even if the NPV is negative. e. The NPV method is not affected by the multiple IRR problem.

Q: Which of the following statements is correct? a. The discounted payback is generally shorter than the regular payback. b. Any type of project might have multiple rates of return if the IRR is sufficiently high. c. The NPV and IRR methods can lead to conflicting accept/reject decisions only if (1) mutually exclusive projects are being evaluated and (2) if the projects' NPV profiles cross at a rate less than the firm's required rate of return. d. The NPV and IRR methods can lead to conflicting accept/reject decisions only if (1) mutually exclusive projects are being evaluated and (2) if the projects' NPV profiles cross at a rate greater than the firm's required rate of return. e. None of the above is a correct statement.

Q: Which of the following statements is correct? a. Because discounted payback takes account of the required rate of return, a project's discounted payback is normally shorter than its regular payback. b. The NPV and IRR methods use the same basic equation, but in the NPV method the discount rate is specified and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found. c. If the required rate of return is less than the crossover rate for two mutually exclusive projects' NPV profiles, a NPV/IRR conflict will not occur. d. If you are choosing between two projects which have the same life, and if their NPV profiles cross, then the smaller project will probably be the one with the steeper NPV profile. e. If the required rate of return is relatively high, this will favor larger, longer-term projects over smaller, shorter-term alternatives because it is good to earn high rates on larger amounts over longer periods.

Q: The present value of the expected net cash inflows for a project will most likely exceed the present value of the expected net profit after tax for the same project because a. Income is reduced by taxes paid, but cash flow is not. b. There is a greater probability of realizing the projected cash flow than the forecasted income. c. Income is reduced by dividends paid, but cash flow is not. d. Income is reduced by depreciation charges, but cash flow is not. e. Cash flow reflects any change in net working capital, but sales do not.

Q: Risk in a revenue producing project can best be adjusted for by a. Ignoring it. b. Adjusting the discount rate upward for increasing risk. c. Adjusting the discount rate downward for increasing risk. d. Picking a risk factor equal to the average discount rate. e. Reducing the NPV by 10 percent for risky projects.

Q: A firm is considering the purchase of an asset whose risk is greater than the current risk of the firm, based on any method for assessing risk. In evaluating this asset, the decision maker should a. Increase the IRR of the asset to reflect the greater risk. b. Increase the NPV of the asset to reflect the greater risk. c. Reject the asset, since its acceptance would increase the risk of the firm. d. Ignore the risk differential if the asset to be accepted would comprise only a small fraction of the total assets of the firm. e. Increase the required rate of return used to evaluate the project to reflect the higher risk of the project.

Q: Which of the following is not discussed in the text as a method for analyzing risk in capital budgeting? a. Sensitivity analysis. b. Beta, or CAPM, analysis. c. Monte Carlo simulation. d. Scenario analysis. e. All of the above are discussed in the text as methods of analyzing risk in capital budgeting.

Q: Which of the following statements is correct? a. If a firm's stockholders are well diversified, we know from theory and from studies of market behavior that corporate risk is not important. b. Undiversified stockholders, including the owners of small businesses, are more concerned about corporate risk than market risk. c. Empirical studies of the determinants of required rates of return (r) have found that only market risk affects stock prices. d. Market risk is important but does not have a direct effect on stock price because it only affects beta.

Q: Which of the following statements is correct? a. Capital budgeting analysis for expansion and replacement projects is essentially the same because the types of cash flows involved are the same. b. In estimating supplemental operating cash flows for the purpose of capital budgeting, interest payments should not be included since the effects of these payments are already included in the rate of return the firm is required to earn from its investments. c. When equipment is sold, companies receive a tax credit as long as the salvage value is less than the initial cost of the equipment. d. All of the above answers are correct. e. None of the above answers is correct.

Q: Which of the following statements is correct? a. Capital budgeting analysis for expansion and replacement projects is essentially the same because the types of cash flows involved are the same. b. The replacement decision involves an analysis of two independent projects where the relevant cash flows include the initial investment, additional depreciation, and the terminal value. c. The change in working capital for a project is the difference between the required increase in current assets and the spontaneous increase in current liabilities and is always positive. d. The supplemental operating cash flow for capital budgeting includes return on invested capital, which is net income, and return of part of invested capital, which is depreciation. e. When a firm implements a project which requires an increase in working capital, both the increase in current assets and current liabilities must be financed.

