Which of the following statements is CORRECT?
| | a. The IRR method appeals to some managers because it gives an estimate of the rate of return on projects rather than a dollar amount, which the NPV method provides. | | |
| | b. To find the MIRR, we discount the TV at the IRR. | | |
| | c. The discounted payback method eliminates all of the problems associated with the payback method. | | |
| | d. When evaluating independent projects, the NPV and IRR methods often yield conflicting results regarding a project's acceptability. | | |
| | e. A project's NPV profile must intersect the X-axis at the project's WACC. | | |
Moerdyk & Co. is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under certain conditions choosing projects on the basis of the IRR will not cause any value to be lost because the one with the higher IRR will also have the higher NPV, i.e., no conflict will exist.
| WACC: | 8.25% | | | | |
| | 0 | 1 | 2 | 3 | 4 |
| CFS | -$825 | $550 | $390 | $230 | $70 |
| CFL | -$825 | $135 | $295 | $455 | $615 |
Kosovski Company is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and are not repeatable. If the decision is made by choosing the project with the higher IRR, how much value will be forgone? Note that under some conditions choosing projects on the basis of the IRR will cause $0.00 value to be lost.
| WACC: | 6.25% | | | | |
| | 0 | 1 | 2 | 3 | 4 |
| CFS | -$1,050 | $675 | $650 | | |
| CFL | -$1,050 | $360 | $360 | $360 | $360 |
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.
| | a. If a project's IRR is greater than its WACC, then the MIRR will be less than the IRR. | | |
| | b. If a project's IRR is greater than its WACC, then the MIRR will be greater than the IRR. | | |
| | c. A project's MIRR is always less than its regular IRR. | | |
| | d. A project's MIRR is always greater than its regular IRR. | | |
| | e. To find a project's MIRR, we compound cash inflows at the IRR and then discount the terminal value back to t = 0 at the WACC. | |
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. A project's MIRR is always less than its regular IRR. | | |
| | b. If a project's IRR is greater than its WACC, then its MIRR will be greater than the IRR. | | |
| | c. 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. | | |
| | d. 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. | | |
| | e. A project's MIRR is always greater than its regular IRR. | |
Datta Computer Systems is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC (and even negative), in which case it will be rejected.
| Year | 0 | 1 | 2 | 3 |
| Cash flows | -$1,010 | $430 | $450 | $470 |
Warnock Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that a project's projected NPV can be negative, in which case it will be rejected.
| WACC: | 10.00% | | | |
| Year | 0 | 1 | 2 | 3 |
| Cash flows | -$1,050 | $500 | $400 | $300 |
The NPV method is based on the assumption that projects' cash flows are reinvested at the project's risk-adjusted cost of capital.
You are considering two mutually exclusive, equally risky, projects. Both have IRRs that exceed the WACC. Which of the following statements is CORRECT? Assume that the projects have normal cash flows, with one outflow followed by a series of inflows.
| | a. If the cost of capital is less than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. One project will rank higher by both criteria. | | |
| | b. If the two projects' NPV profiles do not cross, then there will be a sharp conflict as to which one should be selected. | | |
| | c. For a conflict to exist between NPV and IRR, one project must have an increasing stream of cash flows over time while the other has a decreasing stream. If both sets of cash flows are increasing or decreasing, then it would be impossible for a conflict to exist, even if one project is larger than the other. | | |
| | d. If the cost of capital is greater than the crossover rate, then the IRR and the NPV criteria will not result in a conflict between the projects. One project will rank higher by both criteria. | | |
| | e. For a conflict to exist between NPV and IRR, the initial investment cost of one project must exceed the cost of the other. | | |
The NPV and IRR methods, when used to evaluate two independent and equally risky projects, will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their costs of capital.
