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36843462-Chapter-12

36843462-Chapter-12

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CHAPTER 12 CAPITAL BUDGETING: DECISION CRITERIA

(Difficulty: E = Easy, M = Medium, and T = Tough)

True-False Easy:
Capital budget Answer: b Diff: E 1. A firm should never undertake an investment if accepting the project would cause an increase in the firm's cost of capital. a. True b. False PV of cash flows Answer: b Diff: E 2. Because present value refers to the value of cash flows that occur at different points in time, present values cannot be added to determine the value of a capital budgeting project. a. True b. False Ranking methods Answer: b Diff: E 3. Given two mutually exclusive projects and a zero cost of capital, the payback method and NPV method of selecting investments will always lead to the same decision on which project to undertake. a. True b. False Payback period Answer: a Diff: E 4. One advantage of the payback period method of evaluating fixed asset investment possibilities is that it provides a rough measure of a project's liquidity and risk. a. True b. False NPV 5. Answer: Assuming that the total cash flows are equal, the NPV of whose cash flows accrue relatively rapidly is more sensitive in the discount rate than is the NPV of a project whose cash in more slowly. a. True b. False b Diff: E a project to changes flows come

Chapter 12 - Page 1

IRR 6.

Answer: a Diff: E The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs) with the present value of the cash inflows. a. True b. False

IRR 7.

Answer: a Diff: E Under certain conditions, a particular project may have more than one IRR. One condition under which this situation can occur is if, in addition to the initial investment at time = 0, a negative cash flow occurs at the end of the project's life. a. True b. False

IRR 8.

Answer: b Diff: E Other things held constant, an increase in the cost of capital discount rate will result in a decrease in a project's IRR. a. True b. False

IRR and NPV Answer: b Diff: E 9. If a project's NPV exceeds the project's IRR, then the project should be accepted. a. True b. False Multiple IRRs Answer: b Diff: E 10. The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects which have different lives are being compared. a. True b. False Modified IRR Answer: b Diff: E 11. The modified IRR (MIRR) method has wide appeal to professors, but most business executives prefer the NPV method to either the regular or modified IRR. a. True b. False Modified IRR Answer: b Diff: E 12. The modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method. a. True b. False

Chapter 12 - Page 2

Mutually exclusive projects Answer: a Diff: E 13. 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. a. True b. False Reinvestment rate assumption Answer: a Diff: E 14. 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. This makes the NPV method preferable to the IRR method. a. True b. False Replacement chain Answer: b Diff: E 15. The replacement chain, or common life, approach is applicable whether two projects with differing lives are mutually exclusive or independent. a. True b. False

Medium:
Ranking methods Answer: a Diff: M 16. 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. a. True b. False Ranking methods Answer: b Diff: M 17. 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 Mutually exclusive projects Answer: b Diff: M 18. 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

Chapter 12 - Page 3

NPV 19.

Answer: b Diff: M 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

NPV 20.

Answer: a Diff: M 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 cost of capital, 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

IRR and NPV Answer: b Diff: M 21. 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 NPV versus IRR Answer: b Diff: M 22. 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 NPV versus IRR Answer: b Diff: M 23. 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 cost of capital. a. True b. False NPV profile Answer: b Diff: M 24. 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. a. True b. False Chapter 12 - Page 4

a. Extending projects with different lives to a common life for comparison purposes. approach is appealing for dealing with projects with different lives. it is not used in industry because there are no projects which meet the assumptions the method requires. should be done only if there is a high probability that the projects will actually be replicated beyond their initial lives. False Chapter 12 . a. False Common life comparisons Answer: a Diff: M 28. it is possible that NPV and IRR will both involve an assumption of reinvestment of the project's cash flows at the same rate. Small businesses probably make less use of the DCF capital budgeting techniques than large businesses.Reinvestment rate assumption Answer: a Diff: M 25.Page 5 . but it may also reflect a rational conclusion that the costs of using DCF analysis outweigh the benefits of these methods for those firms. True b. This may reflect a lack of knowledge on the part of small firms' managers. True b. False Small business Answer: a Diff: M 26. False Replacement chain Answer: b Diff: M 27. a. while theoretically appealing. In capital budgeting analyses. or common life. True b. True b. Although the replacement chain. a.

Which of the following statements is most correct? a. All else equal. The NPV method does not consider the inflation premium. A major disadvantage of the payback period method is that it a. Payback period Answer: e 31. All else equal. a declines. a declines. All of the answers above are correct. Assume a project has normal cash flows (i. d.Page 6 . and particularly cash flows beyond the payback period.e. Answers b and c are project's IRR increases as the cost of capital project's NPV increases as the cost of capital project's MIRR is unaffected by changes in the correct. c. Is useless as a risk indicator. b. The NPV method assumes that cash flows will be reinvested at the cost of capital while the IRR method assumes reinvestment at the IRR.Multiple Choice: Conceptual Easy: Ranking methods Answer: b Diff: E 29. Only answers b and c are correct.. Ignores cash flows beyond the payback period. The IRR method does not consider all relevant cash flows. c. Which of the following statements is most correct? a. c. e. b. Answers a and b are e. d. All else equal. correct. e. b. Answer: a Diff: E Ranking conflicts 30. The NPV method assumes that cash flows will be reinvested at the risk free rate while the IRR method assumes reinvestment at the IRR. The NPV method assumes that cash flows will be reinvested at the cost of capital while the IRR method assumes reinvestment at the risk-free rate. d. the initial cash flow is negative. a cost of capital. Does not directly account for the time value of money. and all other cash flows are positive). Diff: E Chapter 12 .

None of the answers above is correct. b. Project A must have a higher NPV than Project B. The IRR calculation implicitly assumes that all cash flows are reinvested at a rate of return equal to the cost of capital. e. NPV and IRR 33. c. NPV and IRR Answer: a Diff: E 34. c. d. while the other project has larger cash flows in the later years. The two NPV profiles are given below: NPV A B r Which of the following statements is most correct? a. c.Page 7 . Both projects have a cost of capital of 12 percent. If Project A has a higher IRR than Project B. We require information on the cost of capital in order to determine which project has larger early cash flows. Project A has the smaller cash flows in the later years. Project A has the larger cash flows in the later years. d. and c are correct. then the project’s net present value (NPV) must be positive. Projects A and B have the same expected lives and initial cash outflows. e. b. Which of the following statements is most correct? a. then Project A must also have a higher NPV. Project A has an internal rate of return (IRR) of 15 percent. However. Chapter 12 . d. b. b. Project B has an IRR of 14 percent. Which of the following statements is most correct? Answer: a Diff: E a. Statements a.NPV profiles Answer: b Diff: E 32. None of the statements above is correct. Answers a and c are correct. Statements a and c are correct. e. one project's cash flows are larger in the early years. If the cost of capital were less than 12 percent. If a project’s internal rate of return (IRR) exceeds the cost of capital. Both projects have a positive net present value (NPV). Project B would have a higher IRR than Project A. The NPV profile graph is inconsistent with the statement made in the problem.