Q: Which of the following is not a cash flow that results from the decision to accept a project? a. Changes in working capital. b. Shipping and installation costs. c. Sunk costs. d. Opportunity costs. e. Externalities.

Q: Which of the following statements is most correct? a. Sunk costs should be ignored in capital budgeting. b. Opportunity costs should be ignored in capital budgeting. c. Externalities should be ignored in capital budgeting. d. Answers a, b, and c are all correct. e. Answers a, b, and c are all incorrect.

Q: When evaluating a new project, the firm should consider all of the following factors except: a. Changes in working capital attributable to the project. b. Previous expenditures associated with a market test to determine the feasibility of the project, if the expenditures have been expensed for tax purposes. c. The current market value of any equipment to be replaced. d. The resulting difference in depreciation expense if the project involves replacement. e. All of the above should be considered.

Q: Which of the following statements is correct? a. The NPV method assumes that cash flows will be reinvested at the required rate of return while the IRR method assumes reinvestment at the IRR. b. The NPV method assumes that cash flows will be reinvested at the risk-free rate while the IRR method assumes reinvestment at the IRR. c. The NPV method assumes that cash flows will be reinvested at the required rate of return while the IRR method assumes reinvestment at the risk-free rate. d. The NPV method does not consider the inflation premium. e. The IRR method does not consider all relevant cash flows, and particularly cash flows beyond the payback period.

Q: The post-audit is used to a. Improve cash flow forecasts. b. Stimulate management to improve operations and bring results into line with forecasts. c. Eliminate potentially profitable but risky projects. d. All of the above are correct. e. Only answers a and b are correct.

Q: The underlying cause of ranking conflicts between the NPV and IRR methods is differing a. Initial cost. b. Reinvestment rate assumption. c. Cash flow timing. d. Profitability indices. e. All of the above comprise the underlying cause of ranking conflicts.

Q: If the calculated NPV is negative, then which of the following must be true? The discount rate used is a. Equal to the internal rate of return. b. Too high. c. Greater than the internal rate of return. d. Too low. e. Less than the internal rate of return.

Q: A major disadvantage of the payback period method is that it a. Is useless as a risk indicator. b. Ignores cash flows beyond the payback period. c. Does not directly account for the time value of money. d. All of the above are correct. e. Only answers b and c are correct.

Q: Assume a project has normal cash flows (i.e., the initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct? a. All else equal, a project's IRR increases as the required rate of return declines. b. All else equal, a project's NPV increases as the required rate of return declines. c. All else equal, a project's IRR is unaffected by changes in the required rate of return. d. Answers a and b are both correct. e. Answers b and c are both correct.

Q: When a project's NPV exceeds zero, a. The project will also be acceptable using payback criteria. b. The IRR should be calculated to insure that the project's projected rate of return exceeds the required rate of return. c. The project should be accepted without any further consideration, assuming we are confident that the cash flows and the required rate of return have been properly estimated. d. Only answers a and c are correct. e. None of the above is correct.

Q: Which of the following capital budgeting methods might not consider the salvage value of a machine being considered for purchase? a. Internal rate of return. b. Net present value. c. Payback. d. Discounted payback. e. Answers c and d are both correct.

Q: Repatriation of funds is not relevant in multinational capital budgeting analysis as the funds generated in foreign countries can be reinvested in that country generating larger cash flows for the parent company. a. True b. False

Q: One of the disadvantages of the payback method for evaluating capital budgeting projects is that it does not adjust for the riskiness of different projects. a. True b. False

Q: The internal rate of return for a project that has initial costs of $10,000 and generates cash flows of $7,000 in year one, $8,000 in year two, and $5,000 in year three is 35.7%. a. True b. False

Q: The net present value of capital budgeting project with an initial cost of $5,000 that generates $1,000 after-tax cash flows each year for ten years is $1,710 when discounted at 8 percent. a. True b. False

Q: Internal rate of return assumes that all of the cash flows from a capital budgeting can be reinvested at the weighted average cost of capital. a. True b. False

