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TitleChapter 11 the Basics of Capital Budgeting (1)
TagsCapital Budgeting Internal Rate Of Return Net Present Value Corporations
File Size525.7 KB
Total Pages68
Document Text Contents
Page 1

CHAPTER 11—THE BASICS OF CAPITAL BUDGETING

1. A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC).
a. True
b. Fals

e

ANSWER: False

POINTS: 1

DIFFICULTY: EASY

REFERENCES: 11-1 An Overview of Capital Budgeting

LEARNING OBJECTIV
ES:

FOFM.BRIG.16.11.01 - An Overview of Capital Budgeting

NATIONAL STANDAR
DS:

United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking

STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and
cost of capital

TOPICS: Capital budget

KEYWORDS: Bloom's: Comprehension

2. Because "present value" refers to the value of cash flows that occur at different points in time, a series of present values
of cash flows should not be summed to determine the value of a capital budgeting project.
a. True
b. Fals

e

ANSWER: False

POINTS: 1

DIFFICULTY: EASY

REFERENCES: 11-2 Net Present Value (NPV)

LEARNING OBJECTIV
ES:

FOFM.BRIG.16.11.02 - Net Present Value (NPV)

NATIONAL STANDAR
DS:

United States - BUSPROG.FOFM.BRIG.16.06 - Reflective thinking

STATE STANDARDS: United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and
cost of capital

TOPICS: PV of cash flows

KEYWORDS: Bloom’s: Knowledge

3. Assuming that their NPVs based on the firm's cost of capital are equal, the NPV of a project whose cash flows accrue
relatively rapidly will be more sensitive to changes in the discount rate than the NPV of a project whose cash flows come
in later in its life.
a. True
b. Fals

e

ANSWER: False

POINTS: 1

DIFFICULTY: EASY

REFERENCES: 11-2 Net Present Value (NPV)

LEARNING OBJECTIV FOFM.BRIG.16.11.02 - Net Present Value (NPV)

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CHAPTER 11—THE BASICS OF CAPITAL BUDGETING



Statement a is false, because if the profiles do not cross, then one will dominate
the other, with both a higher IRR and a higher NPV at every discount rate.
Statement b is true. Statement c is false. Statement d is false because a conflict
can result from differences in the timing of the cash flows. Statement e is false
because scale differences can result in profile crossovers and thus conflicts.

POINTS: 1

DIFFICULTY: MODERATE/CHALLENGING

REFERENCES
:

11-7 NPV Profiles

LEARNING O
BJECTIVES:

FOFM.BRIG.16.11.07 - NPV Profiles

NATIONAL ST
ANDARDS:

United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills

STATE STAND
ARDS:

United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS: NPV profiles

KEYWORDS: Bloom's: Analysis

OTHER: Multiple Choice: Conceptual

66. Project X's IRR is 19% and Project Y's IRR is 17%. The projects have the same risk and the same lives, and each has
constant cash flows during each year of their lives. If the WACC is 10%, Project Y has a higher NPV than X. Given this
information, which of the following statements is CORRECT?
a. The crossover rate must be less than 10%.
b. The crossover rate must be greater than 10%.
c. If the WACC is 8%, Project X will have the higher NPV.
d. If the WACC is 18%, Project Y will have the higher NPV.
e. Project X is larger in the sense that it has the higher initial cost.

ANSWER: b

RATIONALE: Again, it is useful to draw NPV profiles that fit the description given in the
question. Any number that meets the criteria will do.

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CHAPTER 11—THE BASICS OF CAPITAL BUDGETING



As we can see from the graph, statement b is true, but the other statements are
false.

POINTS: 1

DIFFICULTY: MODERATE/CHALLENGING

REFERENCES: 11-7 NPV Profiles

LEARNING OBJ
ECTIVES:

FOFM.BRIG.16.11.07 - NPV Profiles

NATIONAL STAN
DARDS:

United States - BUSPROG.FOFM.BRIG.16.03 - Analytic skills

STATE STANDAR
DS:

United States - OH - DISC.FOFM.BRIG.16.03 - Capital budgeting and cost of
capital

TOPICS: NPV profiles

KEYWORDS: Bloom's: Application

OTHER: Multiple Choice: Conceptual

67. You are on the staff of Camden Inc. The CFO believes project acceptance should be based on the NPV, but Steve
Camden, the president, insists that no project should be accepted unless its IRR exceeds the project's risk-adjusted WACC.
Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of
Year 1 and −$100,000 at the end of Year 2. The president and the CFO both agree that the appropriate WACC for this
project is 10%. At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one at 527%, and a MIRR of
11.32%. Which of the following statements best describes your optimal recommendation, i.e., the analysis and
recommendation that is best for the company and least likely to get you in trouble with either the CFO or the president?
a. You should recommend that the project be rejected because its NPV is negative and its

IRR is less than the WACC.
b.You should recommend that the project be rejected because, although its NPV is

positive, it has an IRR that is less than the WACC.
c. You should recommend that the project be accepted because (1) its NPV is positive

and (2) although it has two IRRs, in this case it would be better to focus on the MIRR,
which exceeds the WACC. You should explain this to the president and tell him that
that the firm's value will increase if the project is accepted.

d.You should recommend that the project be rejected because (1) its NPV is positive and
(2) it has two IRRs, one of which is less than the WACC, which indicates that the
firm's value will decline if the project is accepted.

e. You should recommend that the project be rejected because, although its NPV is
positive, its MIRR is less than the WACC, and that indicates that the firm's value will
decline if it is accepted.

ANSWER: c

RATIONALE: Statement c is true, while the other statements are false. It is not necessary to
calculate the two IRRs and the MIRR as the data in the problem are correct, but

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