CHAPTER 11

THE BASICS OF CAPITAL BUDGETING: EVALUATING CASH FLOWS

True/False

Multiple Choice: Problems

Easy:
(11.2) NPV (constant cash flows; 3 years) Answer: a EASY
1
. 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.

WACC: 10.00%
Year: 0 1 2 3
Cash flows: -$1,000 $500 $500 $500

a. $243.43
b. $255.60
c. $268.38
d. $281.80
e. $295.89

(11.2) NPV (constant cash flows; 4 years) Answer: c EASY

2
. Johnson Enterprises 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.

WACC: 10.00%
Year: 0 1 2 3 4
Cash flows: -$1,000 $350 $350 $350 $350

a. $98.78
b. $103.98
c. $109.45
d. $114.93
e. $120.67

(11.2) NPV (constant cash flows; 5 years) Answer: e EASY

3
. Humboldt Inc. 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.

WACC: 9.00%

Chapter 11: Capital Budgeting Problems Page 1

 Year: 0 1 2 3 4 5
Cash flows: -$1,000 $300 $300 $300 $300 $300

a. $135.94
b. $143.09
c. $150.62
d. $158.55
e. $166.90

(11.3) IRR (constant cash flows; 3 years) Answer: b EASY

4
. Tucker Corp. 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 negative, in which case it will be rejected.

Year: 0 1 2 3
Cash flows: -$1,000 $450 $450 $450

a. 15.82%
b. 16.65%
c. 17.48%
d. 18.36%
e. 19.27%

(11.3) IRR (constant cash flows; 4 years) Answer: d EASY

5
. Levin Company 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 negative, in which case it will be rejected.

Year: 0 1 2 3 4
Cash flows: -$1,000 $400 $400 $400 $400

a. 15.94%
b. 17.71%
c. 19.68%
d. 21.86%
e. 24.05%

(11.3) IRR (constant cash flows; 5 years) Answer: a EASY

6
. Frye Foods 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 negative, in which case it will be rejected.

Year: 0 1 2 3 4 5
Cash flows: -$1,000 $325 $325 $325 $325 $325

Page 2 Problems Chapter 11: Capital Budgeting

 a. 18.72%
b. 19.65%
c. 20.64%
d. 21.67%
e. 22.75%

(11.8) Payback (constant cash flows; 3 years) Answer: c EASY

7
. Wells Inc. is considering a project that has the following cash flow
data. What is the project's payback?

Year: 0 1 2 3
Cash flows: -$1,000 $500 $500 $500

a. 1.62 years
b. 1.80 years
c. 2.00 years
d. 2.20 years
e. 2.42 years

Easy/Medium:
(11.2) NPV (uneven cash flows; 3 years) Answer: a EASY/MEDIUM
8
. Adler Enterprises 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.

WACC: 10.00%
Year: 0 1 2 3
Cash flows: -$1,000 $450 $460 $470

a. $142.37
b. $149.49
c. $156.97
d. $164.82
e. $173.06
(11.2) NPV (uneven cash flows; 3 years) Answer: c EASY/MEDIUM
9
. Babcock Inc. 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.

WACC: 10.00%
Year: 0 1 2 3
Cash flows: -$950 $500 $400 $300

Chapter 11: Capital Budgeting Problems Page 3

 a. $54.62
b. $57.49
c. $60.52
d. $63.54
e. $66.72

(11.2) NPV (uneven cash flows; 4 years) Answer: e EASY/MEDIUM

10
. Rappaport Enterprises 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.

WACC: 10.00%
Year: 0 1 2 3 4
Cash flows: -$1,000 $400 $405 $410 $415

a. $190.16
b. $211.29
c. $234.77
d. $260.85
e. $289.84

(11.2) NPV (uneven cash flows; 5 years) Answer: b EASY/MEDIUM

11
. 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.

WACC: 10.00%
Year: 0 1 2 3 4 5
Cash flows: -$1,200 $400 $395 $390 $385 $380

a. $253.81
b. $282.01
c. $310.21
d. $341.23
e. $375.35

(11.3) IRR (uneven cash flows; 3 years) Answer: d EASY/MEDIUM

12
. Choi Computer Systems 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.

Year: 0 1 2 3
Cash flows: -$1,000 $450 $470 $490

Page 4 Problems Chapter 11: Capital Budgeting

 a. 13.89%
b. 15.43%
c. 17.15%
d. 19.05%
e. 20.96%

(11.3) IRR (uneven cash flows; 4 years) Answer: a EASY/MEDIUM

13
. 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.