Chapter 12 . All of the above answers are correct. Both projects have the same risk. The project’s WACC is 12 percent and its net present value is $10. Project B has an IRR of 18 percent. e. If the WACC is greater than 18 percent. c. the IRR of both projects will decline. b. A project has an up-front cost of $100. None of the above answers is correct. b. d. b. A B C B and C E Answer: b Diff: E Project A has an IRR of 15 percent. and you only have the information that is provided. and the NPV of Project B will exceed the NPV of Project A.000.Page 8 . If the following projects are mutually exclusive. Eliminate potentially profitable but risky projects. If the WACC is 10 percent. The project’s internal rate of return is greater than 12 percent. e. If the WACC is 15 percent. which should you accept? A 1 18% $40 B 5 20% $75 C 2 20% $35 E 5 12% $100 Payback (years) IRR NPV (Millions) a. Which of the following statements is most correct? a. Answers a and b are correct. IRR. Improve cash flow forecasts. The post-audit is used to Answer: e Diff: E a.Post-audit 35. The project should be rejected since its return is less than the WACC. c. d. both projects will have a positive NPV. All of the answers above are correct. e. Your company has a cost of capital equal to 10%. If the WACC increases.000. d. d. If the WACC is less than 18 percent. c. Project B will always have a shorter payback than Project A. Stimulate management to improve operations and bring results into line with forecasts. The project’s modified internal rate of return is less than 12 percent. IRR 37. the NPV of Project B will exceed the NPV of Project A. e. b. Project selection Answer: e Diff: E 36. Project B will always have a shorter payback than Project A. and MIRR Answer: b Diff: E 38. NPV. Which of the following statements is most correct? a. c.

NPV profiles Answer: a Diff: M 40. Which project's NPV will be more sensitive to changes in the discount rate? (Hint: Projects with steeper NPV profiles are more sensitive to discount rate changes. 18 percent. Project S. Project L has total. since both have NPV profiles which are horizontal. Two mutually exclusive projects each have a cost of $10. The NPV and IRR methods will select the same project if the cost of capital is greater than 10 percent. b. c. b. while the undiscounted cash flows from Project S total $13. followed by a series of positive cash inflows. Neither project is sensitive to changes in the discount rate. The NPV and IRR methods will select the same project if the cost of capital is less than 10 percent. Chapter 12 . 8 percent. Which of the following statements best describes this situation? a. c. while S has total undiscounted inflows of $15. e.Page 9 .000. d. Further. because it has a higher IRR. The solution cannot be determined unless the timing of the cash flows is known. Both projects are equally sensitive to changes in the discount rate since their NPVs are equal at all costs of capital. Projects L and S each have an initial cost of $10. Project S should be selected at any cost of capital. Project L should be selected at any cost of capital. because it has a higher IRR. at a discount rate of 10 percent. e. for example.000.) a. Project L.000. The total. To determine if a ranking conflict will occur between the two projects the cost of capital is needed as well as an additional piece of information. the two projects have identical NPVs. for example. undiscounted cash inflows of $16.000.000. undiscounted cash flows from Project L are $15.000.Medium: NPV profiles Answer: b Diff: M 39. Their NPV profiles cross at a discount rate of 10 percent. d.

i. c. b. only if the cost of capital is to the left of (or lower than) the discount rate at which the crossover occurs. c. Statements a. If the IRR of Project A exceeds the IRR of Project B. IRR. If IRR = r (the cost of capital). and MIRR 43. All of the above statements are correct. c. NPV. one or more initial cash outflows (the investment) followed by a series of cash inflows. Which of the following statements is most correct? Answer: a Diff: M a. b. The MIRR method can overcome the multiple IRR problem. and MIRR 44. while the NPV method cannot. Chapter 12 . NPV and IRR 42. then the project must have a positive NPV. c. any independent project acceptable by the NPV method will also be acceptable by the IRR method. If a conflict exists between the NPV and the IRR. None of the answers above is correct. e. The modified internal rate of return (MIRR) can never exceed the IRR. and even then. NPV. b. Which of the following statements is most correct? Answer: c Diff: M a.. b. Assume that you are comparing two mutually exclusive projects. Assuming a project has normal cash flows. d. If the multiple IRR problem does not exist. Which of the following statements is most correct? a. The NPV method is not affected by the multiple IRR problem.Page 10 . d. e. b. Answers a and c are correct. Statements a and c are correct.e. If a project with normal cash flows has an IRR which exceeds the cost of capital. and c are true. the NPV will be positive if the IRR is less than the cost of capital.NPV and IRR Answer: c Diff: M 41. d. d. e. There will be a meaningful (as opposed to irrelevant) conflict only if the projects' NPV profiles cross. IRR. then NPV = 0. then Project A must also have a higher NPV. Which of the following statements is incorrect? Answer: a Diff: M a. the conflict can always be eliminated by dropping the IRR and replacing it with the MIRR. The MIRR method uses a more reasonable assumption about reinvestment rates than the IRR method. The MIRR method will always arrive at the same conclusion as the NPV method. The NPV and IRR rules will always lead to the same decision unless one or both of the projects are "non-normal" in the sense of having only one change of sign in the cash flow stream. NPV can be negative if the IRR is positive.

Page 11 . IRR. d. Answer: e The internal rate of return of a capital investment a. b. Assume a project has normal cash flows (that is. Project Y has an internal rate of return of 15 percent. Overcomes the problems of cash flow timing and project size that lead to criticism of the regular IRR method. Project X has an internal rate of return of 20 percent. Is similar to the yield to maturity on a bond. All else equal. All else equal. e. Always leads to the same ranking decision as NPV for independent projects. NPV. c. Project X must have a higher net present value than Project Y. a cost of capital. None of the above answers is correct. b.NPV. Which of the following statements is most correct? a. Both projects have a positive net present value. c. IRR. b. e. e. Project X must have a shorter payback than Project Y. d. All else equal. Is equal to the annual net cash flows divided by one half of the project's cost when the cash flows are an annuity. Overcomes the problem of multiple rates of return. d. Answers a and b are e. Which of the following statements is most correct? The modified IRR (MIRR) method: a. Answers c and d are correct. c. c. Changes when the cost of capital changes. a declines. Both answers b and c are correct. Project X must have a higher net present value. correct. the initial cash flow is negative. and MIRR Answer: b Diff: M 45. Compounds cash flows at the cost of capital. Diff: M Chapter 12 . Answers b and c are correct. Which of the following statements is most correct? a. Answers b and c are project's IRR increases as the cost of capital project's NPV increases as the cost of capital project's MIRR is unaffected by changes in the correct. Modified IRR Answer: e Diff: M 48. b. and all other cash flows are positive). a declines. Must exceed the cost of capital in order for the firm to accept the investment. and payback Answer: e Diff: M 46. d. IRR 47. If the two projects have the same WACC.

