Fin 534 quiz 4 (30 questions with answers) 99,99 % scoredDocument Transcript
FIN 534 Quiz 4 (30 questions with answers) 99,99 % Scored PLEASE DOWNLOAD HEREQuestion 1Which of the following statements is CORRECT?AnswerFor a project with normal cash flows, any change in the WACC will change boththe NPV and the IRR.To find the MIRR, we first compound cash flows at the regular IRR to find the TV,and then we discount the TV at the WACC to find the PV.The NPV and IRR methods both assume that cash flows can be reinvested at theWACC. However, the MIRR method assumes reinvestment at the MIRR itself.If two projects have the same cost, and if their NPV profiles cross in the upperright quadrant, then the project with the higher IRR probably has more of its cashflows coming in the later years.If two projects have the same cost, and if their NPV profiles cross in the upperright quadrant, then the project with the lower IRR probably has more of its cashflows coming in the later years.2 pointsQuestion 2Which of the following statements is CORRECT?AnswerIf a project with normal cash flows has an IRR greater than the WACC, the projectmust 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 projectmust have a positive NPV.
If the NPV is negative, the IRR must also be negative.2 pointsQuestion 3Which of the following statements is CORRECT?AnswerThe regular payback method recognizes all cash flows over a project’s life.The discounted payback method recognizes all cash flows over a project’s life,and it also adjusts these cash flows to account for the time value of money.The regular payback method was, years ago, widely used, but virtually nocompanies even calculate the payback today.The regular payback is useful as an indicator of a project’s liquidity because itgives managers an idea of how long it will take to recover the funds invested in aproject.The regular payback does not consider cash flows beyond the payback year, butthe discounted payback overcomes this defect.2 pointsQuestion 4Projects S and L both have an initial cost of $10,000, followed by a series ofpositive cash inflows. Project S’s undiscounted net cash flows total $20,000, whileL’s total undiscounted flows are $30,000. At a WACC of 10%, the two projectshave identical NPVs. Which project’s NPV is more sensitive to changes in theWACC?AnswerProject S.Project L.Both projects are equally sensitive to changes in the WACC since their NPVs areequal at all costs of capital.Neither project is sensitive to changes in the discount rate, since both have NPVprofiles that are horizontal.
The solution cannot be determined because the problem gives us no informationthat can be used to determine the projects’ relative IRRs.2 pointsQuestion 5Which of the following statements is CORRECT? Assume that the project beingconsidered has normal cash flows, with one outflow followed by a series ofinflows.AnswerA project’s NPV is found by compounding the cash inflows at the IRR to find theterminal value (TV), then discounting the TV at the WACC.The lower the WACC used to calculate a project’s NPV, the lower the calculatedNPV will be.If a project’s NPV is less than zero, then its IRR must be less than the WACC.If a project’s NPV is greater than zero, then its IRR must be less than zero.The NPV of a relatively low-risk project should be found using a relatively highWACC.2 pointsQuestion 6Which of the following statements is CORRECT?AnswerThe MIRR and NPV decision criteria can never conflict.The IRR method can never be subject to the multiple IRR problem, while theMIRR method can be.One reason some people prefer the MIRR to the regular IRR is that the MIRR isbased on a generally more reasonable reinvestment rate assumption.The higher the WACC, the shorter the discounted payback period.The MIRR method assumes that cash flows are reinvested at the crossover rate.2 points
Question 7Which of the following statements is CORRECT? Assume that the project beingconsidered has normal cash flows, with one outflow followed by a series ofinflows.AnswerThe longer a project’s payback period, the more desirable the project is normallyconsidered to be by this criterion.One drawback of the regular payback for evaluating projects is that this methoddoes not properly account for the time value of money.If a project’s payback is positive, then the project should be rejected because itmust have a negative NPV.The regular payback ignores cash flows beyond the payback period, but thediscounted payback method overcomes this problem.If a company uses the same payback requirement to evaluate all projects, say itrequires a payback of 4 years or less, then the company will tend to rejectprojects with relatively short lives and accept long-lived projects, and this willcause its risk to increase over time.2 pointsQuestion 8Which of the following statements is CORRECT?AnswerThe NPV, IRR, MIRR, and discounted payback (using a payback requirement of 3years or less) methods always lead to the same accept/reject decisions forindependent projects.For mutually exclusive projects with normal cash flows, the NPV and MIRRmethods can never conflict, but their results could conflict with the discountedpayback and the regular IRR methods.Multiple IRRs can exist, but not multiple MIRRs. This is one reason some peoplefavor 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 theproject’s WACC.2 pointsQuestion 9Which of the following statements is CORRECT? Assume that the project beingconsidered has normal cash flows, with one outflow followed by a series ofinflows.AnswerA project’s NPV is generally found by compounding the cash inflows at theWACC to find the terminal value (TV), then discounting the TV at the IRR to findits PV.The higher the WACC used to calculate the NPV, the lower the calculated NPVwill be.If a project’s NPV is greater than zero, then its IRR must be less than the WACC.If a project’s NPV is greater than zero, then its IRR must be less than zero.The NPVs of relatively risky projects should be found using relatively low WACCs.2 pointsQuestion 10Which of the following statements is CORRECT?AnswerThe NPV method assumes that cash flows will be reinvested at the WACC, whilethe IRR method assumes reinvestment at the IRR.The NPV method assumes that cash flows will be reinvested at the risk-free rate,while the IRR method assumes reinvestment at the IRR.The NPV method assumes that cash flows will be reinvested at the WACC, whilethe IRR method assumes reinvestment at the risk-free rate.The NPV method does not consider all relevant cash flows, particularly cashflows beyond the payback period.The IRR method does not consider all relevant cash flows, particularly cash flowsbeyond the payback period.