Year: 0 1 2 3 4
Cash flows: -$650 $250 $230 $210 $190

a. 14.04%
b. 15.44%
c. 16.99%
d. 18.69%
e. 20.56%

(11.3) IRR (uneven cash flows; 5 years) Answer: c EASY/MEDIUM

14
. Thompson Stores 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.

Year: 0 1 2 3 4 5
Cash flows: -$1,000 $300 $295 $290 $285 $270

a. 11.16%
b. 12.40%
c. 13.78%
d. 15.16%
e. 16.68%

Chapter 11: Capital Budgeting Problems Page 5

 (11.6) MIRR (constant cash flows; 3 years) Answer: e MEDIUM
15
. Edelman Electric Systems is considering a project that has the following
cash flow and WACC data. What is the project's MIRR? Note that a
project's projected MIRR can be less than the WACC (and even negative),
in which case it will be rejected.

WACC: 10.00%
Year: 0 1 2 3
Cash flows: -$800 $350 $350 $350

a. 8.62%
b. 9.58%
c. 10.64%
d. 11.82%
e. 13.14%

(11.6) MIRR (uneven cash flows; 4 years) Answer: b MEDIUM

16
. Hindelang Inc. is considering a project that has the following cash flow
and WACC data. What is the project's MIRR? Note that a project's
projected MIRR can be less than the WACC (and even negative), in which
case it will be rejected.

WACC: 10.00%
Year: 0 1 2 3 4
Cash flows: -$900 $300 $320 $340 $360

a. 12.61%
b. 14.01%
c. 15.41%
d. 16.95%
e. 18.64%

(11.8) Payback (uneven cash flows; 5 years) Answer: e MEDIUM

17
. Stewart Associates is considering a project that has the following cash
flow data. What is the project's payback?

Year: 0 1 2 3 4 5
Cash flows: -$1,000 $300 $310 $320 $330 $340

a. 2.11 years
b. 2.34 years
c. 2.60 years
d. 2.89 years
e. 3.21 years

Page 6 Problems Chapter 11: Capital Budgeting

 (11.8) Discounted payback (constant CFs; 3 years) Answer: b MEDIUM
18
. Garvin Enterprises is considering a project that has the following cash
flow and WACC data. What is the project's discounted payback?

WACC: 10.00%
Year: 0 1 2 3
Cash flows: -$1,000 $500 $500 $500

a. 2.12 years
b. 2.35 years
c. 2.59 years
d. 2.85 years
e. 3.13 years

(11.8) Discounted payback (uneven CFs, 4 years) Answer: d MEDIUM

19
. Bey Bikes is considering a project that has the following cash flow and
WACC data. What is the project's discounted payback?

WACC: 10.00%
Year: 0 1 2 3 4
Cash flows: -$1,000 $525 $485 $445 $405

a. 1.72 years
b. 1.92 years
c. 2.13 years
d. 2.36 years
e. 2.60 years

Chapter 11: Capital Budgeting Problems Page 7

 (Comp: 11.2-11.4) NPV vs IRR (constant CFs; 3 years) Answer: d MEDIUM
20
. Last month, Smith Systems Inc. decided to accept the project whose cash
flows are shown below. However, before actually starting the project,
the Federal Reserve took actions that lowered interest rates and
therefore Smith's WACC. By how much did the change in the WACC affect
the project's forecasted NPV? Assume that the Fed action does not
affect the cash flows, and note that a project's projected NPV can be
negative, in which case it should be rejected.

New WACC: 8.00% Old WACC: 11.00%

Year: 0 1 2 3
Cash flows: -$1,000 $500 $500 $500

a. $57.18
b. $60.19
c. $63.36
d. $66.69
e. $70.03

(Comp: 11.2-11.4) NPV vs IRR (uneven CFs; 3 yrs) Answer: a MEDIUM

21
. The Federal Reserve recently shifted its monetary policy, causing Lasik
Vision's WACC to change. Lasik had recently analyzed the project whose
cash flows are shown below. However, the CFO wants to reconsider this
and all other proposed projects in view of the Fed action. How much did
the changed WACC cause the forecasted NPV to change? Assume that the
Fed action does not affect the cash flows, and note that a project's
projected NPV can be negative, in which case it should be rejected.

