i.

Assuming that their NPVs based on the firm's cost of capital are equal,
the NPV of a project whose cash flows accrue relatively rapidly will be
more sensitive to changes in the discount rate than the NPV of a project
whose cash flows come in later in its life.

a. True
b. False

(11.3) IRR Answer: a EASY

ii. The internal rate of return is that discount rate that equates the
present value of the cash outflows (or costs) with the present value of
the cash inflows.

a. True
b. False

(11.3) IRR Answer: b EASY

iii Other things held constant, an increase in the cost of capital will
. result in a decrease in a project's IRR.

a. True
b. False

(11.4) NPV and IRR Answer: b EASY

iv. If a project's NPV exceeds its IRR, then the project should be accepted.

a. True
b. False

(11.4) Mutually exclusive projects Answer: a EASY

v. 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

(11.4) Reinvestment rate assumption Answer: a EASY

vi. 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 is an important reason why the NPV
method is generally preferred over the IRR method.

a. True
b. False

(11.5) Multiple IRRs Answer: a EASY

vii Under certain conditions, a project may have more than one IRR. One such
. condition is when, in addition to the initial investment at time = 0, a
 negative cash flow (or cost) occurs at the end of the project's life.

a. True
b. False

(11.5) Multiple IRRs Answer: b EASY

The phenomenon called "multiple internal rates of return" arises when
vii two or more mutually exclusive projects that have different lives are
i. being compared.

a. True
b. False

(11.6) Modified IRR Answer: b EASY

ix. 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

(11.6) Modified IRR Answer: b EASY

x. When evaluating mutually exclusive projects, the modified IRR (MIRR)
always leads to the same capital budgeting decisions as the NPV method,
regardless of the relative lives or sizes of the projects being
evaluated.

a. True
b. False

(11.8) Payback Answer: a EASY

xi. One advantage of the payback method for evaluating potential investments
is that it provides some information about a project's liquidity and risk.

a. True
b. False

(11.4) NPV vs IRR Answer: b MEDIUM

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

a. True
b. False

(Comp: 11.2,11.3) NPV and IRR Answer: b MEDIUM

A decrease in the firm's discount rate (r, or WACC) will increase
projects' NPVs, which could change the accept/reject decision for any
potential project. However, such a change would have no impact on the
project's IRR; therefore, the accept/reject decision under the IRR
method is independent of the cost of capital.

a. True
b. False

(Comp: 11.2,11.4) NPV Answer: a MEDIUM

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
(11.2) NPV Answer: c EASY
xii 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 NPV is found by compounding the cash inflows at the IRR to

find the terminal value (TV), then discounting the TV at the WACC.
b. The lower the WACC used to calculate it, the lower the calculated
NPV will be.
c. If a project’s NPV is less than zero, then its IRR must be less
than the WACC.
d. If a project’s NPV is greater than zero, then its IRR must be less
than zero.
e. The NPV of a relatively low risk project should be found using a
relatively high WACC.

(11.3) IRR Answer: e EASY

Which of the following statements is CORRECT?
xii
i.

a. One defect of the IRR method is that it does not take account of
cash flows over a project’s full life.
b. One defect of the IRR method is that it does not take account of
the time value of money.
c. One defect of the IRR method is that it does not take account of
the cost of capital.
d. 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 some
time in the future.
e. 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.

(11.3) IRR Answer: d EASY

xiv 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 cash inflows at
the WACC to find the terminal value (TV), then discounting this TV
at the WACC.
b. A project’s regular IRR is found by discounting the cash inflows at
the WACC to find the present value (PV), then compounding this PV
to find the IRR.
c. If a project’s IRR is greater than the WACC, then its NPV must be
negative.
d. To find a project’s IRR, we must solve for the discount rate that
causes the PV of the inflows to equal the PV of the project’s costs.
e. To find a project’s IRR, we must find a discount rate that is equal
to the WACC.
(11.3) IRR Answer: d EASY
xv. 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 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.

(11.5) Normal vs. nonnormal cash flows Answer: e EASY

xvi Which of the following statements is CORRECT?
.

a. If a project has “normal” cash flows, then its IRR must be

positive.
b. If a project has “normal” cash flows, then its MIRR must be
positive.
c. If a project has “normal” cash flows, then it will have exactly two
real IRRs.
d. The definition of “normal” cash flows is that the cash flow stream
has one or more negative cash flows followed by a stream of
positive cash flows and then one negative cash flow at the end of
the project’s life.
e. If a project has “normal” cash flows, then it can have only one
real IRR, whereas a project with “nonnormal” cash flows might have
more than one real IRR.

(11.5) Normal vs. nonnormal cash flows Answer: a EASY

Which of the following statements is CORRECT?
xvi
i.

a. Projects with “normal” cash flows can have only one real IRR.
b. Projects with “normal” cash flows can have two or more real IRRs.
 c. Projects with “normal” cash flows must have two changes in the sign
of the cash flows, e.g., from negative to positive to negative. If
there are more sign changes, then the cash flow stream is
“nonnormal.”
d. The “multiple IRR problem” can arise if a project’s cash flows are
“normal.”
e. Projects with “nonnormal” cash flows are almost never encountered
in the real world.

