FIN 2010

Topics: Net present value, Internal rate of return, Corporate finance Pages: 10 (1906 words) Published: April 8, 2014
Fin 350 Exam 2, Fall 2010Name ___________________________

This has answers to the problems which I believe, but cannot guarantee, are correct.

1. Under certain conditions, a particular project may have more than one IRR. One condition under which this situation can occur is if, in addition to the initial investment at time = 0, a negative cash flow occurs at the end of the project's life.

a.True
b.False

2. The modified IRR (MIRR) method has wide appeal to professors, but most business executives prefer the NPV method to either the regular or modified IRR.

a.True
b.False

3. A firm should never undertake an investment if accepting the project would cause an increase in the firm's cost of capital.

a.True
b.False

4. A decrease in the firm's discount rate (r) will increase NPV, which could change the accept/reject decision for a potential project. However, such a change would have no impact on the project's IRR, hence on the accept/reject decision under the IRR method.

a.True
b.False

5. If the IRR of normal Project X is greater than the IRR of mutually exclusive Project Y (also normal), we can conclude that the firm will select X rather than Y if X has a NPV > 0.

a.True
b.False

6. Estimating project cash flows is considered the most difficult step in the capital budgeting process. Both the number of variables and the interdepartmental nature of the process contribute to the difficulty of estimating cash flows.

a.True
b.False

7. A project's market risk increases if the correlation of its cash flows with the economy decreases.

a.True
b.False

8. Risky projects can be evaluated by discounting expected cash flows using a risk-adjusted discount rate.

a.True
b.False

9. Opportunity costs include those cash inflows that could be generated from assets the firm already owns, if those assets are not used for the project being evaluated.

a.True
b.False

10. Suppose a firm is considering production of a new product whose projected sales include sales that will be taken away from another product the firm also produces. The lost sales on the existing product are a sunk cost and are not a relevant cost to the new product.

a.True
b.False

11. Capital can be defined as the funds supplied by investors. a. True
b. False

Multiple choice questions count 2 points each.

1. 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 risk free 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.

2. A company is considering an expansion project. The company’s CFO plans to calculate the project’s NPV by discounting the relevant cash flows (which include the initial up-front costs, the operating cash flows, and the terminal cash flows) at the company’s cost of capital (WACC). Which of the following factors should the CFO include when estimating the relevant cash flows?

a.Any sunk costs associated with the project.
b.Any interest expenses associated with the project.
c.Any opportunity costs associated with the project.
d.Answers b and c are correct.
e.All of the answers above are correct.

3. Adams Audio is considering whether to make an investment in a new type of technology. Which of the following factors should the company consider when it decides whether to undertake the investment?

a.The company has already spent $3 million researching the technology. b.The new technology will affect the cash flows produced by its other operations. c.If the investment is not made, then the company will be able to sell one of its...
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