New WACC: 7.00% Old WACC: 10.00%

Year: 0 1 2 3
Cash flows: -$1,000 $500 $520 $540

a. $72.27
b. $75.88
c. $79.68
d. $83.66
e. $87.85

Page 8 Problems Chapter 11: Capital Budgeting

 (Comp: 11.3,11.6) IRR vs MIRR Answer: d MEDIUM/HARD
22
. Pappas Products is considering Projects S and L, whose cash flows are
shown below. These projects are mutually exclusive, equally risky, and
not repeatable. The CEO believes the IRR is the best selection criterion,
while the CFO advocates the MIRR. If the decision is made by choosing
the project with the higher IRR rather than the one with the higher MIRR,
how much, if any, value will be forgone? Note that under some conditions
the choice will have no effect on the value gained or lost.

WACC: 11.00%
0 1 2 3 4
CFS -$1,100 $550 $600 $100 $100
CFL -$2,700 $650 $725 $800 $1,400

a. -$1.60
b. -$1.44
c. -$1.30
d. $0.00
e. $1.60

Chapter 11: Capital Budgeting Problems Page 9

 CHAPTER 11
ANSWERS AND SOLUTIONS

Page 10 Answers Chapter 11: Capital Budgeting

1. (11.2) NPV (constant cash flows; 3 years) Answer: a EASY

WACC: 10.00%
Year: 0 1 2 3
Cash flows: -$1,000 $500 $500 $500

NPV = $243.43

2. (11.2) NPV (constant cash flows; 4 years) Answer: c EASY

WACC: 10.00%
Year: 0 1 2 3 4
Cash flows: -$1,000 $350 $350 $350 $350

NPV = $109.45

3. (11.2) NPV (constant cash flows; 5 years) Answer: e EASY

WACC: 9.00%
Year: 0 1 2 3 4 5
Cash flows: -$1,000 $300 $300 $300 $300 $300

NPV = $166.90

4. (11.3) IRR (constant cash flows; 3 years) Answer: b EASY

Year: 0 1 2 3
Cash flows: -$1,000 $450 $450 $450

IRR = 16.65%

5. (11.3) IRR (constant cash flows; 4 years) Answer: d EASY

Year: 0 1 2 3 4
Cash flows: -$1,000 $400 $400 $400 $400

IRR = 21.86%

6. (11.3) IRR (constant cash flows; 5 years) Answer: a EASY

Year: 0 1 2 3 4 5
Cash flows: -$1,000 $325 $325 $325 $325 $325

IRR = 18.72%

7. (11.8) Payback (constant cash flows; 3 years) Answer: c EASY

Year: 0 1 2 3
Cash flows: -$1,000 $500 $500 $500
Cumulative CF -$1,000 -$500 $0 $500
Payback = 2.00 — — 2.00 —

8. (11.2) NPV (uneven cash flows; 3 years) Answer: a EASY/MEDIUM

WACC: 10.00%
Year: 0 1 2 3
Cash flows: -$1,000 $450 $460 $470
 NPV = $142.37

9. (11.2) NPV (uneven cash flows; 3 years) Answer: c EASY/MEDIUM

WACC: 10.00%
Year: 0 1 2 3
Cash flows: -$950 $500 $400 $300

NPV = $60.52

10. (11.2) NPV (uneven cash flows; 4 years) Answer: e EASY/MEDIUM

WACC: 10.00%
Year: 0 1 2 3 4
Cash flows: -$1,000 $400 $405 $410 $415

NPV = $289.84

11. (11.2) NPV (uneven cash flows; 5 years) Answer: b EASY/MEDIUM

WACC: 10.00%
Year: 0 1 2 3 4 5
Cash flows: -$1,200 $400 $395 $390 $385 $380

NPV = $282.01

12. (11.3) IRR (uneven cash flows; 3 years) Answer: d EASY/MEDIUM

Year: 0 1 2 3
Cash flows: -$1,000 $450 $470 $490

IRR = 19.05%

13. (11.3) IRR (uneven cash flows; 4 years) Answer: a EASY/MEDIUM

Year: 0 1 2 3 4
Cash flows: -$650 $250 $230 $210 $190

IRR = 14.04%

14. (11.3) IRR (uneven cash flows; 5 years) Answer: c EASY/MEDIUM

Year: 0 1 2 3 4 5
Cash flows: -$1,000 $300 $295 $290 $285 $270

IRR = 13.78%

15. (11.6) MIRR (constant cash flows; 3 years) Answer: e MEDIUM

WACC: 10.00%
Year: 0 1 2 3
Cash flows: -$800 $350 $350 $350 TV = Sum of compounded inflows:
Compounded values, FVs: $423.50 $385.00 $350.00 $1,158.50