Which of the following is most correct? Answer: e Diff: M a. The Modified Internal Rate of Return (MIRR) compounds cash outflows at the cost of capital. a project's discounted payback is normally shorter than its regular payback. The project with the higher the higher MIRR. Because discounted payback takes account of the cost of capital. The project with the higher the higher MIRR. The project with the higher the higher IRR. Miscellaneous concepts 51. shorter-term alternatives because it is good to earn high rates on larger amounts over longer periods.Page 12 . Conflicts between NPV and IRR rules arise in choosing between two mutually exclusive projects (that each have normal cash flows) when the cost of capital exceeds the crossover point (that is. Which of the following statements is correct? Answer: b Diff: M a. then the smaller project will probably be the one with the steeper NPV profile. c. and if their NPV profiles cross. a NPV/IRR conflict will not occur. NPV may not always be the project with NPV may not always be the project with IRR may not always be the project with correct. e. None of the statements above is correct. longer-term projects over smaller. c. unless one or both of the projects are “non-normal” in the sense of having only one change of sign in the cash flow stream. b. e. All of the answers above are e. but in the NPV method the discount rate is specified and the equation is solved for NPV. d. Chapter 12 . d. If the cost of capital is relatively high. In comparing two mutually exclusive projects of equal size and equal life. If you are choosing between two projects which have the same life. If the cost of capital is less than the crossover rate for two mutually exclusive projects' NPV profiles. the point at which the NPV profiles cross). c. The discounted payback method overcomes the problems that the payback method has with cash flows occurring after the payback period. this will favor larger. while in the IRR method the NPV is set equal to zero and the discount rate is found. The NPV and IRR rules will always lead to the same decision in choosing between mutually exclusive projects. d. Answers a and c are correct. Ranking methods Answer: e Diff: M 50.Ranking methods 49. b. which of the following statements is most correct? a. The NPV and IRR methods use the same basic equation. b.

Which of the following independent projects should the company accept? a. the decision to accept or reject will always be the same using either the IRR method or the NPV method. d. Which of the following statements is most correct? a. Statements a and c are correct.5 percent. but they are more common in cases where project cash flows are nonnormal. rate of return.000 generates a positive internal rate of return of 9. Two of the statements above are correct. Project B has a modified internal rate of return of 9. Normal projects C and D are mutually exclusive.000. c. b. For independent projects. Which of the following statements is most correct? Answer: e Diff: M a. e. e. All of the statements above are correct.000 generates a net present value of $3. scale than Project C. Project C requires an up-front expenditure of $1. Project C has a higher net present value if the WACC is less than 12 percent.5 percent. whereas Project D has a higher net present value if the WACC exceeds 12 percent.7 percent. None of the projects above should be accepted. e.Miscellaneous concepts 52. The IRR method is appealing to some managers because it produces a rate of return upon which to base decisions rather than a dollar amount like the NPV method. The discounted payback method solves all the problems associated with the payback method. Both projects have a positive NPV if the WACC is 12 percent. Project selection Answer: a Diff: M 55. All of the statements above are correct. Multiple IRRs can occur in cases when project cash flows are normal. d. Miscellaneous concepts 53. b. managers should accept all projects with IRRs greater than the weighted average cost of capital.Page 13 . A company estimates that its weighted average cost of capital (WACC) is 10 percent. d.000. One of the disadvantages of choosing between mutually exclusive projects on the basis of the discounted payback method is that you might choose the project with the faster payback period but with the lower total return. Project D has an internal rate of return of 9. d. and and Chapter 12 . Which of the following statements is most correct? Answer: a Diff: M a. payback. Project A requires an up-front expenditure of $1. Project D has a higher internal Project D is probably larger in Project C probably has a faster All of the statements above are Answers a and c are correct. e. correct. b. c.200. Miscellaneous concepts Answer: a Diff: M 54. c. When choosing between mutually exclusive projects. b. c.

and if their NPV profiles cross in the lower left quadrant. e.Page 14 . Statements a. IRR. your assistant must have made a mistake. When dealing with independent projects. When dealing with mutually exclusive projects. and both would be accepted if they were not mutually exclusive. this suggests that a NPV versus IRR conflict is not likely to exist. c. NPV. discounted payback (using a payback requirement of 3 or less years). then the one with the steeper profile probably has the lower initial cost. then there will probably not be a NPV versus IRR conflict. followed by a series of positive cash inflows. then one of the projects should be accepted. hence the project appears to have two IRRs. but those rankings can conflict with rankings produced by the discounted payback and the regular IRR methods. Whenever a conflict between NPV and IRR exist. in the upper left quadrant. If the two projects have the same investment cost. Of the following statements regarding the profiles. if they have identical cash flow patterns. and if their NPV profiles cross once in the upper right quadrant. b. c. and MIRR 57. the one with the steeper NPV profile probably has less rapid cash flows. if the two projects have the same initial cost. Your assistant has just completed an analysis of two mutually exclusive projects. irrespective of the relative sizes of the two projects. NPV. Statements a and c are true. and this fact is one reason given by the textbook for favoring MIRR (or modified IRR) over IRR. d. Which of the following statements is most correct? Answer: c Diff: T a. practical sense (that is. To help you with your presentation. If one of the projects has a NPV profile which crosses the X-axis twice. a conflict which will affect the actual investment decision). Chapter 12 . at a discount rate of minus 10 percent. which one is most reasonable? a. IRR.Tough: NPV profiles Answer: b Diff: T 56. If the two projects both have a single outlay at t = 0. your assistant also constructed a graph with NPV profiles for the two projects. the NPV and modified IRR methods always rank projects the same. Multiple rates of return are possible with the regular IRR method but not with the modified IRR method. at a discount rate of 40 percent. and c are false. However. b. If the two projects' NPV profiles cross once. so you do not know which line applies to which project. However. d. then. in any meaningful. she forgot to label the profiles. and modified IRR always lead to the same accept/reject decisions for a given project. e. You must now take her report to a board of directors meeting and present the alternatives for the board's consideration. b.

