The relative risk of a proposed project is best accounted for by which of the following procedures?
Adjusting the discount rate upward if the project is judged to have above-average risk.
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.
Adjusting the discount rate upward if the project is judged to have above-average risk.
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.
Masulis Inc. is considering a project that has the following cash flow and WACC data. What is the project's discounted payback?
WACC: 10.00%
Year 0 1 2 3 4
Cash flows -$950 $525 $485 $445 $405
1.61 years
1.79 years
1.99 years
2.22 years
2.44 years
Which of the following statements is CORRECT?
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.
Noe Drilling Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the MIRR. If the decision is made by choosing the project with the higher IRR rather than the one with the higher MIRR, how much, if any, value will be forgone. In other words, what's the NPV of the chosen project versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. MIRR will have no effect on the value lost.
WACC: 7.00%
Year 0 1 2 3 4
CFS -$1,100 $550 $600 $100 $ 100
CFL -$2,750 $725 $725 $800 $1,400
$185.90
$197.01
$208.11
$219.22
$230.32
WACC: 10.00%
Year 0 1 2 3 4
Cash flows -$950 $525 $485 $445 $405
1.61 years
1.79 years
1.99 years
2.22 years
2.44 years
Which of the following statements is CORRECT?
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.
Noe Drilling Inc. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO believes the IRR is the best selection criterion, while the CFO advocates the MIRR. If the decision is made by choosing the project with the higher IRR rather than the one with the higher MIRR, how much, if any, value will be forgone. In other words, what's the NPV of the chosen project versus the maximum possible NPV? Note that (1) "true value" is measured by NPV, and (2) under some conditions the choice of IRR vs. MIRR will have no effect on the value lost.
WACC: 7.00%
Year 0 1 2 3 4
CFS -$1,100 $550 $600 $100 $ 100
CFL -$2,750 $725 $725 $800 $1,400
$185.90
$197.01
$208.11
$219.22
$230.32
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.
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.
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.
Dalrymple Inc. is considering production of a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated?
The company will produce the new product in a vacant building that was used to produce another product until last year. The building could be sold, leased to another 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 not now using. A used equipment dealer has offered to buy the equipment.
The company has spent and expensed for tax purposes $3 million on research related to the new detergent. These funds cannot be recovered, but the research may 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.
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.
Tuttle Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's expected NPV is negative, it should be rejected.
WACC: 11.00%
Year 0 1 2 3 4
Cash flows -$1,000 $350 $350 $350 $350
$77.49
$81.56
$85.86
$90.15
$94.66
WACC: 11.00%
Year 0 1 2 3 4
Cash flows -$1,000 $350 $350 $350 $350
$77.49
$81.56
$85.86
$90.15
$94.66
Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one cash outflow at t = 0 followed by a series of positive cash flows.
A project's MIRR is always greater than its regular IRR.
A project's MIRR is always less than its regular IRR.
If a project's IRR is greater than its WACC, then its MIRR will be greater than the IRR.
To find a project’s MIRR, we compound cash inflows at the regular IRR and then find the discount rate that causes the PV of the terminal value to equal the initial cost.
To find a project’s MIRR, the textbook procedure compounds cash inflows at the WACC and then finds the discount rate that causes the PV of the terminal value to equal the initial cost.