MIRR = 13.14% Found as discount rate that equates PV of TV to cost, discounted back 3 years @ 10%
MIRR = 13.14% Alternative calculation, using Excel's MIRR function
16. (11.6) MIRR (uneven cash flows; 4 years) Answer: b MEDIUM

WACC: 10.00%
Year: 0 1 2 3 4
Cash flows: -$900 $300 $320 $340 $360 TV = Sum of comp’ed inflows:
Compounded values: $399.30 $387.20 $374.00 $360.00 $1,520.50

MIRR = 14.01% Found as discount rate that equates PV of TV to cost, discounted back 4 years @ 10%
MIRR = 14.01% Alternative calculation, using Excel's MIRR function

17. (11.8) Payback (uneven cash flows; 5 years) Answer: e MEDIUM

Year: 0 1 2 3 4 5
Cash flows: -$1,000 $300 $310 $320 $330 $340
Cumulative CF -$1,000 -$700 -$390 -$70 $260 $600
Payback = 3.21 — — — — 3.21 —

18. (11.8) Discounted payback (constant CFs; 3 years) Answer: b MEDIUM

WACC: 10.00%
Year: 0 1 2 3
Cash flows: -$1,000 $500 $500 $500
PV of CFs -$1,000 $455 $413 $376
Cumulative CF -$1,000 -$545 -$132 $243
Payback = 2.35 — — — 2.35

19. (11.8) Discounted payback (uneven CFs, 4 years) Answer: d MEDIUM

WACC: 10.00%
Year: 0 1 2 3 4
Cash flows: -$1,000 $525 $485 $445 $405
PV of CFs -$1,000 $477 $401 $334 $277
Cumulative CF -$1,000 -$523 -$122 $212 $489
Payback = 2.36 — — — 2.36 —

20. (Comp: 11.2-11.4) NPV vs IRR (constant CFs; 3 years) Answer: d MEDIUM

New WACC: 8.00% Old WACC: 11.00%

Year: 0 1 2 3
Cash flows: -$1,000 $500 $500 $500
New NPV = $288.55
Old NPV = $221.86
Change = $66.69

21. (Comp: 11.2-11.4) NPV vs IRR (uneven CFs; 3 yrs) Answer: a MEDIUM

New WACC: 7.00% Old WACC: 10.00%

Year: 0 1 2 3
Cash flows: -$1,000 $500 $520 $540

New NPV = $362.28

Old NPV = $290.01
 Change = $72.27

22. (Comp: 11.3,11.6) IRR vs MIRR Answer: d MEDIUM/HARD

First, recognize that NPV makes theoretically correct capital budgeting decisions, so the highest NPV tells us how
much value could be added. We calculate the two projects' NPVs, IRRs, and MIRRs. We then see what NPV
would result if the decision were based on the IRR and the MIRR. Under some conditions, MIRR will choose the
project with the higher NPV while the IRR chooses the lower NPV project. Then, the difference between the NPV
is the loss incurred if the IRR criterion is used. Of course, it's possible that both the MIRR and the IRR could
choose the wrong project. This problem shows that that could happen, but does not directly address it.

WACC: 11.000%
0 1 2 3 4 TV MIRR
CFS -$1,100 $550 $600 $100 $100
752.20 739.26 111.00 100.00 $1,702.46 11.5375%
CFL -$2,700 $650 $725 $800 $1,400
888.96 893.27 888.00 1400.00 $4,070.23 10.8062%

NPV, L = -$18.81 MIRR, L = 10.806% IRR, L = 10.712%

NPV, S = $21.46 MIRR, S = 11.537% IRR, S = 12.242%
-0.7313% -1.530%

NPV if decided based on IRR: 21.46

NPV if decided based on MIRR: 21.46
Lost value using IRR vs. MIRR criterion: 0.00

With the cash flows given here, the IRR and MIRR will make the same decision with any WACC above 7.895%
but different decisions and thus an advantage to MIRR below that rate. Note also that both the IRR and MIRR
choose the wrong project at WACCs about 7.986%. So, MIRR is better at low rates, but both are wrong at high
rates.

Note that the WACC is not constrained to be less than the crossover point, so there may not be a conflict between
MIRR and IRR, hence following the IRR rule may not result in a loss of value. In that case, the correct answer is
$0.00. Note, though, that both IRR and MIRR can lead to incorrect decisions vis à vis the NPV method.