Fin 534 quiz 11 (30 questions with answers) 99,99 % scoredDocument Transcript
FIN 534 Quiz 11 (30 questions with answers) 99,99 % Scored PLEASE DOWNLOAD HEREQuestion 1Projects 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 2Which of the following statements is CORRECT?AnswerOne defect of the IRR method versus the NPV is that the IRR does not takeaccount of cash flows over a project’s full life.One defect of the IRR method versus the NPV is that the IRR does not takeaccount of the time value of money.One defect of the IRR method versus the NPV is that the IRR does not takeaccount of the cost of capital.One defect of the IRR method versus the NPV is that the IRR values a dollarreceived today the same as a dollar that will not be received until sometime in thefuture.
One defect of the IRR method versus the NPV is that the IRR does not takeproper account of differences in the sizes of projects.2 pointsQuestion 3Which of the following statements is CORRECT? Assume that the project beingconsidered has normal cash flows, with one outflow followed by a series ofinflows.AnswerIf Project A has a higher IRR than Project B, then Project A must have the lowerNPV.If Project A has a higher IRR than Project B, then Project A must also have ahigher NPV.The IRR calculation implicitly assumes that all cash flows are reinvested at theWACC.The IRR calculation implicitly assumes that cash flows are withdrawn from thebusiness rather than being reinvested in the business.If a project has normal cash flows and its IRR exceeds its WACC, then theproject’s NPV must be positive.2 pointsQuestion 4Assume that the economy is enjoying a strong boom, and as a result interestrates and money costs generally are relatively high. The WACC for two mutuallyexclusive projects that are being considered is 12%. Project S has an IRR of20% while Project Ls IRR is 15%. The projects have the same NPV at the 12%current WACC. However, you believe that the economy will soon fall into a mildrecession, and money costs and thus your WACC will soon decline. You alsothink that the projects will not be funded until the WACC has decreased, and theircash flows will not be affected by the change in economic conditions. Underthese conditions, which of the following statements is CORRECT?AnswerYou should reject both projects because they will both have negative NPVs underthe new conditions.
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.You should recommend Project L, because at the new WACC it will have thehigher NPV.You should recommend Project S, because at the new WACC it will have thehigher NPV.You should recommend Project L because it will have both a higher IRR and ahigher NPV under the new conditions.2 pointsQuestion 5Which of the following statements is CORRECT?AnswerProjects with “normal” cash flows can have only one real IRR.Projects with “normal” cash flows can have two or more real IRRs.Projects with “normal” cash flows must have two changes in the sign of the cashflows, e.g., from negative to positive to negative. If there are more than two signchanges, then the cash flow stream is “nonnormal.”The “multiple IRR problem” can arise if a project’s cash flows are “normal.”Projects with “nonnormal” cash flows are almost never encountered in the realworld.2 pointsQuestion 6Which of the following statements is CORRECT?AnswerFor a project to have more than one IRR, then both IRRs must be greater thanthe WACC.If two projects are mutually exclusive, then they are likely to have multiple IRRs.If a project is independent, then it cannot have multiple IRRs.
Multiple IRRs can occur only if the signs of the cash flows change more thanonce.If a project has two IRRs, then the smaller one is the one that is most relevant,and it should be accepted and relied upon.2 pointsQuestion 7Which 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 pointsQuestion 8Which 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 9Which of the following statements is CORRECT?AnswerThe shorter a project’s payback period, the less desirable the project is normallyconsidered to be by this criterion.One drawback of the regular payback is that this method does not take account ofcash flows beyond the payback period.If a project’s payback is positive, then the project should be accepted because itmust have a positive NPV.The regular payback ignores cash flows beyond the payback period, but thediscounted payback method overcomes this problem.One drawback of the discounted payback is that this method does not considerthe time value of money, while the regular payback overcomes this drawback.2 pointsQuestion 10Which 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 11Westchester Corp. is considering two equally risky, mutually exclusive projects,both of which have normal cash flows. Project A has an IRR of 11%, whileProject Bs IRR is 14%. When the WACC is 8%, the projects have the sameNPV. Given this 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 12Assume that the economy is in a mild recession, and as a result interest ratesand money costs generally are relatively low. The WACC for two mutuallyexclusive projects that are being considered is 8%. Project S has an IRR of 20%while Project Ls IRR is 15%. The projects have the same NPV at the 8% currentWACC. However, you believe that the economy is about to recover, and moneycosts and thus your WACC will also increase. You also think that the projects willnot be funded until the WACC has increased, and their cash flows will not beaffected by the change in economic conditions. Under these conditions, which ofthe following statements is CORRECT?AnswerYou should reject both projects because they will both have negative NPVs underthe new conditions.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.
