Exam 12: Capital Budgeting

A) You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC.
B) You should recommend that the project be accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that the firm's value will increase if the project is accepted.
C) You should recommend that the project be rejected. Although its NPV is positive it has two IRRs, one of which is less than the WACC, which indicates that the firm's value will decline if the project is accepted.
D) You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm's value will decline if it is accepted.
E) You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.

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A) 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.
B) You should recommend Project R, because at the new WACC it will have the higher NPV.
C) You should recommend Project K, because at the new WACC it will have the higher NPV.
D) You should recommend Project K because it has the higher IRR and will continue to have the higher IRR even at the new WACC.
E) You should reject both projects because they will both have negative NPVs under the new conditions.

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A) If Project S has a positive NPV, Project L must also have a positive NPV.
B) If the WACC falls, each project's IRR will increase.
C) If the WACC increases, each project's IRR will decrease.
D) If Projects S and L have the same NPV at the current WACC, 10%, then Project L, the one with the lower IRR, would have a higher NPV if the WACC used to evaluate the projects declined.
E) Project S must have a higher NPV than Project L.

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A) The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases.
B) An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life.
C) An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital.
D) We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV.
E) An NPV profile graph shows how a project's payback varies as the cost of capital changes.

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A) A project's MIRR is always less than its regular IRR.
B) If a project's IRR is greater than its WACC, then the MIRR will be less than the IRR.
C) If a project's IRR is greater than its WACC, then the MIRR will be greater than the IRR.
D) To find a project's MIRR, we compound cash inflows at the IRR and then discount the terminal value back to t = 0 at the WACC.
E) A project's MIRR is always greater than its regular IRR.

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A) Project L.
B) Both projects are equally sensitive to changes in the WACC since their NPVs are equal at all costs of capital.
C) Neither project is sensitive to changes in the discount rate, since both have NPV profiles that are horizontal.
D) The solution cannot be determined because the problem gives us no information that can be used to determine the projects' relative IRRs.
E) Project S.

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True

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A) Since the smaller project has the higher IRR, the two projects' NPV profiles will cross, and the larger project will look better based on the NPV at all positive values of WACC.
B) If the company uses the NPV method, it will tend to favor smaller, shorter-term projects over larger, longer-term projects, regardless of how high or low the WACC is.
C) Since the smaller project has the higher IRR but the larger project has the higher NPV at a zero discount rate, the two projects' NPV profiles will cross, and the larger project will have the higher NPV if the WACC is less than the crossover rate.
D) Since the smaller project has the higher IRR and the larger NPV at a zero discount rate, the two projects' NPV profiles will cross, and the smaller project will look better if the WACC is less than the crossover rate.
E) Since the smaller project has the higher IRR, the two projects' NPV profiles cannot cross, and the smaller project's NPV will be higher at all positive values of WACC.

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C

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A) If the WACC is 6%, Project S will have the higher NPV.
B) If the WACC is 13%, Project S will have the lower NPV.
C) If the WACC is 10%, both projects will have a negative NPV.
D) Project S's NPV is more sensitive to changes in WACC than Project L's.
E) If the WACC is 10%, both projects will have positive NPVs.

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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.

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