TRUE OR FALSE

1. Internal Rate of Return (IRR) becomes completely unreliable for projects that have non-normal cash flow patterns. If we need to use a rate of return measure for a non-normal project we should use Modified Internal Rate of Return (MIRR), not IRR.

2. If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital, the payback method and NPV method would always lead to the same decision on which project to undertake.

3. Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method puts the other one first. In theory, such conflicts should be resolved in favor of the project with the higher NPV.

4. One must always be careful to accurately measure sunk costs so they can be included in a projects cash flows.

5. Choose which statement makes this sentence FALSE: The basic IRR statistic

requires at least one positive and one negative cash flow in order to compute an answer.

can find more than one answer for projects with non-normal cash flows.

assumes that cash flows are reinvested at the cost of capital.

can rank mutually exclusive projects differently than NPV in some circumstances.

all of these are true statements.

6. Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, projects' initial outlays and subsequent costs can be forecasted with great accuracy. This is especially true for large product development projects.

7. If an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land.

8. Hurdle rates are basically specific costs of capital for specific investment projects. Hurdle rates may be higher or lower than the firm's cost of capital depending on the risk level of the project.

9. All else equal, an increase in a project's required return will cause its IRR to fall.

10. In order to have a successful firm, we should focus on generating net income. Profit is the most important measure of the firm's success.

11. The replacement chain and the EAC techniques will give the same recommendation on accepting or rejecting projects with unequal life-spans in normal situations.

12. One benefit of the payback period is that it forces decision makers to think about forecasting risk. All else equal projects with longer paybacks should have more forecast risk and should be more likely to be accepted.

13. For normal projects, as required rates increase NPVs will increase, all else equal.

14. Depreciation gets subtracted out of the cash flow forecast before taxes are computed, then added back after taxes are deducted. We do this because depreciation is a valid tax-deductible expense, but it is a non-cash expense - it only affects cash flow through its tax effect.

15. The decision rule for payback is always to accept the project if payback < 3 years.

16. While NPV, IRR, and PI will all reach the same accept/reject decision for projects with normal cash flow patterns, they can yield significant differences in ranking mutually exclusive projects. When ranking differences exist, it is generally best to rely on NPV to make decisions.

17. Any cash outflows at the beginning of a project due to increases in working capital are recovered at the end of the projects life, creating cash inflows. Since these cash flows sum to zero it is acceptable to omit them from a capital budgeting cash flow analysis.

18. Estimating the hurdle rate is the first step in the capital budgeting process.

19. All else equal, higher paybacks are better.

20. The two cardinal rules that financial analysts should follow to avoid errors are: (1) in the NPV equation, the numerator should use income calculated in accordance with generally accepted accounting principles, and (2) all incremental cash flows should be considered when making accept/reject decisions for capital budgeting projects.