Choosing among mutually exclusive projects Answer: c Diff: T 59.12 4.23 4.00 6. What is the payback period for this investment? a. b. d.NPV.000 per year in Years 5 through 9. c. then the project with the higher IRR probably has more of its cash flows coming in the later years. the MIRR method assumes reinvestment at the MIRR itself. Project A probably has a faster payback than Project B. Answers b and c are correct. Assuming that the two projects have the same scale. d. $35. The NPV and IRR methods both assume that cash flows are reinvested at the cost of capital. d.e. To find the MIRR. Multiple Choice: Problems Easy: Payback period Answer: b Diff: E 60. b. However. and MIRR 58. This investment will cost the firm $150. i. However. Which of the following statements is correct? Answer: a Diff: T a. and if their NPV profiles cross. c. A change in the cost of capital would normally change both a project's NPV and its IRR. e. Answers a and b are correct. The Seattle Corporation has been presented with an investment opportunity which will yield cash flows of $30.000 in Year 10. and the firm's cost of capital is 10 percent.000 today.86 4. b. if the company’s cost of capital (WACC) is 12 percent. There can never be a conflict between NPV and IRR decisions if the decision is related to a normal. c. e. and then we discount the TV at the cost of capital to find the PV.35 years years years years years Chapter 12 ..000 per year in Years 1 through 4. NPV will never indicate acceptance if IRR indicates rejection. Assuming the timing of the two projects is the same. Assume cash flows occur evenly during the year. while Project B has an internal rate of return of 16 percent. 1/365th each day.Page 15 . e. Which of the following statements is most correct? a. Project B has a higher net present value. we first compound CFs at the regular IRR to find the TV. independent project. and $40. IRR. If you are choosing between two projects which have the same cost. The crossover rate for the two projects is less than 12 percent. Project A has an internal rate of return of 18 percent. 5. Project A is probably of larger scale than Project B.

625 15. b.000 15. c. Neither.NPV 61.000 10.500 If the required rate of return on these projects is 10 percent. Project A because it has the higher NPV.625 15. Project B because it has the higher NPV. NPV. which project would you choose? a. X. which would be chosen and why? a. Neither Project Project Project Project project. Answer: a Diff: E exclusive and have the Two projects being considered following projected cash flows: are mutually Year 0 1 2 3 4 5 Project A Cash Flow -$50. NPV 62. since it it it it has has has has the the the the higher higher higher higher IRR. c.625 15.625 Project B Cash Flow -$50.000 50.000 30.000 30.000 40.000 40. since Z. because both have IRRs less than the cost of capital. d.000 Project Z Cash Flow -$100. e. since Z.625 15.Page 16 . b. since X.000 10. d. Answer: a Diff: E As the director of capital budgeting for Denver Corporation. NPV. e. Project B because it has the higher IRR. IRR.000 Year 0 1 2 3 4 If Denver's cost of capital is 15 percent. Chapter 12 .000 0 0 0 0 99. you are evaluating two mutually exclusive projects with the following net cash flows: Project X Cash Flow -$100.000 60. Project A because it has the higher IRR.

would cost $500.000 50. The project will generate positive cash flows of $60. b.000. which would be bought immediately (at t = 0).0000 2.6380 years years years years years Chapter 12 . c. Haig Aircraft is considering a project which has an up-front cost paid today at t = 0. Michigan Mattress Company is considering the purchase of land and the construction of a new plant. d. 4 c.35 4. c. What is the project’s simple. 3. e. has a cost of $100. It is estimated that the firm's after-tax cash flow will be increased by $100. e.000 40.8763 2.54 2. 6 d. d.22 1. b. 2 b. The land. Lloyd Enterprises has a project which has the following cash flows: Year 0 1 2 3 4 5 Cash Flow -$200. 1.4793 2. What is the approximate payback period? a.3333 2.000 What is the project's discounted The cost of capital is 10 percent. which would be erected at the end of the first year (t = 1).Page 17 .000 25.000 starting at the end of the second year.000 and the building.Medium: Payback period Answer: c Diff: M 63.000 150.000 a year at the end of each of the next five years. The project’s NPV is $75. payback? a. regular payback? a.000 and the company’s WACC is 10 percent.000 100. 8 e. 10 years years years years years Payback period Answer: c Diff: M 64.16 years years years years years Discounted payback Answer: e Diff: M 65. and that this incremental flow would increase at a 10 percent rate annually over the next 10 years.56 2.

000 Project B Cash Flow -$80.000 0 Year 0 1 2 3 4 Which investment project(s) does the company invest in? a. b.Discounted payback Answer: b Diff: M 66. b.000 30. 1. discounted payback? a. Project Neither Project Project A only. The corporation uses the discounted payback method to assess potential projects and utilizes a discount rate of 10 percent.67 years years years years years Discounted payback Answer: d Diff: M 67. Project A nor Project B. d.000 60.000 30. e. d.86 2.000 40.000 20. c.67 1.000 40.000 40.000 What is the project’s The company has a 10 percent cost of capital. Davis Corporation is faced with two independent investment opportunities.000 30. Chapter 12 .Page 18 .000 90. Polk Products is considering an investment project with the following cash flows: Year 0 1 2 3 4 Cash Flow -$100.000 50. The corporation has an investment policy which requires acceptable projects to recover all costs within 3 years. B only.000 40.11 2. A and Project B. c. The cash flows for the two projects are: Project A Cash Flow -$100.49 2.

and the cash flows occur at the end of each year. What is the NPV for this investment? a. $ 577. c.146 NPV 69.000 today.984 $ 18. Answer: b Diff: M You are considering the purchase of an investment that would pay you $5. $3.5 years. and $40.000 per year for Years 9 and 10.NPV 68.500 The project has a payback of 2. e. $15. This investment will cost the firm $150.815.000 3. d. $135.85 $38.Page 19 . and the firm's cost of capital is 10 percent.415.91 $1. d. $35. b.023 $219. b.00 $52.91 Chapter 12 .27 $21. e.000 per year for Years 6-8.045 $ 51.819.000 1.80 $2. The firm’s cost of capital is 12 percent.765.26 $32.71 NPV and payback Answer: b Diff: M 70. Answer: d Diff: M The Seattle Corporation has been presented with an investment opportunity which will yield end-of-year cash flows of $30. e. Shannon Industries is considering a project which has the following cash flows: Year 0 1 2 3 4 Cash Flow ? $2.138 $ 92.000 per year in Years 5 through 9. What is the project’s net present value NPV? a. then how much should you be willing to pay for this investment? a. and $2. b. c.000 per year for Years 1-5.68 $ 765. d.000 3. c.761.32 $3.000 in Year 10.000 per year in Years 1 through 4.000. If you require a 14 percent rate of return.937.049.