Q: Net present value and internal rate of return will always give the same accept or reject decision for mutually exclusive projects, but they might give different rankings for independent projects. a. True b. False

Q: The change in net working capital that results from the acceptance of a project is an incremental cash flow that must be considered in capital budgeting analysis. a. True b. False

Q: The depreciable base of an asset includes the purchase price and any additional expenditures required to make the asset operational, including shipping and installation. a. True b. False

Q: Only the incremental after-tax cash flows associated with a capital project are relevant in capital budgeting. a. True b. False

Q: Capital budgeting decisions must be based on net income to determine if the investment is to create value for the firm. a. True b. False

Q: Estimating the cash flows in a capital project is the easiest and least important part of the capital budgeting process. a. True b. False

Q: If a firm invests in a project with a present value less than its cost, the value of the firm will increase. a. True b. False

Q: Capital budgeting is process of planning expenditures on assets whose cash flows are expected to end in less than one year. a. True b. False

Q: Assume the following: (1) A firm is considering two projects, one with a 5-year life and the other with a 10-year life; (2) the cash flows of the two projects are equally risky by all definitions of the word "risky"; (3) the company uses 40 percent debt and 60 percent equity to finance the projects; (4) the debt used to finance any given project has a maturity equal to the life of the project; and (5) the term structure of interest rates has a sharp upward slope. This would suggest, other things held constant, that a lower discount rate should be used to find the NPV for the 5-year project than for the 10-year project. a. True b. False

Q: Other things held constant, if a firm takes on a project that increases its beta coefficient, unless the increased beta is offset by a higher expected return, the firm's stock price will decline. a. True b. False

Q: If a project is small relative to the total firm, and if its returns are not highly correlated with the returns on the firm's other assets, then the project may not be very risky in either the within-firm (corporate) or the market risk sense, even if the returns on the project are highly uncertain and thus the project has a high degree of stand-alone risk. a. True b. False

Q: As a practical matter, it is much easier to use market risk analysis at the project level than at the divisional level because it is easier to estimate the beta of a single project such as a machine tool die maker than the beta of an entire division (or subsidiary) such as Phillip Morris' Kraft foods unit. a. True b. False

Q: Sensitivity analysis measures the stand-alone risk of a project by showing how much the project's NPV is affected by a small change in one of the input variables, such as sales. Other things held constant, with the independent variable graphed on the horizontal axis, the steeper the graph of the relationship line, the less risky the project. a. True b. False

Q: Many firms use more than one technique to evaluate capital budgeting projects because multiple measures can provide decision makers with somewhat different pieces of relevant information. a. True b. False

Q: The net present value of a replacement item of equipment will decrease if the current market value of the equipment to be replaced is increased, other things held constant. a. True b. False

Q: It is possible with a replacement project that the incremental depreciation cash flows will be negative even if the actual depreciation on the new asset is positive. a. True b. False

Q: The change in net working capital is always positive, meaning more working capital is required, for projects considered in capital budgeting because all projects are either expansion projects or replacement projects which have expansion effects. a. True b. False

Q: It is extremely difficult to estimate the revenues and costs associated with large complex projects that take several years to develop. This is why subjective judgment is recommended for such projects instead of cash flow analysis. a. True b. False

Q: Superior analytical techniques, such as NPV, used in combination with adjustments to the average required rate of return, can overcome the problem of poor cash flow estimation in decision making. a. True b. False

Q: Suppose a firm is considering production of a new product whose projected sales include sales that will be taken away from another product the firm also produces. The lost sales on the existing product are a sunk cost and are not a relevant cost to the new product. a. True b. False

Q: Opportunity costs include those cash inflows that could be generated from assets the firm already owns, if those assets are not used for the project being evaluated. a. True b. False

Q: The two cardinal rules which financial analysts follow to avoid capital budgeting errors are: (1) capital budgeting decisions must be based on accounting income, and (2) only incremental cash flows are relevant to accept/reject decisions. a. True b. False

Q: Small businesses probably make less use of the 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 those firms. a. True b. False

Q: In capital budgeting analyses, it is possible that NPV and IRR will both involve assuming reinvestment of the project's cash flows at the same rate. a. True b. False

Q: 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 required rate of return. 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. a. True b. False

