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Business Finance I (FIN 506)

Quiz 5A
Directions:
Formula sheet is attached.
You must show the workings in numerical questions.

1. (TRUE/FALSE) Other things held constant, an increase in the cost of capital will result in a decrease in a
project's IRR.

2. Which of the following statements is CORRECT?

a. One defect of the IRR method is that it does not take account of the time value of money.
b. One defect of the IRR method is that it does not take account of the cost of capital.
c. One defect of the IRR method is that it values a dollar received today the same as a dollar
that will not be received until sometime in the future.
d. One defect of the IRR method is that it assumes that the cash flows to be received
from a project can be reinvested at the IRR itself, and that assumption is often not
valid.
e. One defect of the IRR method is that it does not take account of cash flows over a project's
full life.

3. Ellmann 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 expected NPV is negative, it should be rejected.

WACC: 9.00%
Year 0 1 2 3
Cash flows −$1,000 $500 $500 $500

a. $265.65
b. $278.93
c. $292.88
d. $307.52
4.
e. $322.90
4. Markman & Sons is considering Projects S and L. These projects are mutually exclusive, equally risky, and
not repeatable and their cash flows are shown below. Project S has IRR = 19.86% and L has IRR = 15.66%.
If the decision is made by choosing the project with the higher IRR, how much value will be forgone?

WACC: 10.00%
Year 0 1 2 3 4
CFS −$1,025 $650 $450 $250 $50
CFL −$1,025 $100 $300 $500 $700

a. $5.47
b. $6.02
c. $6.62
d. $7.29
e. $7.82

5. The NPV profile for mutually exclusive Projects A and B is shown below.

WACC A B
0% 495.0 910.0
2% 421.9 762.9
4% 354.4 626.9
6% 291.7 500.8
8% 233.6 383.8
10% 179.5 274.9
12% 129.2 173.6
14% 82.2 79.0
16% 38.3 −9.4
18% −2.8 −92.1
20% −41.3 −169.6
22% −77.4 −242.4
24% −111.4 −310.7

If the ____ is less than ___, then a conflict will exist between the NPV and IRR methods.
a. IRR, 16%
b. IRR, 13%
c. WACC, 16%
d. WACC, 13%
e. NPV, 38.3