0% MIRR and CAPM Answer: d Diff: M 72.0% 17. It has an estimated life of 10 years..000 and is expected to provide after-tax annual cash flows of $73. d.Page 20 . The IRR has been calculated to be 15 percent. and the estimated market risk premium is 6 percent. Alyeska Salmon Inc. $1.019 Chapter 12 .500 $4. the risk-free rate is 7 percent.9% Before-tax cash flows Answer: b Diff: M 73. Currently.000.4% 16. b. d. what is the annual before-tax cash flow each year? (Assume depreciation is a negligible amount. If cash flows are evenly distributed and the tax rate is 40 percent. e. The firm's management is uncomfortable with the IRR reinvestment assumption and prefers the modified IRR approach.000 at the end of the next 3 years. The project has a cost of $275. b. c. a large salmon canning firm operating out of Valdez.) a.0% 17.0% 16. b. c.Modified IRR Answer: d Diff: M 71. Nulook is evaluating a project which has a cost today of $2.306 for eight years.0% 14. 12. d. 15. e.321 $1. e. and it uses the Capital Asset Pricing Model with a historical beta to determine its cost of equity. Scott Corporation's new project calls for an investment of $10.5% 20. c.983 $5.0% 22. You have calculated a cost of capital for the firm of 12 percent. Below are the returns of Nulook Cosmetics and "the market" over a three-year period: Year 1 2 3 Nulook 9% 15 36 Market 6% 10 24 Nulook finances internally using only retained earnings. What is this project's MIRR? a. What is the project's MIRR? a.993 $3.0% 12. has a new automated production line project it is considering. Alaska.028 and will provide estimated cash inflows of $1.

7 percent. This project has two imaginary IRRs.000 100. Two fellow financial analysts following net cash flows: Year 0 1 2 are evaluating a Answer: c Diff: T project with the Cash Flow -$ 10. There are multiple IRRs of approximately 12. You agree to settle the dispute by analyzing the project cash flows.000 One analyst says that the project has an IRR of between 12 and 13 percent. e.000 -100. This project has no IRR. There are an infinite number of IRRs between 12. Chapter 12 . c.Page 21 . Which statement best describes the IRR for this project? a. d. There is a single IRR of approximately 12. The other analyst calculates an IRR of just under 800 percent.5 percent and 790 percent that can define the IRR for this project. because the NPV profile does not cross the X axis. b. but fears his calculator's battery is low and may have caused an error.Tough: Multiple IRRs 74.7 percent and 787 percent.

b.53% 18.500 S -1.310 at the end of 20 years if you pay premiums of $100 per year at the end of each year for 20 years. 12.08% 20. 7% c. c. the project which the company should choose if it wants to maximize its stock price? a.. of $44. Find the internal rate of return to the nearest whole percentage point. 9% b. e.Financial Calculator Section Multiple Choice: Problems Easy: IRR 75. S and L.e. What is the regular IRR (not MIRR) of the better project. is expected to last for 10 years and produce after-tax cash flows. If the firm's cost of capital is 14 percent and its tax rate is 40 percent. 3% e. including depreciation. 5% d.Page 22 . d. IRR 76.000. Answer: c Diff: E The capital budgeting director of Sparrow Corporation is evaluating a project which costs $200. whose cash flows are shown below: Years 0 r = 12% 1 | | 1. and it can get an unlimited amount of capital at that cost. 11% IRR and mutually exclusive projects Answer: d Diff: E 77. a. 8% 14% 18% -5% 12% Answer: c Diff: E An insurance firm agrees to pay you $3.000 0 2 | 350 300 3 | 50 1.503 per year.00% 15. c. d. A company is analyzing two mutually exclusive projects.100 The company's cost of capital is 12 percent.62% 19.46% Chapter 12 . e.100 L -1. what is the project's IRR? a. b. i.

360 $11.000 18. Your company is choosing between the following non-repeatable. $243.000 20. c.76 5 | 668.76 668. $ 7. e.510 $15.090 $ 8.000 a. Your cost of capital is 10 percent. mutually exclusive projects with the cash flows shown below.000 12.000 6.NPV and IRR Answer: b Diff: E 78. c.000 10. d. b. d.000 Year 0 1 2 3 4 The company’s cost of capital is 10 percent (WACC = 10%).76 3 | 500 4 | 668.50 $481.76 2 | 500 3 | 668.Page 23 . Green Grocers is deciding among two mutually exclusive projects.000 12.000 40.13 1 | 1 | 500 2 | 668.76 NPV and IRR Answer: e Diff: E 79. b.15 $535.000 15.43 $291. The two projects have the following cash flows: Project A Cash Flow -$50.70 $332. e. What is the net present value (NPV) of the project with the highest internal rate of return (IRR)? a.000 Project L: 0 r = 10% | -2.450 $12. How much value will your firm sacrifice if it selects the project with the higher IRR? Project S: 0 r = 10% | -1.200 Chapter 12 .000 Project B Cash Flow -$30. equally risky.

6.6. b. $300.22%. 2. What is the project’s payback.69 $1. IRR.22%.12%. Braun Industries is considering an investment project which has the following cash flows: Year 0 1 2 3 4 Cash Flow -$1. e. 2. Inflation is expected to be zero during the next 4 years. d. and payback Answer: d Diff: E 80. b.89 $1. If the cost of capital for the project is 11 percent. 21. b. Chapter 12 . by what amount will the better project increase Vanderheiden's value? a. and in three years it will receive $90 million.00%.6.72 million.000 per year for 4 years. Replacement chain Answer: d Diff: E 81.000 and will produce net cash flows of $5. $260. NPV NPV NPV NPV NPV = = = = = $600. e. NPV = $2.72 million.76 $1. Process L will cost $11. If the company goes ahead with the project.31 Medium: NPV. NPV = $12. e. IRR IRR IRR IRR IRR = = = = = 10. None of the above. and if Vanderheiden's cost of capital is 10 percent. so the shirts will not be produced after 4 years. c. Vanderheiden Inc. internal rate of return. Process S has a cost of $8. d.22%.NPV. In two years it will receive $80 million. IRR = 16%.500 and will produce cash flows of $4. NPV = $12.72 million. IRR = Two positive IRRs. The company has a contract that requires it to produce the shirts for 4 years.4. 21. what are the project’s NPV and IRR? a.72 million. 2. and Sunk Costs Answer: d Diff: M 82.237. and then spend $20 million in one year. IRR = Two positive IRRs. $260. IRR. 24.Page 24 . it must immediately spend another $100 million now.179.4. $ 677.000 400 300 500 400 The company’s WACC is 10 percent. $300.46 $1. but the patent will expire after 4 years. 2. Payback Payback Payback Payback Payback = = = = = 2. c. A company just paid $10 million for a feasibility study. IRR = 16%. d.098.312. If cash inflows occur at the end of each year. and net present value? a. c. 21. is considering two average-risk alternative ways of producing its patented polo shirts.000 per year for 2 years. NPV = $2.

