1. 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. The longer a project's payback period, the more desirable the project is normally considered to be by this criterion.
b. One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.
c. If a project's payback is positive, then the project should be rejected because it must have a negative NPV.
d. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem.
e. If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time.
2. Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT?
a. The project's IRR increases as the WACC declines.
b. The project's NPV increases as the WACC declines.
c. The project's MIRR is unaffected by changes in the WACC.
d. The project's regular payback increases as the WACC declines.
e. The project's discounted payback increases as the WACC declines.
3. Which of the following statements is CORRECT?
a. For a project to have more than one IRR, then both IRRs must be greater than the WACC.
b. If two projects are mutually exclusive, then they are likely to have multiple IRRs.
c. If a project is independent, then it cannot have multiple IRRs.
d. Multiple IRRs can only occur if the signs of the cash flows change more than once.
e. If a project has two IRRs, then the smaller one is the one that is most relevant, and it should be accepted and relied upon.
4. Which of the following statements is CORRECT?
a. The MIRR and NPV decision criteria can never conflict.
b. The IRR method can never be subject to the multiple IRR problem, while the MIRR method can be.
c. One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on what is generally a more reasonable assumption about the reinvestment rate than the regular IRR.
d. The higher the WACC, the shorter the discounted payback period.
e. The MIRR method assumes that cash flows are reinvested at the crossover rate.
5. 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. A project's MIRR is always greater than its regular IRR.
b. A project's MIRR is always less than its regular IRR.
c. If a project's IRR is greater than its WACC, then the MIRR will be less than the IRR.
d. If a project's IRR is greater than its WACC, then the MIRR will be greater than the 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.
6. Edmondson Electric Systems is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's projected NPV is negative, it should be rejected.
7. Tucker Corp. 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 negative, in which case it will be rejected.
8. ZumBahlen Inc. is considering the following mutually exclusive projects:
At what cost of capital will the net present value of the two projects be the same? (That is, what is the "crossover" rate?)
9. Suppose Tapley Corporation uses a WACC of 8% for below-average risk projects, 10% for average-risk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects?
a. Project A, which has average risk and an IRR = 9%.
b. Project B, which has below-average risk and an IRR = 8.5%.
c. Project C, which has above-average risk and an IRR = 11%.
d. Without information about the projects' NPVs we cannot determine which one or ones should be accepted.
e. All of the projects should be accepted.
10. Langston Labs has an overall (composite) WACC of 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Langston evaluates low-risk projects with a WACC of 8%, average projects at 10%, and high-risk projects at 12%. The company is considering the following projects:
Which set of projects would maximize shareholder wealth?
A and B.
A, B, and C.
A, B, and D.
A, B, C, and D.
A, B, C, D, and E.© BrainMass Inc. brainmass.com October 17, 2018, 1:19 am ad1c9bdddf
The problem deals with finance issues in capital budgeting: Net present value, Internal rate of return, Modified Internal rate of return, and project payback.
Finance: Price of stock, required rate of return, dividend growth, NPV, IRR, MIRR
1 . John and Larry's, Inc. does not pay dividends at this time. You overhear the CFO tell the CEO that the plan is to begin paying dividends in 4 years. The first dividend will be $2.00 and the dividends are expected to grow at a 5% rate
thereafter. Given required rate of return of 15.5%, what should be the price of the stock today? (3 points)
2 . The Suretype Typewriter Company is facing decreased sales due to the continual trend toward the use of computers for word processing tasks. Based on the most recent long-term earnings forecasts, it is anticipated that dividends will decline at
a rate of 9% annually, forever. If the firm just paid a dividend of $1.75 and the required return on the stock is 14%, at what price should the stock sell for? (3 points)
3 . What is the value of 2,000 shares of Creative Crafts, Inc. stock? Creative Crafts, Inc. just paid a $2.00 dividend (D0). You expect dividends to grow by 20% per year in years 1 and 2, by 12% in year 3, and by 5% thereafter. The required return on the stock is 16%. (3 points)
4 . The stock of Rockstar International is selling for $28.75 per share. Rockstar's last dividend (D0) was $2.50 per share and its dividends are projected to grow at a constant rate in the future. If the required return on the stock is 13 percent, what
is the projected dividend growth rate? (3 points)
5 . What price would you be willing to pay for a stock that just paid a $4.25 dividend (D0) if the anticipated dividend growth rate is 6% and the required return on the stock is 14%? (3 points)
6 . Two investors are evaluating AT&T's stock for possible purchase. They agree on the expected value of D1 and also on the expected future dividend growth rate. Further, they agree on the riskiness of the stock, and thus, the discount rate.