2 pointsQuestion 11Which of the following statements is CORRECT? Assume that the project beingconsidered has normal cash flows, with one outflow followed by a series ofinflows.AnswerA project’s regular IRR is found by compounding the initial cost at the WACC tofind the terminal value (TV), then discounting the TV at the WACC.A project’s regular IRR is found by compounding the cash inflows at the WACC tofind the present value (PV), then discounting the TV to find the IRR.If a project’s IRR is smaller than the WACC, then its NPV will be positive.A project’s IRR is the discount rate that causes the PV of the inflows to equal theproject’s cost.If a project’s IRR is positive, then its NPV must also be positive.2 pointsQuestion 12Projects C and D are mutually exclusive and have normal cash flows. Project Chas a higher NPV if the WACC is less than 12%, whereas Project D has a higherNPV if the WACC exceeds 12%. Which of the following statements isCORRECT?AnswerProject D probably has a higher IRR.Project D is probably larger in scale than Project C.Project C probably has a faster payback.Project C probably has a higher IRR.The crossover rate between the two projects is below 12%.2 pointsQuestion 13
Projects S and L are equally risky, mutually exclusive, and have normal cashflows. Project S has an IRR of 15%, while Project L’s IRR is 12%. The twoprojects have the same NPV when the WACC is 7%. Which of the followingstatements is CORRECT?AnswerIf the WACC is 10%, both projects will have positive NPVs.If the WACC is 6%, Project S will have the higher NPV.If the WACC is 13%, Project S will have the lower NPV.If the WACC is 10%, both projects will have a negative NPV.Project S’s NPV is more sensitive to changes in WACC than Project Ls.2 pointsQuestion 14Which of the following statements is CORRECT?AnswerAn NPV profile graph shows how a project’s payback varies as the cost of capitalchanges.The NPV profile graph for a normal project will generally have a positive (upward)slope as the life of the project increases.An NPV profile graph is designed to give decision makers an idea about how aproject’s risk varies with its life.An NPV profile graph is designed to give decision makers an idea about how aproject’s contribution to the firm’s value varies with the cost of capital.We cannot draw a project’s NPV profile unless we know the appropriate WACCfor use in evaluating the project’s NPV.2 pointsQuestion 15Westchester Corp. is considering two equally risky, mutually exclusive projects,both of which have normal cash flows. Project A has an IRR of 11%, while ProjectBs IRR is 14%. When the WACC is 8%, the projects have the same NPV. Giventhis information, which of the following statements is CORRECT?
