CORPPORATE FINANCE

MBAC 6060
Chapter 10 (13th ed.) The Basics of Capital Budgeting
1.

Assume a project has a normal cash flows (i.e., the initial cash flow is negative, and all
other cash flows are positive). Which of the follow1ng statements is most correct?
a.
b.
c.
d.
e.

2.

All else equal, a project's IRR increases as the cost of capital declines.
All else equal, a project's NPV increases as the cost of capital declines.
All else equal, a project's MIRR is unaffected by changes in the cost of capital.
Answers a and b are correct.
Answers b and c are correct.

Which of the following statements is most correct given conventional cash flows?
a. If a projects internal rate of return (IRR) exceeds the cost of capital, then the
projects net present value (NPV) must be positive.
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 a rate of
return equal to the cost of capital.
d. Answers a and c are correct..
e None of the answers above is correct.

3.

Project A has an IRR of 15 percent. Project B has an IRR of 18 percent. Both projects
have the same risk. Which of the following statements is most correct?
a. If the WACC is 10 percent, both projects will have a positive NPV, and the NPV of
Project B will exceed the NPV of Project A.
b. If the WACC is 15 percent, the NPV of Project B will exceed the NPV of Project A.
c. If the WACC if less than 18 percent, Project B will always have a shorter payback
than Project A.
d. If the WACC is greater than 18 percent, Project B will always have a shorter payback
than Project A.
e. If the WACC increases, the IRR of both projects will decline.

4.

Two mutually exclusive projects each have a cost of $10,000. The total, undiscounted
cash flows from Project L are $15,000, while the undiscounted cash flows from Project S
total $13,000. Their NPV profiles cross at a discount rate of 10 percent. Which of the
following statements best describes this situation?
a. The NPV and IRR methods will select the same project if the cost of capital is
greater than 10 percent; for example, 18 percent.
b. The NPV and IRR methods will select the same project if the cost of capital is less
than 10 percent. For example, 8 percent.
c. To determine if a ranking conflict will occur between the two projects the cost of
capital is needed as well as an additional piece of information.
d. Project L should be selected at any cost of capital, because it has a higher IRR.
e. Project S should be selected at any cost of capital, because it has a higher IRR.

5.

Which of the following is most correct?

a. The NPV and IRR rules will always lead to the same decision in choosing between
mutually exclusive projects, unless one or both of the projects are non-normal in
the sense of having only one change of sign in the cash flow stream.
b. The modified Internal Rate of Return (MIRR) compounds cash outflows at the cost of
capital.
c. Conflicts between NPV and IRR rules arise in choosing between two mutually
exclusive projects (that each have normal cash flows) when the cost of capital
exceeds the crossover point (that is, the point at which NPV profiles cross).
d. The discounted payback method overcomes the problems that the payback method
has with cash flows occurring after the payback period.
e. None of the statements above is correct.

6.

A company estimates that its weighted average cost of capital (WACC) is 10 percent.
Which of the following independent projects should the company accept?
a. Project A requires an up-front expenditure of $1,000,000 and generates a net present
value of $3,200.
b. Project B has a modified internal rate of return of 9.5 percent.
c. Project C requires an up-front expenditure of $1,000,000 and generates a positive
internal rate of return of 9.7 percent.
d. Project D has an internal rate of return of 9.5 percent.
e. None of the projects above should be accepted.

7.

You are considering the purchase of an investment that would pay you $5,000 per year
for Years 1-5, $3,000 per year for Years 6-8, and $2,000 per year for Years 9 and 10. If
you require a 14 percent rate of return, and the cash flows occur at the end of each year,
then how much should you be willing to pay for this investment?
a.
b.
c.
d.
e.

8.

$15,819.27
$21,937.26
$32,415.85
$38,000.00
52,815.71

Alyeska Salmon Inc., a large salmon canning firm operating in Valdex, Alaska, has a new
automated production line project it is considering. The project has a cost of $275,000
and is expected to provide after-tax annual cash flows of $73,306 for eight years. The
firms management is uncomfortable with the IRR reinvestment assumption and prefers
the modified IRR approach. You have calculated a cost of capital for the firm at 12
percent. What is the projects MIRR?
a.
b.
c.
d.
e.

15.0%
14.0%
12.0%
16.0%
17.0%

9.

Two projects being considered by a firm are mutually exclusive and have the following
projected cash flows:
Year

Project A Cash Flow

Project B Cash Flow

($100,000)

($100,000)

39.500

39,500

39,500

133,000

Based on only the information given, which of the following projects would be preferred,
and why?
a.
b.
c.
d.

Project A, because it has a shorter payback period.

Project B, because it has a higher IRR.
Indifferent, because the projects have equal IRRs.
Include both in the capital budget, since the sum of the cash inflows exceeds the
initial investment in both cases.
E. Choose neither, since their NPVs are negative.
10.

Scotts Corporations new project calls for an investment of $10,000. It has an estimated
life of 10 years. The IRR has been calculated to be 15 percent. If cash flows are evenly
distributed and the tax rate is 40 percent, what is the annual before-tax cash flow each
year? (Assume depreciation is a negligible amount.)
a.
b.
c.
d.
e.

$1,993
$3,321
$1,500
$4,483
$5,019

11.
WorldWide Pants Inc. has been in business four years. Over those four years, the market
has seen annual returns of 19%, -3%, 20%, and 16%. Over the same time frame, Treasuries
average a 6.0% return. WorldWide finances only with equity from retained earnings; has a Beta
of 1.31, and it uses the CAPM to estimate its cost of capital. WorldWide is considering two
alternative trucks. Truck S has a cost of $12,000 and is expected to produce cash flows of
$4,500 per year for four years. Truck L has a cost of $20,000 and is expected to produce cash
flows of $7,500 per year for 4 years. What is the differential in value generated between the two
truck projects. What is the MIRR of the better truck?

Corporate Finance
Ch 10 (13th ed) Capital Budgeting
ProbSet Answers
1. B
2. A
3. B
4. A
5. E
6. A
7. B
8. D
9. B
10. B
11. $535.56
MIRR = 17.05%