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Exam 9: Capital Budgeting Techniques

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Question 31

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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

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Question 32

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A major disadvantage of the payback period method is 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.

F) C) and D)
G) B) and D)

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Question 33

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Using the discounted payback method, a project should be accepted when the discounted payback is greater than the projects expected life.

The capital budgeting director of Sparrow Corporation is evaluating a project which costs $200,000, is expected to last for 10 years and produce after-tax cash flows, including depreciation, of $44,503 per year.If the firm's required rate of return is 14 percent and its tax rate is 40 percent, what is the project's IRR?

When Richard evaluated a capital budgeting project, a new machine needed to manufacture inventory using his firm's required rate of return, he discovered that the project's net present value (NPV) is negative.Based on this information, which of the following must be correct?

There exists an IRR solution for each time the direction of cash flows associated with project is interrupted.

If a project's NPV exceeds the project's IRR, then the project should be accepted.

Which of the following statements is false?

A college intern working at Anderson Paints evaluated potential investments that is, capital budgeting projects using the firm's average required rate of return (WACC) , and he produced the following report for the capital budgeting manager: $\begin{array}{llll}\underline{\text { Project }} &\underline{\text { NPV } }&\underline{\text { IRR }} & \underline{\text { Risk }} \\\text { LOM } & \$ 1,500 & 12.5 \% & \text { High } \\\text { QUE } & 0 & 11.0 & \text { Low } \\\text { YUP } & 800 & 9.5 & \text { Averag } \\\text { DOG } & (450) & 10.0 & \text { Low }\end{array}$ The capital budgeting manager usually considers the risks associated with capital budgeting projects before making her final decision.If a project has a risk that is different from average, she adjusts the average required rate of return by adding or subtracting 2 percentage points.If the four projected listed above are independent, which one(s) should the capital budgeting manager recommend be purchased?

Two projects being considered by a firm are mutually exclusive and have the following projected cash flows: $\begin{array}{lll}\underline{\text { Year }} &\underline{ \text { Project A }}&\underline{ \text { Project B }}\\0 & (\$ 100,00) & (\$ 100,000 \\1 & 39,500 & 0 \\2 & 39,500 & 0 \\3 & 39,500 & 133,000\end{array}$ Based only on the information given, which of the two projects would be preferred, and why?

The Seattle Corporation has been presented with an investment opportunity which will yield end of year cash flows of $30,000 per year in Years 1 through 4, $35,000 per year in Years 5 through 9, and $40,000 in Year 10.This investment will cost the firm $150,000 today, and the firm's required rate of return is 10 percent.What is the NPV for this investment?

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.

Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV.

The involves comparing the actual results with those predicted by the project's sponsors and explaining why Any differences occur.

Woodson Inc.has two possible projects, Project A and Project B, with the following cash flows: $\begin{array}{rrr}\underline{\text { Year }} & \underline{\text { Project A }} & \underline{\text { Project B }} \\0 & -150,000 & -100,000 \\2 & 100,000 & 45,000 \\3 & 105,000 & 65,000 \\3 & 40,000 & 80,000\end{array}$ . At what required rate of return do the two projects have the same net present value (NPV) ? (In other words, what is the "crossover rate" of the projects' NPV profiles?)

Net present value is preferred to internal rate of return for capital budgeting decisions because

Two fellow financial analysts are evaluating a project with the following net cash flows: $\begin{array} { l l } \text { Year } & \text { Cash Flow } \\0 & \$ - 10,000 \\1 & 100,000 \\2 & - 100,000\end{array}$ One analyst says that the project has an IRR of between 12 and 13%.The other analyst calculates an IRR of just under 800%, but fears his calculator's battery is low and may have caused an error.You agree to settle the dispute by analyzing the project cash flows.Which statement best describes the IRR for this project?

Which of the following statements is correct?

An increase in the discount rate used in computing the NPV of a project will lower the value of the NPV for that project.

Projects A and B have the same expected lives and initial cash outflows.However, one project's cash flows are larger in the early years, while the other project has larger cash flows in the later years.The two NPV profiles are given below: Which of the following statements is correct?