You should recommend Project L, because at the new WACC it will have thehigher NPV.You should recommend Project S, because at the new WACC it will have thehigher NPV.You should recommend Project S because it has the higher IRR and will continueto have the higher IRR even at the new WACC.2 pointsQuestion 13Assume a project has normal cash flows. All else equal, which of the followingstatements is CORRECT?AnswerA project’s IRR increases as the WACC declines.A project’s NPV increases as the WACC declines.A project’s MIRR is unaffected by changes in the WACC.A project’s regular payback increases as the WACC declines.A project’s discounted payback increases as the WACC declines.2 pointsQuestion 14Which of the following statements is CORRECT?AnswerOne advantage of the NPV over the IRR is that NPV takes account of cash flowsover a project’s full life whereas IRR does not.One advantage of the NPV over the IRR is that NPV assumes that cash flows willbe reinvested at the WACC, whereas IRR assumes that cash flows arereinvested at the IRR. The NPV assumption is generally more appropriate.One advantage of the NPV over the MIRR method is that NPV takes account ofcash flows over a project’s full life whereas MIRR does not.One advantage of the NPV over the MIRR method is that NPV discounts cashflows 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 thesame order.2 pointsQuestion 15Which of the following statements is CORRECT?AnswerThe NPV method was once the favorite of academics and business executives,but today most authorities regard the MIRR as being the best indicator of aproject’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 aproject’s profitability; hence, most academics recommend that firms use only thisone 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 thecash flows occur early or late in the project’s life.The NPV and IRR methods may give different recommendations regarding whichof two mutually exclusive projects should be accepted, but they always give thesame recommendation regarding the acceptability of a normal, independentproject.2 pointsQuestion 16Which of the following statements is CORRECT?AnswerSince depreciation is not a cash expense, and since cash flows and notaccounting income are the relevant input, depreciation plays no role in capitalbudgeting.Under current laws and regulations, corporations must use straight-linedepreciation for all assets whose lives are 3 years or longer.If firms use accelerated depreciation, they will write off assets slower than theywould under straight-line depreciation, and as a result projects’ forecasted NPVs
are normally lower than they would be if straight-line depreciation were requiredfor tax purposes.If they use accelerated depreciation, firms can write off assets faster than theycould under straight-line depreciation, and as a result projects’ forecasted NPVsare normally lower than they would be if straight-line depreciation were requiredfor tax purposes.If they use accelerated depreciation, firms can write off assets faster than theycould under straight-line depreciation, and as a result projects’ forecasted NPVsare normally higher than they would be if straight-line depreciation were requiredfor tax purposes.2 pointsQuestion 17Which of the following statements is CORRECT?AnswerAn externality is a situation where a project would have an adverse effect onsome other part of the firm’s overall operations. If the project would have afavorable effect on other operations, then this is notan externality.An example of an externality is a situation where a bank opens a new office, andthat new office causes deposits in the bank’s other offices to increase.The NPV method automatically deals correctly with externalities, even if theexternalities are not specifically identified, but the IRR method does not. This isanother reason to favor the NPV.Both the NPV and IRR methods deal correctly with externalities, even if theexternalities are not specifically identified. However, the payback method doesnot.Identifying an externality can never lead to an increase in the calculated NPV.2 pointsQuestion 18Which of the following procedures does the text say is used most frequently bybusinesses when they do capital budgeting analyses?Answer
The firm’s corporate, or overall, WACC is used to discount all project cash flowsto find the projects’ NPVs. Then, depending on how risky different projects arejudged to be, the calculated NPVs are scaled up or down to adjust for differentialrisk.Differential project risk cannot be accounted for by using “risk-adjusted discountrates” because it is highly subjective and difficult to justify. It is better to not riskadjust at all.Other things held constant, if returns on a project are thought to be positivelycorrelated with the returns on other firms in the economy, then the project’s NPVwill be found using a lower discount rate than would be appropriate if the project’sreturns were negatively correlated.Monte Carlo simulation uses a computer