(11.8) Payback Answer: b EASY

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

(Comp: 11.2,11.3,11.6,11.8) Ranking methods Answer: b EASY

xix Assume a project has normal cash flows. All else equal, which of the
. following statements is CORRECT?

a. The project’s IRR increases as the WACC declines.

b. The project’s NPV increases as the WACC declines.
c. The project’s MIRR is unaffected by changes in the WACC.
d. The project’s regular payback increases as the WACC declines.
e. The project’s discounted payback increases as the WACC declines.
(11.2) NPV Answer: e MEDIUM
xx. 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.
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.

(11.2) NPV Answer: b MEDIUM

xxi 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 NPV is generally found by compounding the cash inflows

at the WACC to find the terminal value (TV), then discounting the
TV at the IRR to find its PV.
b. The higher the WACC used to calculate the NPV, the lower the
calculated NPV will be.
c. If a project’s NPV is greater than zero, then its IRR must be less
than the WACC.
d. If a project’s NPV is greater than zero, then its IRR must be less
than zero.
e. The NPVs of relatively risky projects should be found using
relatively low WACCs.

(11.4) Ranking conflicts Answer: a MEDIUM

Which of the following statements is CORRECT?
xxi
i.

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.

(11.4) NPV and IRR Answer: e MEDIUM

Which of the following statements is CORRECT? Assume that the project
xxi being considered has normal cash flows, with one outflow followed by a
ii. 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.
(11.4) NPV and mutually exclusive projects Answer: c HARD
McCall Manufacturing has a WACC of 10%. The firm is considering two
xxi normal, equally risky, mutually exclusive, but not repeatable projects.
. The two projects have the same investment costs, but Project A has an
IRR of 15%, while Project B has an IRR of 20%. Which of the following
statements is CORRECT?

a. Each project must have a negative NPV.

b. Since the projects are mutually exclusive, the firm should always
select Project B.
c. If the crossover rate is 8%, Project B will have the higher NPV.
d. Only one project has a positive NPV.
e. If the crossover rate is 8%, Project A will have a higher NPV than
Project B.

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

xxv 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
(11.3) IRR (constant cash flows; 3 years) Answer: b EASY
Tucker Corp. is considering a project that has the following cash flow
xxv data. What is the project's IRR? Note that a project's projected IRR
i. 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

Levin Company is considering a project that has the following cash flow
xxv data. What is the project's IRR? Note that a project's projected IRR
ii. 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

Frye Foods is considering a project that has the following cash flow
xxv data. What is the project's IRR? Note that a project's projected IRR
iii. 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

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

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

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

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

xxx 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
Babcock Inc. is considering a project that has the following cash flow
xxx and WACC data. What is the project's NPV? Note that a project's
i. 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

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

Rappaport Enterprises is considering a project that has the following
xxx cash flow and WACC data. What is the project's NPV? Note that a
ii. 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

Barry Company is considering a project that has the following cash flow
xxx and WACC data. What is the project's NPV? Note that a project's
iii. 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

 Choi Computer Systems is considering a project that has the following
xxx cash flow data. What is the project's IRR? Note that a project's
iv. 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

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

Rentz Recreation Inc. is considering a project that has the following
xxx cash flow data. What is the project's IRR? Note that a project's
v. 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

Thompson Stores is considering a project that has the following cash
xxx flow data. What is the project's IRR? Note that a project's projected
vi. 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%
i. (11.2) NPV Answer: b EASY

ii. (11.3) IRR Answer: a EASY

iii. (11.3) IRR Answer: b EASY

iv. (11.4) NPV and IRR Answer: b EASY

v. (11.4) Mutually exclusive projects Answer: a EASY

vi. (11.4) Reinvestment rate assumption Answer: a EASY

vii. (11.5) Multiple IRRs Answer: a EASY

viii. (11.5) Multiple IRRs Answer: b EASY

ix. (11.6) Modified IRR Answer: b EASY

x. (11.6) Modified IRR Answer: b EASY

xi. (11.8) Payback Answer: a EASY

xii. (11.2) NPV Answer: c EASY

xiii. (11.3) IRR Answer: e EASY

The IRR assumes reinvestment at the IRR, and that is generally not as valid as assuming reinvestment at the
WACC, as with the NPV.

xiv. (11.3) IRR Answer: d EASY

xv. (11.3) IRR Answer: d EASY

xvi. (11.5) Normal vs. nonnormal cash flows Answer: e EASY

xvii. (11.5) Normal vs. nonnormal cash flows Answer: a EASY

xviii. (11.8) Payback

Answer: b EASY

xix. (Comp: 11.2,11.3,11.6,11.8) Ranking methods Answer: b EASY

xx. (11.2) NPV Answer: e MEDIUM

Statement e is correct. The others are false. If you draw an NPV profile for one project, you will see that if the
WACC is less than the IRR, the NPV will be positive.

xxi. (11.2) NPV Answer: b MEDIUM

xxii. (11.4) Ranking conflicts Answer: a MEDIUM

xxiii. (11.4) NPV and IRR

Answer: e MEDIUM

xxiv. (11.4) NPV and mutually exclusive projects Answer: c HARD

Statement c is true, while the other statements are false. If we draw an NPV profile graph, we would see that A
 must have the steeper slope. If the crossover is 8% and the WACC is 10%, then B will have the higher NPV.

xxv. (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

xxvi. (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%

xxvii. (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%

xxviii. (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%

xxix. (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 —

xxx. (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

xxxi. (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
xxxii. (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

xxxiii. (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

xxxiv. (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%

xxxv. (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%

xxxvi. (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%