Bacnmh
CHAPTER 10
THE BASICS OF CAPITAL BUDGETING
(Difficulty: E = Easy, M = Medium, and T = Tough)
Multiple Choice: Conceptual
Easy:
Ranking methods
1.
Answer: b
Diff: E
Assume a project has normal cash flows (that is, the initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct?
a. All else equal, a project’s IRR increases as the cost of capital declines. b. All else equal, a project’s NPV increases as the cost of capital declines. c. All else equal, a project’s MIRR is unaffected by changes in the cost of capital.
d. Statements a and b are correct.
e. Statements b and c are correct.
Ranking conflicts
2.
Answer: a
Diff: E
Which of the following statements is most correct?
a. The NPV method assumes that cash flows will be reinvested at the cost of 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 cost of capital, while the IRR method assumes reinvestment at the risk-free rate. 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.
Payback period
3.
Answer: d
Diff: E
A major disadvantage of the payback period is that it
a.
b.
c.
d.
e.
Is useless as a risk indicator.
Ignores cash flows beyond the payback period.
Does not directly account for the time value of money.
Statements b and c are correct.
All of the statements above are correct.
Chapter 10 - Page 1
NPV profiles
4.
Answer: b
Diff: E
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 the other project has larger cash flows in the later years.
THE BASICS OF CAPITAL BUDGETING
(Difficulty: E = Easy, M = Medium, and T = Tough)
Multiple Choice: Conceptual
Easy:
Ranking methods
1.
Answer: b
Diff: E
Assume a project has normal cash flows (that is, the initial cash flow is negative, and all other cash flows are positive). Which of the following statements is most correct?
a. All else equal, a project’s IRR increases as the cost of capital declines. b. All else equal, a project’s NPV increases as the cost of capital declines. c. All else equal, a project’s MIRR is unaffected by changes in the cost of capital.
d. Statements a and b are correct.
e. Statements b and c are correct.
Ranking conflicts
2.
Answer: a
Diff: E
Which of the following statements is most correct?
a. The NPV method assumes that cash flows will be reinvested at the cost of 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 cost of capital, while the IRR method assumes reinvestment at the risk-free rate. 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.
Payback period
3.
Answer: d
Diff: E
A major disadvantage of the payback period is that it
a.
b.
c.
d.
e.
Is useless as a risk indicator.
Ignores cash flows beyond the payback period.
Does not directly account for the time value of money.
Statements b and c are correct.
All of the statements above are correct.
Chapter 10 - Page 1
NPV profiles
4.
Answer: b
Diff: E
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 the other project has larger cash flows in the later years.