Unit 11: Basics Of Capital Budgeting

Question 1

Assume a project has normal cash flows (that is, the initial cash flow isnegative, and all other cash flows are positive). statements is most correct?Which of the following

a. All else equal, a project’s IRR increases as the cost of capitaldeclines.
b. All else equal, a project’s NPV increases as the cost of capitaldeclines
c. All else equal, a project’s MIRR is unaffected by changes in the costof capital.
d. Statements a and b are correct.
e. Statements b and c are correct.

Answer 1

B

Question 2

Which of the following statements is most correct?

a. The NPV method assumes that cash flows will be reinvested at the costof capital, while the IRR method assumes reinvestment at the IRR.
b. The NPV method assumes that cash flows will be reinvested at the riskfree rate, while the IRR method assumes reinvestment at the IRR.
c. The NPV method assumes that cash flows will be reinvested at the costof capital, while the IRR method assumes reinvestment at the risk-freerate.
d. The NPV method does not consider the inflation premium.
e. The IRR method does not consider all relevant cash flows, particularly,cash flows beyond the payback period.

Answer 2

A

Question 3

A major disadvantage of the payback period is that it

a. Is useless as a risk indicator.
b. Ignores cash flows beyond the payback period.
c. Does not directly account for the time value of money.
d. Statements b and c are correct.
e. All of the statements above are correct.

Answer 3

D

Question 4

Projects A and B have the same expected lives and initial cash outflows.However, one project’s cash flows are larger in the early years, while theother project has larger cash flows in the later years. profiles are given below:

[Inverse slope graph] [2lines]

Which of the following statements is most correct?

a. Project A has the smaller cash flows in the later years.
b. Project A has the larger cash flows in the later years.
c. We require information on the cost of capital in order to determinewhich project has larger early cash flows.
d. The NPV profile graph is inconsistent with the statement made in theproblem.
e. None of the statements above is correct.

Answer 4

B