000) 39. Two companies have submitted bids. e.000 0 0 0 3. b.Mutually exclusive projects Answer: b Diff: M 83. requires a new machine. because it has a higher IRR. 24%.877 Machine B Cash Flow -$2. Choose neither. c. which of the two projects would be preferred. 18%.500 Project B Cash Flow ($100. Cash flow analysis indicates the following: Machine A Cash Flow -$2. e. Project B. of the cash Answer: d Diff: M Genuine Products Inc.500 39.500 39. and you have been assigned the task of choosing one of the machines. Indifferent. d. and why? a. Two projects being considered by a firm are mutually exclusive and have the following projected cash flows: Project A Cash Flow ($100. 18%. because it has a shorter payback period. 24%. since the sum inflows exceeds the initial investment in both cases. IRRB IRRB IRRB IRRB IRRB = = = = = 20% 20% 16% 24% 26% Chapter 12 . because the projects have equal IRRs. since their NPVs are negative.Page 25 . b. IRR 84. c. Include both in the capital budget. d.000 832 832 832 832 Year 0 1 2 3 4 What is the internal rate of return for each machine? a. IRRA IRRA IRRA IRRA IRRA = = = = = 16%.000 Year 0 1 2 3 Based only on the information given. Project A.000) 0 0 133.

e.000 5.88% 12.Page 26 . S and L. d. The mine will bring year-end after-tax cash inflows of $2 million at the end of the two succeeding years. respectively. b. d. Whitney Crane Inc. 14.53% Chapter 12 . 16% 18% 18% 18% 16% and and and and and 14% 10% 20% 13% 13% NPV and IRR Answer: a Diff: M 86.IRR 85. Your company is planning to open a new gold mine which will cost $3 million to build.009 Life (Years) 1 2 3 4 IRR 15 13 The IRRs for Projects A and C.09% 12.696 1. b.100 -1.36% 10. e. c. 13.5 million to close down the mine at the end of the third year of operation.) a. What is the regular IRR (not MIRR) of the better project? (Hint: Note that the better project may or may not be the one with the higher IRR.100 1 900 0 2 350 300 3 50 500 4 10 850 The company's cost of capital is 12 percent. c. b. and then it will cost $0. What is this project's IRR? a. A company is analyzing two mutually exclusive projects.000 Annual Cash Inflows $11. e.800 3.70% 21.17% 17. has the opportunities for the coming year: following Answer: c Diff: M independent investment Project A B C D Cost $10. with the expenditure occurring at the end of the year three years from today.00% 17. are: a.53% IRR of uneven CF stream Answer: d Diff: M 87.000 12. d.075 5. c.42% 12.000 3. and it can get an unlimited amount of capital at that cost. whose cash flows are shown below: Years S L 0 -1.46% 13.

Page 27 . All cash inflows and outflows are after taxes. As the capital budgeting director for Chapel Hill Coffins Company. $1.000 for repairs. It will then receive net cash flows of $0. Within what range is the plant's IRR? a.29% c.000.5 million at the end of Years 2 . and $2 million at the end of Years 3 through 5. b. you are evaluating construction of a new plant. and it expects to sell the property and net $1 million at the end of Year 6. e.33% Chapter 12 . 8.5% 11. Houston Inc.000 operating cash inflow and an outflow of $1.000. d. 9. What is the project's modified IRR (MIRR)? a.9% 12. However.) a. and it uses the modified IRR criterion for capital budgeting decisions.5 million at the end of Year 2.000. c. Capitol City Transfer Company is considering building a new terminal in Salt Lake City. e.000 must be incurred at the end of the 10th year. repairs which will cost $1. If the company goes ahead with the project.45% e.5. and it will provide net cash inflows of $1 million at the end of Year 1.IRR of uneven CF stream Answer: e Diff: M 88. is considering a project which involves building a new refrigerated warehouse which will cost $7. d. at the end of Year 10 there will be a $500.0% 11. 7. c.81% d. The company's cost of capital is 12 percent.000 at t = 0 and which is expected to have operating cash flows of $500. 12.75% b. The plant has a net cost of $5 million in Year 0 (today). If Houston's cost of capital is 12 percent. 14 15 16 17 18 15% 16% 17% 18% 19% Modified IRR Answer: e Diff: M 89. b.7% Modified IRR Answer: b Diff: M 90. it must spend $1 million immediately (at t = 0) and another $1 million at the end of Year 1 (t = 1). what is the project's MIRR? (Hint: Think carefully about the MIRR equation and the treatment of cash outflows.4% 11. 11. Thus.000 at the end of each of the next 20 years. 11.

000.54% 23. Belanger Construction is considering the following project. What is the project’s modified internal rate of return (MIRR)? a.00% 19.000) 125. b.000 a year for each of the remaining three years (t = 3.45% Modified IRR Answer: b Diff: M 92. d. e.95% 16.25% 19. and it has a cost of capital of 10 percent. c. Acheson Aluminum is considering a project with the following cash flows. The company has a cost of capital of 12 percent. c.65% 21.000 What is the project’s modified internal Modified IRR Answer: d Diff: M 93.000 140.82% 14.86% Cash Flow ($200. b.10% 14. and t = 5).000) 100. 10.000 each year for the first two years (t = 1 and t = 2).Modified IRR Answer: e Diff: M 91.23% 12.90% 15. c.75% Chapter 12 .00% 18. Cash flows in parentheses denote negative cash flows.5 years. Martin Manufacturers is considering a five-year investment which costs $100. The project has an up-front cost and will also generate the following subsequent cash flows: t = 1 $400 t = 2 500 t = 3 200 The project’s payback is 1. What is the MIRR of the investment? a. $50.000 (50.33% 16. e. d. Year 0 1 2 3 4 Acheson’s WACC is 10 percent.Page 28 . rate of return (MIRR)? a.38% 14. d. 12. The investment will produce cash flows of $25. 17. e. t = 4. b.

000 operating cash inflow and an outflow of $6.000 at the end of the second year.000 When is Project B more lucrative than Project A? (That is. c.000.57%. 0. For all Project Project For all For all values of r B is always A is always values of r values of r less than 7. more profitable than Project A.65% e.000 60.000 at t = 0. e.000 40.11% 34.000 40. However. Jones Company's end-of-year net of capital for What is the sum a. of the project's IRR and its MIRR? MIRR and IRR Answer: b Diff: M 95.000 50. more profitable than Project B.59% Answer: e Diff: M new truck has a cost of $20. Thus. greater than 6. and it will produce cash inflows of $7. b.Page 29 .78% NPV profiles 96. e. d.000 40. The cost an average-risk project like the truck is 8 percent.48% 18. The project is expected to have operating cash flows of $5. 3.000 for repairs. 9.00% b. c. The following projects: Answer: d Diff: M mutually exclusive cash flows are estimated for two Year 0 1 2 3 4 Project A Cash Flow -$100. 13.51% c.25%.000. at the end of Year 2 there will be a $5. less than 6. Chapter 12 .000 20.75% 26. d.57%.MIRR and IRR 94.000 20.) a. over what range of costs of capital (r) does Project B have a higher NPV than Project A?) (Choose the best answer.000.000.40% d. 0. The company's cost of capital is 15 percent.000. Florida Phosphate is considering a project which involves opening a new mine at a cost of $10.000 Project B Cash Flow -$110. the facility will have to be repaired at a cost of $6.000 at the end of each of the next 4 years.000 10. b. What is the difference between the project's MIRR and its regular IRR? a.23% 37.000 per year for 5 years.000. 15.