Q: The NPV and IRR methods, when used to evaluate an independent project, will lead to different accept/reject decisions unless the IRR is greater than the required rate of return. a. True b. False

Q: The main reason that the NPV method is regarded as being conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist. a. True b. False

Q: If the IRR of normal Project X is greater than the IRR of mutually exclusive Project Y (also normal), we can conclude that the firm will select X rather than Y if X has a NPV > 0. a. True b. False

Q: When considering two mutually exclusive projects, the financial manager should always select that project whose internal rate of return is the highest provided the projects have the same initial cost. a. True b. False

Q: Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large cash flows late in its life. At the current required rate of return, normal Projects S and L have identical NPVs. Now suppose interest rates and money costs generally decline. Other things held constant, this change will cause L to become preferred to S. a. True b. False

Q: Normal Projects Q and R have the same NPV when the discount rate is zero. However, Project Q has larger early cash flows than R. Therefore, we know that at all discount rates greater than zero, Project R will have a greater NPV than Q. a. True b. False

Q: A decrease in the firm's discount rate (r) will increase NPV, which could change the accept/reject decision for a potential project. However, such a change would have no impact on the project's IRR, hence on the accept/reject decision under the IRR method. a. True b. False

Q: Any capital budgeting investment rule should depend solely on forecasted cash flows and the opportunity rate of return. The rule itself should not be affected by managers' tastes, the choice of accounting method, or the profitability of other independent projects. a. True b. False

Q: The cost of capital may be different for a foreign project than for an equivalent domestic project because foreign projects may be more or less risky. a. True b. False

Q: The cash flows relevant for the analysis of a foreign investment should, from the parent company's perspective, include the financial cash flows that the subsidiary can legally send back to the parent company and the cash flows which must remain in the foreign country. a. True b. False

Q: Exchange rate risk is the risk that the cash flows from a foreign project will be worth less than those same cash flows denominated in the parent company's home currency. a. True b. False

Q: If a firm faces capital rationing, it should select that set of investments which has the highest total net present value, subject to the constraint that it does not require more capital than is available. a. True b. False

Q: The situation where a firm accepts projects to the point where the return on the last project accepted is just equal to or greater than the firm's required rate of return (IRR u2265 r at the margin) is called capital rationing. a. True b. False

Q: Using the same risk-adjusted discount rate to discount all cash flows ignores the fact that the more distant cash flows are riskier. a. True b. False

Q: If a firm is considering purchasing an asset whose beta is greater than the current beta of the firm, it should use a discount rate greater than the firm's average required rate of return to evaluate the possible investment. a. True b. False

Q: The lower the correlation of a project's cash flows with those of the rest of the firm, the greater will be the benefits of the project with regard to reducing within-firm risk. a. True b. False

Q: If a particular project would increase a firm's beta coefficient if it is accepted, then we can conclude that the firm's required rate of return also would increase, other things held constant. a. True b. False

Q: Quantification of risk is the easiest part of incorporating risk into capital budgeting; treatment of that calculated risk measure is more difficult. a. True b. False

Q: One problem with Monte Carlo simulation analysis is that, while the simulation may provide some insights into the riskiness of a project, the analysis does not lead to a clear-cut accept versus reject decision. a. True b. False

Q: When risk is explicitly accounted for in capital budgeting, a project will be acceptable to a firm if its IRR is greater than the firm's average required rate of return. a. True b. False

Q: Risky projects can be evaluated by discounting expected cash flows using a risk-adjusted discount rate. a. True b. False

Q: A particular project might have very uncertain cash flows, hence a highly uncertain NPV and IRR, yet it may not have high market risk. a. True b. False

Q: If an asset being considered for acquisition has beta of zero, its purchase will have no effect on the firm's market risk. a. True b. False

Q: A project's market risk rises if the correlation of its cash flows with the economy decreases. a. True b. False

Q: A key difference between replacement and expansion project analyses is that with replacement, the incremental cash flows are measured as the net difference between projected cash flows from the current productive assets and cash flows of the proposed new productive assets. a. True b. False

Q: Externalities present in projects being considered in capital budgeting are very difficult to quantify and as a result of this, they should be excluded from the financial analyses. a. True b. False