AnswerIf the WACC is 13%, Project A’s NPV will be higher than Project B’s.If the WACC is 9%, Project A’s NPV will be higher than Project B’s.If the WACC is 6%, Project B’s NPV will be higher than Project A’s.If the WACC is greater than 14%, Project A’s IRR will exceed Project B’s.If the WACC is 9%, Project B’s NPV will be higher than Project A’s.2 pointsQuestion 16Rowell Company spent $3 million two years ago to build a plant for a newproduct. It then decided not to go forward with the project, so the building isavailable for sale or for a new product. Rowell owns the building free and clear--there is no mortgage on it. Which of the following statements is CORRECT?AnswerSince the building has been paid for, it can be used by another project with noadditional cost. Therefore, it should not be reflected in the cash flows for any newproject.If the building could be sold, then the after-tax proceeds that would be generatedby any such sale should be charged as a cost to any new project that would useit.This is an example of an externality, because the very existence of the buildingaffects the cash flows for any new project that Rowell might consider.Since the building was built in the past, its cost is a sunk cost and thus need notbe considered when new projects are being evaluated, even if it would be usedby those new projects.If there is a mortgage loan on the building, then the interest on that loan wouldhave to be charged to any new project that used the building.2 pointsQuestion 17Which of the following rules is CORRECT for capital budgeting analysis?Answer
The interest paid on funds borrowed to finance a project must be included inestimates of the project’s cash flows.Only incremental cash flows, which are the cash flows that would result if aproject is accepted, are relevant when making accept/reject decisions.Sunk costs are not included in the annual cash flows, but they must be deductedfrom the PV of the project’s other costs when reaching the accept/reject decision.A proposed project’s estimated net income as determined by the firm’saccountants, using generally accepted accounting principles (GAAP), isdiscounted at the WACC, and if the PV of this income stream exceeds theproject’s cost, the project should be accepted.If a product is competitive with some of the firm’s other products, this fact shouldbe incorporated into the estimate of the relevant cash flows. However, if the newproduct is complementary to some of the firm’s other products, this fact need notbe reflected in the analysis.2 pointsQuestion 18A firm is considering a new project whose risk is greater than the risk of the firm’saverage project, based on all methods for assessing risk. In evaluating thisproject, it would be reasonable for management to do which of the following?AnswerIncrease the estimated IRR of the project to reflect its greater risk.Increase the estimated NPV of the project to reflect its greater risk.Reject the project, since its acceptance would increase the firm’s risk.Ignore the risk differential if the project would amount to only a small fraction ofthe firm’s total assets.Increase the cost of capital used to evaluate the project to reflect its higher-than-average risk.2 pointsQuestion 19Dalrymple Inc. is considering production of a new product. In evaluating whetherto go ahead with the project, which of the following items should NOT be explicitlyconsidered when cash flows are estimated?
AnswerThe company will produce the new product in a vacant building that was used toproduce another product until last year. The building could be sold, leased toanother company, or used in the future to produce another of the firm’s products.The project will utilize some equipment the company currently owns but is notnow using. A used equipment dealer has offered to buy the equipment.The company has spent and expensed for tax purposes $3 million on researchrelated to the new detergent. These funds cannot be recovered, but the researchmay benefit other projects that might be proposed in the future.The new product will cut into sales of some of the firm’s other products.If the project is accepted, the company must invest $2 million in working capital.However, all of these funds will be recovered at the end of the project’s life.2 pointsQuestion 20Which of the following statements is CORRECT?AnswerUsing accelerated depreciation rather than straight line would normally have noeffect on a project’s total projected cash flows but it would affect the timing of thecash flows and thus the NPV.Under current laws and regulations, corporations must use straight-linedepreciation for all assets whose lives are 5 years or longer.Corporations must use the same depreciation method (e.g., straight line oraccelerated) for stockholder reporting and tax purposes.Since depreciation is not a cash expense, it has no effect on cash flows and thusno effect on capital budgeting decisions.Under accelerated depreciation, higher depreciation charges occur in the earlyyears, and this reduces the early cash flows and thus lowers a project’s projectedNPV.2 pointsQuestion 21
A company is considering a proposed new plant that would increase productivecapacity. Which of the following statements is CORRECT?AnswerIn calculating the project’s operating cash flows, the firm should notdeduct financing costs such as interest expense, because financing costs areaccounted for by discounting at the WACC. If interest were deducted whenestimating cash flows, this would, in effect, “double count” it.Since depreciation is a non-cash expense, the firm does not need to deal withdepreciation when calculating the operating cash flows.When estimating the project’s operating cash flows, it is important to include bothopportunity costs and sunk costs, but the firm should ignore the cash flow effectsof externalities since they are accounted for in the discounting process.Capital budgeting decisions should be based on before-tax cash flows.The WACC used to discount cash flows in a capital budgeting analysis should becalculated on a before-tax basis.2 pointsQuestion 22Which of the following statements is CORRECT?AnswerA sunk cost is any cost that must be expended in order to complete a project andbring it into operation.A sunk cost is any cost that was expended in the past but can be recovered if thefirm decides not to go forward with the project.A sunk cost is a cost that was incurred and expensed in the past and cannot berecovered if the firm decides not to go forward with the project.Sunk costs were formerly hard to deal with but now that the NPV method iswidely used, it is possible to simply include sunk costs in the cash flows and thencalculate the PV of the project.A good example of a sunk cost is a situation where Home Depot opens a newstore, and that leads to a decline in sales of one of the firm’s existing stores.2 points
Question 23Currently, Powell Products has a beta of 1.0, and its sales and profits arepositively correlated with the overall economy. The company estimates that aproposed new project would have a higher standard deviation and coefficient ofvariation than an average company project. Also, the new project’s sales wouldbe countercyclical in the sense that they would be high when the overall economyis down and low when the overall economy is strong. On the basis of thisinformation, which of the following statements is CORRECT?AnswerThe proposed new project would have more stand-alone risk than the firm’stypical project.The proposed new project would increase the firm’s corporate risk.The proposed new project would increase the firm’s market risk.The proposed new project would not affect the firm’s risk at all.The proposed new project would have less stand-alone risk than the firm’s typicalproject.2 pointsQuestion 24Which of the following should be considered when a company estimates the cashflows used to analyze a proposed project?AnswerThe new project is expected to reduce sales of one of the company’s existingproducts by 5%.Since the firm’s director of capital budgeting spent some of her time last year toevaluate the new project, a portion of her salary for that year should be chargedto the project’s initial cost.The company has spent and expensed $1 million on R&D associated with thenew project.The company spent and expensed $10 million on a marketing study before itscurrent analysis regarding whether to accept or reject the project.The firm would borrow all the money used to finance the new project, and theinterest on this debt would be $1.5 million per year.
