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The NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, will lead to different accept/reject decisions and thus capital budgets if the cost of capital at which the projects' NPV profiles cross is greater than the crossover rate.

A) True
B) False

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Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.


A) If Project A has a higher IRR than Project B, then Project A must have the lower NPV.
B) If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.
C) The IRR calculation implicitly assumes that all cash flows are reinvested at the WACC.
D) The IRR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business.
E) If a project has normal cash flows and its IRR exceeds its WACC, then the project's NPV must be positive.

F) A) and B)
G) A) and C)

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Westchester Corp. is considering two equally risky, mutually exclusive projects, both of which have normal cash flows. Project A has an IRR of 11%, while Project B's IRR is 14%. When the WACC is 8%, the projects have the same NPV. Given this information, which of the following statements is CORRECT?


A) If the WACC is 13%, Project A's NPV will be higher than Project B's.
B) If the WACC is 9%, Project A's NPV will be higher than Project B's.
C) If the WACC is 6%, Project B's NPV will be higher than Project A's.
D) If the WACC is greater than 14%, Project A's IRR will exceed Project B's.
E) If the WACC is 9%, Project B's NPV will be higher than Project A's.

F) C) and D)
G) A) and C)

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For a project with one initial cash outflow followed by a series of positive cash inflows, the modified IRR (MIRR) method involves compounding the cash inflows out to the end of the project's life, summing those compounded cash flows to form a terminal value (TV), and then finding the discount rate that causes the PV of the TV to equal the project's cost.

A) True
B) False

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Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.


A) A project's regular IRR is found by compounding the initial cost at the WACC to find the terminal value (TV) , then discounting the TV at the WACC.
B) A project's regular IRR is found by compounding the cash inflows at the WACC to find the present value (PV) , then discounting the TV to find the IRR.
C) If a project's IRR is smaller than the WACC, then its NPV will be positive.
D) A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost.
E) If a project's IRR is positive, then its NPV must also be positive.

F) A) and B)
G) A) and C)

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The primary reason that the NPV method is conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist, and when that happens, we don't know which IRR is relevant.

A) True
B) False

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Project X's IRR is 19% and Project Y's IRR is 17%. The projects have the same risk and the same lives, and each has constant cash flows during each year of their lives. If the WACC is 10%, Project Y has a higher NPV than X. Given this information, which of the following statements is CORRECT?


A) The crossover rate must be less than 10%.
B) The crossover rate must be greater than 10%.
C) If the WACC is 8%, Project X will have the higher NPV.
D) If the WACC is 18%, Project Y will have the higher NPV.
E) Project X is larger in the sense that it has the higher initial cost.

F) A) and C)
G) A) and D)

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Which of the following statements is CORRECT?


A) The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
B) The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
C) The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
D) The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
E) The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

F) C) and E)
G) A) and E)

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The NPV method is based on the assumption that projects' cash flows are reinvested at the project's risk-adjusted cost of capital.

A) True
B) False

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Which of the following statements is CORRECT?


A) The NPV method was once the favorite of academics and business executives, but today most authorities regard the MIRR as being the best indicator of a project's profitability.
B) If the cost of capital declines, this lowers a project's NPV.
C) The NPV method is regarded by most academics as being the best indicator of a project's profitability, hence most academics recommend that firms use only this one method and disregard other methods.
D) A project's NPV depends on the total amount of cash flows the project produces, but because the cash flows are discounted at the WACC, it does not matter if the cash flows occur early or late in the project's life.
E) The NPV and IRR methods may give different recommendations regarding which of two mutually exclusive projects should be accepted, but they always give the same recommendation regarding the acceptability of a normal, independent project.

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

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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. Neither has negative cash flows after Year 0, and at the current cost of capital, the two projects have identical NPVs. Now suppose interest rates and money costs decline. Other things held constant, this change will cause L to become preferred to S.

A) True
B) False

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Which of the following statements is CORRECT?


A) The MIRR and NPV decision criteria can never conflict.
B) The IRR method can never be subject to the multiple IRR problem, while the MIRR method can be.
C) One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.
D) The higher the WACC, the shorter the discounted payback period.
E) The MIRR method assumes that cash flows are reinvested at the crossover rate.

F) A) and D)
G) B) and E)

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Which of the following statements is CORRECT?


A) The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion.
B) One drawback of the payback criterion is that this method does not take account of cash flows beyond the payback period.
C) If a project's payback is positive, then the project should be accepted because it must have a positive NPV.
D) The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
E) One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback.

F) B) and E)
G) B) and C)

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The NPV and IRR methods, when used to evaluate two independent and equally risky projects, will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their costs of capital.

A) True
B) False

Correct Answer

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Assume that the economy is in a mild recession, and as a result interest rates and money costs generally are relatively low. The WACC for two mutually exclusive projects that are being considered is 8%. Project S has an IRR of 20% while Project L's IRR is 15%. The projects have the same NPV at the 8% current WACC. However, you believe that the economy is about to recover, and money costs and thus your WACC will also increase. You also think that the projects will not be funded until the WACC has increased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT?


A) You should reject both projects because they will both have negative NPVs under the new conditions.
B) You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market.
C) You should recommend Project L, because at the new WACC it will have the higher NPV.
D) You should recommend Project S, because at the new WACC it will have the higher NPV.
E) You should recommend Project L because it will have the higher IRR at the new WACC.

F) D) and E)
G) A) and C)

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Which of the following statements is CORRECT?


A) The NPV method assumes that cash flows will be reinvested at the WACC, 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 WACC, while the IRR method assumes reinvestment at the risk-free rate.
D) The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
E) The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period.

F) A) and D)
G) None of the above

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Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.


A) The longer a project's payback period, the more desirable the project is normally considered to be by this criterion.
B) One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.
C) If a project's payback is positive, then the project should be rejected because it must have a negative NPV.
D) The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
E) If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time.

F) C) and E)
G) C) and D)

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A conflict will exist between the NPV and IRR methods, when used to evaluate two equally risky but mutually exclusive projects, if the projects' cost of capital is less than the rate at which the projects' NPV profiles cross.

A) True
B) False

Correct Answer

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Projects A and B are mutually exclusive and have normal cash flows. Project A has an IRR of 15% and B's IRR is 20%. The company's WACC is 12%, and at that rate Project A has the higher NPV. Which of the following statements is CORRECT?


A) The crossover rate for the two projects must be less than 12%.
B) Assuming the timing pattern of the two projects' cash flows is the same, Project B probably has a higher cost (and larger scale) .
C) Assuming the two projects have the same scale, Project B probably has a faster payback than Project A.
D) The crossover rate for the two projects must be 12%.
E) Since B has the higher IRR, then it must also have the higher NPV if the crossover rate is less than the WACC of 12%.

F) B) and E)
G) A) and B)

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When considering two mutually exclusive projects, the firm should always select the project whose internal rate of return is the highest, provided the projects have the same initial cost. This statement is true regardless of whether the projects can be repeated or not.

A) True
B) False

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