to generate random sets of inputs, thoseinputs are then used to determine a trial NPV, and a number of trial NPVs areaveraged to find the project’s expected NPV. Sensitivity and scenario analyses,on the other hand, require much more information regarding the input variables,including probability distributions and correlations among those variables. Thismakes it easier to implement a simulation analysis than a scenario or a sensitivityanalysis, hence simulation is the most frequently used procedure.DCF techniques were originally developed to value passive investments (stocksand bonds). However, capital budgeting projects are not passive investments--managers can often take positive actions after the investment has been madethat alter the cash flow stream. Opportunities for such actions are called realoptions. Real options are valuable, but this value is not captured by conventionalNPV analysis. Therefore, a project’s real options must be considered separately.2 pointsQuestion 19Which of the following statements is CORRECT?AnswerAn example of a sunk cost is the cost associated with restoring the site of a stripmine once the ore has been depleted.Sunk costs must be considered if the IRR method is used but not if the firm relieson 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 lastyear to investigate the site for a new office, then expensed that cost for taxpurposes, 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 theproject’s calculated NPV will be higher than it otherwise would be.2 pointsQuestion 20Suppose 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 thefollowing independent projects should Tapley accept, assuming that the companyuses the NPV method when choosing projects?AnswerProject A, which has average risk and an %.Project B, which has below-average risk and an %.Project C, which has above-average risk and an %.Without information about the projects’ NPVs we cannot determine whichproject(s) should be accepted.All of these projects should be accepted.2 pointsQuestion 21Which of the following factors should be included in the cash flows used toestimate a project’s NPV?AnswerAll costs associated with the project that have been incurred prior to the time theanalysis is being conducted.Interest on funds borrowed to help finance the project.The end-of-project recovery of any working capital required to operate the project.Cannibalization effects, but only if those effects increase the project’s projectedcash flows.
Expenditures to date on research and development related to the project,provided those costs have already been expensed for tax purposes.2 pointsQuestion 22Which 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 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 statements is CORRECT?AnswerSince depreciation is a cash expense, the faster an asset is depreciated, thelower the projected NPV from investing in the asset.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 for both stockholderreporting and tax purposes.Using accelerated depreciation rather than straight line normally has the effect ofspeedingup cash flows and thus increasing a project’s forecasted NPV.Using accelerated depreciation rather than straight line normally has no effect ona project’s total projected cash flows nor would it affect the timing of those cashflows or the resulting NPV of the project.2 pointsQuestion 25Which 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 pointsQuestion 26When 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.2 pointsQuestion 27The relative risk of a proposed project is best accounted for by which of thefollowing procedures?AnswerAdjusting the discount rate upward if the project is judged to have above-averagerisk.Adjusting the discount rate downward if the project is judged to have above-average risk.Reducing the NPV by 10% for risky projects.Picking a risk factor equal to the average discount rate.
Ignoring risk because project risk cannot be measured accurately.2 pointsQuestion 28Dalrymple 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 29Which 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 30Which one of the following would NOT result in incremental cash flows and thusshould NOT be included in the capital budgeting analysis for a new product?AnswerA firm has a parcel of land that can be used for a new plant site or be sold,rented, or used for agricultural purposes.A new product will generate new sales, but some of those new sales will be fromcustomers who switch from one of the firm’s current products.A firm must obtain new equipment for the project, and $1 million is required forshipping and installing the new machinery.A firm has spent $2 million on R&D associated with a new product. These costshave been expensed for tax purposes, and they cannot be recovered regardlessof whether the new project is accepted or rejected.A firm can produce a new product, and the existence of that product will stimulatesales of some of the firm’s other products.2 points