03% Chapter 12 . b. what is the “crossover” rate?) a. b.000 200 800 3.0 4. c.80% Crossover rate Answer: b Diff: M 98.72% 17.49% 19. At what discount rate would he be indifferent between the two contracts? a.0 Team B Cash Flow $2.000 800 200 Year 0 1 2 3 4 At what cost of capital will the net present value of the two projects be the same? (That is.000 Project B Cash Flow -$5.000 3. Martin Fillmore is a big football star who has been offered contracts by two different teams.0 4.0 4. d.Crossover rate Answer: b Diff: M 97.25% 17.68% 16.000 3.000 5.85% 11.0 8.0 4.15% 16.5 4.67% 21.35% 16. c.Page 30 . e. The payments (in millions of dollars) he receives under the two contracts are listed below: Team A Cash Flow $8. McCarver Inc. is considering the following mutually exclusive projects: Project A Cash Flow -$5.0 4. 10. d.0 Year 0 1 2 3 4 Fillmore is committed to accepting the contract which provides him with the highest net present value (NPV). 15.0 8. e.

is considering two projects which have the following cash flows: Project 1 Project 2 Cash Flow Cash Flow Year 0 -$2.26% 12.70% Answer: d Diff: M exclusive projects.98% 6. Shelby Inc.85% 5. The Crossover rate 100.000 -$1.000 Year 0 1 2 3 4 At what cost of capital do the two projects have the same net present value? (That is. what is the crossover rate?) a.Page 31 . d.100 2 700 900 3 800 800 4 1. 4.000 1.15% Chapter 12 . Jackson Jets is considering two mutually projects have the following cash flows: Project A Cash Flow -$10.000 7. b.Crossover rate Answer: b Diff: M 99.40% 6. 11.000 Project B Cash Flow -$8.000 1.000 2. e.000 1. d.000 1. c.100 400 At what cost of capital would the two projects have the same net present value? a.84% 13.03% 14.000 6.900 1 500 1. c.000 6.73% 5.20% 12. b. e.000 600 5 1.

d. Project A and Project B. 12. The projects are of equal risk and have the following cash flows: Project A Cash Flows -$100.000 55.11% 14.69% b.32% e. b.000 30.000 70. 8. 9.000 Project B Cash Flows -$100.33% 13. 10. Midway Motors is considering two mutually exclusive projects.95% 11. 10. e.000 25.49% Crossover rate Answer: d Diff: M 102. -47.000 Year 0 1 2 3 4 At what WACC would the two projects have the same NPV? a. c.32% d.45% c.000 40.Page 32 .000 15.Crossover rate Answer: c Diff: M 101.96% Chapter 12 . The projects have the following cash flows: Project A Cash Flow -$200 20 30 40 50 60 Project B Cash Flow -$300 90 70 60 50 40 Year 0 1 2 3 4 5 At what cost of capital would the two projects have the same net present value (NPV)? a.21% 25. Robinson Robotics is considering two mutually exclusive projects.000 80. Project A and Project B.000 40.

634.43 $103.52 $ 38.298. $23. b.000 at the end of each of the next two years. c. The company’s cost of capital is 10. Doherty Industries wants to invest in a new computer system.523. both the cash inflows and outflows increase by 10 percent. 5.000 a year for three years (inflows received at t = 4.000). machine B can be replaced at a cost of $55. System A requires an up-front cost of $100.000) and produces after-tax cash inflows of $30. and produces positive after-tax cash inflows of $40. The replacement machine will produce aftertax cash inflows of $32. The company's cost of capital is 11 percent. e.5 percent.000 at the end of each of the next three years. Machine A has an up-front cost of $100. What is the net present value (on a six-year extended basis) of the most profitable machine? a. Johnson Jets is considering two mutually exclusive machines.000 a year at the end of the next three years.238 $62.77 $ 31. d.000 and then generates positive after-tax cash flows of $60.Page 33 .000 a year at the end of each of the next six years.000(CF0 = -50.687 Chapter 12 . Machine B has an up-front cost of $50. d.30 $ 22.000 (paid at t = 3). and has narrowed the choice down to System A and System B. after which time the current owners plan on retiring and liquidating the firm. e.656 $56. and 6).82 Replacement chain Answer: e Diff: M 104. The company only wants to invest in one system. but each time the system is replaced.950 $41. The system can be replaced every two years with the cash inflows and outflows remaining the same.000 (CF0 = -100.065.Replacement chain Answer: c Diff: M 103. $ 17. What is the NPV (on a sixyear extended basis) of the system which creates the most value to the company? a.211. System B also requires an up-front cost of $100. c. System B can be replaced every three years. After three years. b. The company needs a computer system for the six years.000 and then generates positive after-tax cash flows of $48.456 $71.

The projected end-of-year flows from the RPB design are $2. King often assumes that continuous replacements can be made as a project's life ends. d.109 1.21 $633.5 million today.000 a year for another 5 years at which time its salvage value will again be zero. Thus.802. e.4 million in each of the first two years and $2. but the company will be able to purchase another Machine A at a cost of $1. the salvage value of the original machine is zero. King Racing Company (KRC) is considering which of two mutually exclusive engine development projects to pursue. Both projects require an initial investment of $5. by how much will the company's value increase? a.Page 34 .286. Assume that the cost of capital is 12 percent. Machine A costs $1 million. What is the net present value (on an eight-year extended basis) of the project with the most value to the company? a.357. and after ten years it will have an after-tax salvage value of $100.66 Replacement Chain Answer: d Diff: M 106. $ $ $ $ $ 3. If the company chooses the machine which adds the most value to the firm. and generates after-tax cash flows of $350. At the end of 5 years. b.775.000 a year for ten years.4 million. has an expected life of 5 years. b. c.54 $811.00 $451.211 6.0 million in each of the next six years.976 5. and King's cost of capital is 12 percent.6 million at the end of each of the first two years and $1.218 million million million million million Chapter 12 . Frequent changes in racing rules and engine technology make engine development risky. The second Machine A will generate after-tax cash flows of $375.085 5.19 $792. the company can buy Machine B at a cost of $1. A small manufacturer is considering two alternative machines. Machine B will produce after-tax cash flows of $400. King's RPX design has an expected life of 4 years and projected cash inflows are $3.000.000 per year.Replacement chain Answer: d Diff: M 105. King's RPB design is more flexible and has an eight-year life. but King feels that the basic designs can be refined and modified.481.2 million.8 million in each of the next two years. $347. Alternatively. d. c. e.

