Fin534 quiz 6 | Business & Finance homework help

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

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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.

 

Which of the following statements is correct?

      The NPV, IRR, MIRR, and discounted payback (using a payback requirement of 3 years or less) methods always lead to the same accept/reject decisions for independent projects.

      For mutually exclusive projects with normal cash flows, the NPV and MIRR methods can never conflict, but their results could conflict with the discounted payback and the regular IRR methods.

      Multiple IRRs can exist, but not multiple MIRRs. This is one reason some people favor the MIRR over the regular IRR.

      If a firm uses the discounted payback method with a required payback of 4 years, then it will accept more projects than if it used a regular payback of 4 years.

      The percentage difference between the MIRR and the IRR is equal to the project’s WACC.

 

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) 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.

E) 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.

 

Which of the following statements is CORRECT?

           

 

If a project with normal cash flows has an IRR greater than the WACC, the project must also have a positive NPV.

           

 

If Project A’s IRR exceeds Project B’s, then A must have the higher NPV.

           

 

A project’s MIRR can never exceed its IRR.

           

 

If a project with normal cash flows has an IRR less than the WACC, the project must have a positive NPV.

           

 

If the NPV is negative, the IRR must also be negative.

 

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.

Answer

 

    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.

 

    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.

 

    If a project’s IRR is greater than the WACC, then its NPV must be negative.

 

    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.

 

    To find a project’s IRR, we must find a discount rate that is equal to the WACC.

2 points

 

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?

 

 13

 

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

 

 14

 

Which of the following statements is CORRECT?

Answer

 

    One advantage of the NPV over the IRR is that NPV takes account of cash flows over a project’s full life whereas IRR does not.

 

    One advantage of the NPV over the IRR is that NPV assumes that cash flows will be reinvested at the WACC, whereas IRR assumes that cash flows are reinvested at the IRR.  The NPV assumption is generally more appropriate.

 

    One advantage of the NPV over the MIRR method is that NPV takes account of cash flows over a project’s full life whereas MIRR does not.

 

    One advantage of the NPV over the MIRR method is that NPV discounts cash flows whereas the MIRR is based on undiscounted cash flows.

 

    Since cash flows under the IRR and MIRR are both discounted at the same rate (the WACC), these two methods always rank mutually exclusive projects in the same order.

2 points  

 15

 

Which of the following statements is CORRECT?

Answer

 

    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.

 

    If the cost of capital declines, this lowers a project’s NPV.

 

    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.

 

    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.

 

    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.

2 points  

 16

 

Which of the following statements is CORRECT?

Answer

 

    Since depreciation is not a cash expense, and since cash flows and not accounting income are the relevant input, depreciation plays no role in capital budgeting.

 

    Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer.

 

    If firms use accelerated depreciation, they will write off assets slower than they would under straight-line depreciation, and as a result projects’ forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.

 

    If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects’ forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.

 

    If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects’ forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes.

2 points  

 17

 

Which of the following statements is CORRECT?

Answer

 

    An externality is a situation where a project would have an adverse effect on some other part of the firm’s overall operations.  If the project would have a favorable effect on other operations, then this is not

an externality.

 

    An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank’s other offices to increase.

 

    The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not.  This is another reason to favor the NPV.

 

    Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified.  However, the payback method does not.

 

    Identifying an externality can never lead to an increase in the calculated NPV.

2 points  

 18

  Which of the following procedures does the text say is used most frequently by businesses when they do capital budgeting analyses?

 

 19

 

Which of the following statements is CORRECT?

Answer

 

    An example of a sunk cost is the cost associated with restoring the site of a strip mine once the ore has been depleted.

 

    Sunk costs must be considered if the IRR method is used but not if the firm relies on the NPV method.

 

    A good example of a sunk cost is a situation where a bank opens a new office, and that new office leads to a decline in deposits of the bank’s other offices.

 

    A good example of a sunk cost is money that a banking corporation spent last year to investigate the site for a new office, then expensed that cost for tax purposes, and now is deciding whether to go forward with the project.

 

    If sunk costs are considered and reflected in a project’s cash flows, then the project’s calculated NPV will be higher than it otherwise would be.

2 points  

 20

 

Suppose Tapley Inc. uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects.  Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?

Answer

 

    Project A, which has average risk and an IRR = 9%.

 

    Project B, which has below-average risk and an IRR = 8.5%.

 

    Project C, which has above-average risk and an IRR = 11%.

 

    Without information about the projects’ NPVs we cannot determine which project(s) should be accepted.

 

    All of these projects should be accepted.

2 points  

 21

 

Which of the following factors should be included in the cash flows used to estimate a project’s NPV?

A

 22

  Which of the following statements is CORRECT?

Answer

 

    Sensitivity analysis is a good way to measure market risk because it explicitly takes into account diversification effects.

 

    One advantage of sensitivity analysis relative to scenario analysis is that it explicitly takes into account the probability of specific effects occurring, whereas scenario analysis cannot account for probabilities.

 

    Well-diversified stockholders do not need to consider market risk when determining required rates of return.

 

    Market risk is important, but it does not have a direct effect on stock prices because it only affects beta.

 

    Simulation analysis is a computerized version of scenario analysis where input variables are selected randomly on the basis of their probability distributions.

 

  Currently, Powell Products has a beta of 1.0, and its sales and profits are positively correlated with the overall economy.  The company estimates that a proposed new project would have a higher standard deviation and coefficient of variation than an average company project.  Also, the new project’s sales would be countercyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong.  On the basis of this information, which of the following statements is CORRECT?

 

  Which of the following statements is CORRECT?

Answer

 

    Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset.

 

    Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.

 

    Corporations must use the same depreciation method for both stockholder reporting and tax purposes.

 

    Using accelerated depreciation rather than straight line normally has the effect of speeding

up cash flows and thus increasing a project’s forecasted NPV.

 

    Using accelerated depreciation rather than straight line normally has no effect on a project’s total projected cash flows nor would it affect the timing of those cash flows or the resulting NPV of the project.

2 points

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