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Exam 10: The Basics of Capital Budgeting: Evaluating Cash Flows

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Question 41

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Which statement regarding normal cash flows 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 "non-normal" cash flows might have more than one real IRR.

E) A) and B)
F) A) and D)

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Question 42

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Projects C and D are mutually exclusive and have normal cash flows. Project C has a higher NPV if the WACC is less than 12%, whereas Project D has a higher NPV if the WACC exceeds 12%. Which of the following statements is correct?

A) Project D has a higher IRR.
B) Project D is probably larger in scale than Project C.
C) Project C probably has a faster payback.
D) Project C has a higher IRR.

E) C) and D)
F) B) and C)

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Question 43

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Normal Projects Q and R have the same NPV when the discount rate is zero. However, Project Q's cash flows come in faster than those of R. Therefore, we know that at any discount rate greater than zero, R will have a higher NPV than Q.

A decision to undertake significant downsizing to control fixed costs is usually made by senior management, with the decision reported to the firm's board of directors.

Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project's life.

Projects A and B are mutually exclusive and have normal cash flows. Project A has an IRR of 15% and Project B's IRR is 20%. The company's WACC is 12%, and at that rate Project A has the higher NPV. Which of the following statements is correct?

Financing pressure or liquidity can explain the popular use of payback period in project appraisals for small firms.

Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large cash flows late in its life. Neither has negative cash flows after Year 0, and at the current cost of capital, the two projects have identical NPVs. Now, suppose interest rates and money costs decline. Other things held constant, this change will cause L to become preferred to S.

The level of detail needed to determine capital budget expenditures related to compliance with safety and/or environmental issues varies depending on the size and scope of the project(s).