2 pointsQuestion 25Which of the following statements is CORRECT?AnswerSensitivity analysis is a good way to measure market risk because it explicitlytakes into account diversification effects.One advantage of sensitivity analysis relative to scenario analysis is that itexplicitly takes into account the probability of specific effects occurring, whereasscenario analysis cannot account for probabilities.Well-diversified stockholders do not need to consider market risk whendetermining required rates of return.Market risk is important, but it does not have a direct effect on stock pricesbecause it only affects beta.Simulation analysis is a computerized version of scenario analysis where inputvariables are selected randomly on the basis of their probability distributions.2 pointsQuestion 26Which of the following statements is CORRECT?AnswerSensitivity analysis as it is generally employed is incomplete in that it fails toconsider the probability of occurrence of the key input variables.In comparing two projects using sensitivity analysis, the one with the steeper lineswould be considered less risky, because a small error in estimating a variablesuch as unit sales would produce only a small error in the project’s NPV.The primary advantage of simulation analysis over scenario analysis is thatscenario analysis requires a relatively powerful computer, coupled with anefficient financial planning software package, whereas simulation analysis can bedone efficiently using a PC with a spreadsheet program or even with just acalculator.Sensitivity analysis is a type of risk analysis that considers both the sensitivity ofNPV to changes in key input variables and the probability of occurrence of thesevariables’ values.
As computer technology advances, simulation analysis becomes increasinglyobsolete and thus less likely to be used as compared to sensitivity analysis.2 pointsQuestion 27Langston Labs has an overall (composite) WACC of 10%, which reflects the costof capital for its average asset. Its assets vary widely in risk, and Langstonevaluates low-risk projects with a WACC of 8%, average-risk projects at 10%,and high-risk projects at 12%. The company is considering the following projects:Project Risk Expected ReturnA High 15%B Average 12%C High 11%D Low 9%E Low 6%Which set of projects would maximize shareholder wealth?AnswerA and B.A, B, and C.A, B, and D.A, B, C, and D.A, B, C, D, and E.2 pointsQuestion 28Which of the following is NOT a relevant cash flow and thus should not bereflected in the analysis of a capital budgeting project?AnswerChanges in net working capital.
Shipping and installation costs.Cannibalization effects.Opportunity costs.Sunk costs that have been expensed for tax purposes.2 pointsQuestion 29Which of the following statements is CORRECT?AnswerIf a firm is found guilty of cannibalization in a court of law, then it is judged to havetaken unfair advantage of its competitors. Thus, cannibalization is dealt with bysociety through the antitrust laws.If a firm is found guilty of cannibalization in a court of law, then it is judged to havetaken unfair advantage of its customers. Thus, cannibalization is dealt with bysociety through the antitrust laws.If cannibalization exists, then the cash flows associated with the project must beincreased to offset these effects. Otherwise, the calculated NPV will be biaseddownward.If cannibalization is determined to exist, then this means that the calculated NPVif cannibalization is considered will be higher than the NPV if this effect is notrecognized.Cannibalization, as described in the text, is a type of externality that is not againstthe law, and any harm it causes is done to the firm itself.2 pointsQuestion 30When evaluating a new project, firms should include in the projected cash flowsall of the following EXCEPT:AnswerChanges in net working capital attributable to the project.Previous expenditures associated with a market test to determine the feasibility ofthe project, provided those costs have been expensed for tax purposes.
The value of a building owned by the firm that will be used for this project.A decline in the sales of an existing product, provided that decline is directlyattributable to this project.The salvage value of assets used for the project that will be recovered at the endof the project’s life.