Question 1

<!– Screen Reader Anchor–>Which of the following statements is CORRECT?
Answer
For a project with normal cash flows, any change in the WACC will change both the 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 the WACC. 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 upper right quadrant, then the project with the higher IRR probably has more of its cash flows coming in the later years.If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years.
2 points
Question 2

<!– Screen Reader Anchor–>Assume that the economy is in a mild recession, and as a result interest rates and money costs generally are relatively low. The WACC for two mutually exclusive projects that are being considered is 8%. Project S has an IRR of 20% while Project L’s IRR is 15%. The projects have the same NPV at the 8% current WACC. However, you believe that the economy is about to recover, and money costs and thus your WACC will also increase. You also think that the projects will not be funded until the WACC has increased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT?
Answer
You should reject both projects because they will both have negative NPVs under the 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 the higher NPV.You should recommend Project S, because at the new WACC it will have the higher NPV.You should recommend Project S because it has the higher IRR and will continue to have the higher IRR even at the new WACC.
2 points
Question 3

<!– Screen Reader Anchor–>Which of the following statements is CORRECT?
Answer
Projects 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 cash flows, e.g., from negative to positive to negative. If there are more than two sign changes, 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 real world.
2 points
Question 4

<!– Screen Reader Anchor–>Which of the following statements is CORRECT?
Answer
An NPV profile graph shows how a project’s payback varies as the cost of capital changes.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 a project’s risk varies with its life.An NPV profile graph is designed to give decision makers an idea about how a project’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 WACC for use in evaluating the project’s NPV.
2 points
Question 5

<!– Screen Reader Anchor–>Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.
Answer
A project’s regular IRR is found by compounding the cash inflows at the WACC to find 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 to find 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 of the 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 points
Question 6

<!– Screen Reader Anchor–>Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.
Answer
If Project A has a higher IRR than Project B, then Project A must have the lower NPV.If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.The IRR calculation implicitly assumes that all cash flows are reinvested at the WACC.The IRR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business.If a project has normal cash flows and its IRR exceeds its WACC, then the project’s NPV must be positive.