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- 1. FIN 534 Quiz 8 (30 questions with answers) 99,99 % Scored PLEASE DOWNLOAD HEREQuestion 1Which 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 2Which 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.
- 2. The regular payback does not consider cash flows beyond the payback year, butthe discounted payback overcomes this defect.2 pointsQuestion 3Westchester 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 4Which 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 points
- 3. Question 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 regular IRR is found by compounding the cash inflows at the WACC tofind 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 tofind 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 ofthe 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 pointsQuestion 6Which 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 7
- 4. Which of the following statements is CORRECT?AnswerThe IRR method appeals to some managers because it gives an estimate of therate of return on projects rather than a dollar amount, which the NPV methodprovides.The discounted payback method eliminates all of the problems associated withthe payback method.When evaluating independent projects, the NPV and IRR methods often yieldconflicting results regarding a projects acceptability.To find the MIRR, we discount the TV at the IRR.A project’s NPV profile must intersect the X-axis at the project’s WACC.2 pointsQuestion 8Which 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 9Projects 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 projects
- 5. have 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 10Projects 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 11Which of the following statements is CORRECT?Answer
- 6. For 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 12Which 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 13Assume 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 be
- 7. affected 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 14Which 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 points
- 8. Question 15Which 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 16Which 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.
- 9. 2 pointsQuestion 17Which 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 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 points
- 10. Question 19Which 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 20The 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 points
- 11. Question 21Which 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 22Which 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.
- 12. A firm can produce a new product, and the existence of that product will stimulatesales of some of the firm’s other products.2 pointsQuestion 23A company is considering a new project. The CFO plans to calculate the project’sNPV by estimating the relevant cash flows for each year of the project’s life (i.e.,the initial investment cost, the annual operating cash flows, and the terminal cashflow), then discounting those cash flows at the company’s overall WACC. Whichone of the following factors should the CFO be sure to INCLUDE in the cashflows when estimating the relevant cash flows?AnswerAll sunk costs that have been incurred relating to the project.All interest expenses on debt used to help finance the project.The investment in working capital required to operate the project, even if thatinvestment will be recovered at the end of the project’s life.Sunk costs that have been incurred relating to the project, but only if those costswere incurred prior to the current year.Effects of the project on other divisions of the firm, but only if those effects lowerthe project’s own direct cash flows.2 pointsQuestion 24Which 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.
- 13. 2 pointsQuestion 25Which 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 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 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 26Which of the following statements is CORRECT?AnswerIn a capital budgeting analysis where part of the funds used to finance the projectwould be raised as debt, failure to include interest expense as a cost whendetermining the project’s cash flows will lead to an upward bias in the NPV.In a capital budgeting analysis where part of the funds used to finance the projectwould be raised as debt, failure to include interest expense as a cost whendetermining the project’s cash flows will lead to a downward bias in the NPV.The existence of any type of “externality” will reduce the calculated NPV versusthe NPV that would exist without the externality.
- 14. If one of the assets to be used by a potential project is already owned by the firm,and if that asset could be sold or leased to another firm if the new project werenot undertaken, then the net after-tax proceeds that could be obtained should becharged as a cost to the project under consideration.If one of the assets to be used by a potential project is already owned by the firmbut is not being used, then any costs associated with that asset is a sunk costand should be ignored.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 28
- 15. Which 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 29Rowell 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.
- 16. 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?AnswerUsing some of the firm’s high-quality factory floor space that is currently unusedto produce the proposed new product. This space could be used for otherproducts if it is not used for the project under consideration.Revenues from an existing product would be lost as a result of customersswitching to the new product.Shipping and installation costs associated with a machine that would be used toproduce the new product.The cost of a study relating to the market for the new product that was completedlast year. The results of this research were positive, and they led to the tentativedecision to go ahead with the new product. The cost of the research was incurredand expensed for tax purposes last year.It is learned that land the company owns and would use for the new project, if it isaccepted, could be sold to another firm.

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