You finance only with equity. Machine B will have an after-tax salvage value of $100.754 $287. Alternatively.000. Machine A requires an up-front expenditure at t = 0 of $450.42 $12. At the end of four years.Page 35 .Replacement Chain Answer: c Diff: M 107.10 $15.000. The project has a cost of $500 million. $ 7. e. At the end of two years.438 $177. Answer: c Diff: T Returns on the market and Company Y's stock during the last 3 years are shown below: Year 2004 2005 2006 Market -24% 10 22 Company Y -22% 13 36 The risk-free rate is 5 percent. and will generate positive after-tax cash flows of $350. all of which comes from retained earnings. is considering adopting one of two machines. $157. d.5 less than the company's overall corporate beta. The cost of capital is 10 percent.000 per year (all cash flows are realized at year end). c.000 Tough: NPV 108. Machine B has an expected life of four years. Every two years the company can purchase a replacement machine with identical cash flows.000 per year (all cash flows are realized at the end of the year). b. Mills Corp.26 $10. d. b.508 $500. What is the net present value (on an extended four-year life) of the better machine? a. You are considering a low-risk project whose market beta is 0.10 $ 9. c. What is the project's NPV (in millions of dollars)? a. Machine A has an expected life of two years.552 $355. and will generate positive after-tax cash flows of $350. the machine will have zero salvage value.75 Chapter 12 . Machine B requires an expenditure of $1 million at t = 0. and it is expected to provide cash flows of $100 million per year at the end of Years 1 through 5 and then $50 million per year at the end of Years 6 through 10. e. and the required return on the market is 11 percent.

or upper right. ≈ ≈ ≈ ≈ at at at at r r r r 7%. Yes. e. 9%.000 2. you are evaluating two mutually exclusive projects with the following net cash flows: Project X Cash Flow -$100 50 40 30 10 Project Z Cash Flow -$100 10 30 40 60 Year 0 1 2 3 4 Is there a crossover point in the relevant part of the NPV profile graph (the northeast. 12.59% 12. b. c. MIRR and NPV Answer: c Diff: T 110. Yes.89% 15.000 200 100 75 Year 0 1 2 3 4 The projects are equally risky. You must make a recommendation.Page 36 .00% 11.NPV profiles Answer: b Diff: T 109. and the firm's cost of capital is 12 percent. and you must base it on the modified IRR (MIRR). d. e.46% 13. Yes. whose costs and cash flows are shown below: Project X Cash Flow -$2.000 200 600 800 1. c. 13%. b.400 Project Y Cash Flow -$2. No. Yes. What is the MIRR of the better project? a.73% Chapter 12 . Your company is considering two mutually exclusive projects. 11%. X and Y. d. As the director of capital budgeting for Raleigh/Durham Company. quadrant)? a.

d. 11. e.000 5.Page 37 .56% 13.34% Chapter 12 .25% 20.12% Modified IRR Answer: d Diff: T 112. c. Mooradian Corporation estimates that its cost of capital is 11 percent.000 5.000 50.000 50. the modified internal rate of return (MIRR)? a. A company is considering a project with the following cash flows: Year 0 1 2 3 4 Cash flow -$100.000 What is The project’s cost of capital is estimated to be 10 percent.66% 16.Modified IRR Answer: e Diff: T 111.000 50.500 1. d. b.500 -500 Project L Cash Flow -$9.000 Year 0 1 2 3 4 What is the modified internal rate of return (MIRR) of the project with the highest NPV? a.25% 11. c.01% 18.000 2.28% 14.25% 20. The company is considering two mutually exclusive projects whose aftertax cash flows are as follows: Project S Cash Flow -$3. b. 11.000 5.000 -1.89% 13.000 -10.500 1. e.

the market risk premium is 5 percent.76% b. and the tax rate is 30 percent. The company’s stock has a beta = 1.500 What is the project’s The firm’s cost of capital is 11 percent.78% 24.68% 23. b.000 35. Javier Corporation is considering a project with the following cash flows: Year 0 1 2 3 4 Cash Flow -$13.000 60.93% Modified IRR Answer: e Diff: T 114.82% 21. The company is considering a project with the following cash flows: Project A Cash Flow -$50. The company’s bonds have a yield to maturity of 10 percent.26% c. The equity will be financed with retained earnings. The risk-free rate is 6 percent. 16.000 12. 10. Taylor Technologies has a target capital structure which is 40 percent debt and 60 percent equity.000 7.78% d.000 43.000 -40.000 -1. 9. 20.14% e. 6.Page 38 . c. 16.90% 25.Modified IRR Answer: d Diff: T 113.1. d.52% Chapter 12 .000 Year 0 1 2 3 4 What is the project’s modified internal rate of return (MIRR)? a. e.000 8. modified internal rate of return (MIRR)? a.

Page 39 . e. has an investment project with the following cash flows: Project Cash Flow -$1. 17. 2. Conrad Corp. c.Modified IRR Answer: c Diff: T 115. b. internal rate of return (MIRR)? a. d.26% 25.95% 5.68% 6. d.83% Modified IRR Answer: b Diff: T 116.28% 28.63% 3.000 200 -300 900 -700 600 What is the project’s modified Year 0 1 2 3 4 5 The company’s WACC is 12 percent.52% Chapter 12 .20% 3. Simmons Shoes is considering a project with the following cash flows: Project Cash Flow -$700 400 -200 600 500 What is the project’s modified internal Year 0 1 2 3 4 Simmons’ WACC is 10 percent. rate of return (MIRR)? a.93% 29. c. e.10% 18. b.

06 $4. Now the landlord offers Sally a new 5-year lease which calls for zero rent for 6 months.000 at the end of each month for the next 60 months. e. $2.87 $4.09 $3. Sally's cost of capital is 11 percent.803.9166667%.PV of cash flows Answer: c Diff: T 117.) a. By what absolute dollar amount would accepting the new lease change Sally's theoretical net worth? (Hint: The cost of capital per month is 11%/12 = 0.681. Sally's current lease calls for payments of $1.76 Chapter 12 . c.050 at the end of each month for the next 54 months.243. b. After getting her degree in marketing and working for 5 years for a large department store.299. Sally started her own specialty shop in a regional mall. d. then rental payments of $1.Page 40 .810.24 $3.

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