Assume that the first investor would plan to sell the stock after 2 years and the 2nd investor would plan on selling the stock after 10 years. Would they agree on the price of the stock, or would they disagree on the price because of the differences
in the length of time that each plans to hold the stock? Clearly explain your answer. (3 points)
7 . A proposed new project requires an initial investment of $847,000. The expected cash flows are $172,000 per year for the first two years, and then $500,000 per year in the third and fourth years. Assume the appropriate discount rate is 15%.
a) What is the NPV? (3 points)
b) What is the IRR? (3 points)
c) What is the Modified IRR (MIRR)? (3 points)
d) What is the profitability index? (3 points)
8 . Suppose your firm is evaluating four potential new investments. You calculate that these projects, Q, X, Y, and Z, have the NPV and IRR figures given below:
Project Q: NPV = $7,000 IRR = 15%
Project X: NPV = $4,000 IRR = 16%
Project Y: NPV = -$5,000IRR = 12%
Project Z: NPV = -$800 IRR = 18%
a) Which project(s) should be accepted if they are independent? Clearly explain your reasoning. (3 points)
b) Which project(s) should be accepted if they are mutually exclusive? Clearly explain your reasoning. (3 points)
9 . Suppose an investment costs $650 and generates cash inflows of $121 per year for the next 8 years.
a) What is the payback period (undiscounted)? (3 points)
b) Calculate the discounted payback period using an 7.5% discount rate. (3 points)
c) Calculate the discounted payback period using an 17.5% discount rate. (3 points)
d) Would the payback period (undiscounted) change given a change in the discount rate? Is this a strength or a weakness of the undiscounted payback period approach? (3 points)
e) Can you identify the discount rate at which the investment would just pay off on a discounted basis at the end of its 8-year life? If so, calculate that rate. (3 points)
1 0 . A growing business is considering two mutually-exclusive projects with the following forecasted cash flows.
Time Project A Project B
2 20,000 30,000
3 55,000 9,000
4 95,000 10,000
a) Calculate the IRR of each project. (3 points)
b) Calculate the NPV of each project at discount rates of 0%, 5%, 10% and 15%. (3points)
c) Calculate the incremental IRR (i.e., the crossover rate). (3 points)
d) Construct an NPV profile to illustrate how the choice between the two projects depends on the discount rate. Make sure you are explicit about the conclusions to be drawn from the NPV profile! (i.e., Do X if ...; do Y if ...; do Z if ...) (3 points)
1 1 . Suppose that you are trying to decide between two mutually exclusive projects. Project A has an IRR of 23% and project B has an IRR of 28%. If the appropriate discount rate is 11%, which project should a financial manager that is acting in the best interests of shareholders choose? Clearly explain your answer. (3 points)
1 2 . Consider a firm that currently has a market value of $320,000. The firm is considering a project with the following cash flows and a required return (hurdle rate) of 15.75%.
T = 0 -$100,000
Year 1 $30,000
Year 2 $30,000
Year 3 $30,000
Year 4 $43,000
a) Calculate the undiscounted payback period. (3 points)
b) If the firm decided to accept this project, what would the firm's new market value be? Explain your answer clearly and be sure to support your conclusion with the appropriate figures. (3 points)