One advantage of the payback method for evaluating potential investments is that it provides some information about a project’s liquidity and risk. 8. In theory, any capital budgeting investment rule should depend solely on forecasted cash flows and the opportunity cost of capital.

The rule itself should not be affected by managers’ tastes, the choice of accounting method, or the profitability of other independent projects. 9. When considering two mutually exclusive projects, the firm should always select that project whose internal rate of return is the highest provided the projects have the same initial cost.

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This statement is true regardless of whether the projects can be repeated or not. 10. The primary reason that the NP method is conceptually superior to the AIR method for evaluating mutually exclusive investments is that multiple Iris may exist. 11 . The NP and AIR methods, when used to evaluate independent and equally risky projects, will lead to different accept/reject decisions if their Iris are greater than the cost of capital. 12. A decrease in the firm’s discount rate (r, or WAC) will increase projects’ Naps, which could change the accept/reject decision for any potential project.

However, such a change would have no impact on the project’s AIR; therefore, the accept/reject decision under the AIR method is independent of the cost of capital. 13. Project S has a pattern of high cash flows in its early life, while Project L has a longer life, with large cash flows late in its life. Neither has negative cash flows after Year O, and at the current cost of capital, the two projects have identical Naps. Now suppose interest rates and money costs decline. Other things held constant, this change will cause L to become preferred to S. Multiple Choice Identify the choice that best completes the statement or answers the question. 4. 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 regular AIR is found by compounding the initial cost at the WAC to find the terminal value (TV), then discounting the TV at the WAC. B. A project’s regular AIR is found by compounding the cash inflows at the WAC to find the present value (PA), then discounting to find the AIR. C. If a project’s AIR is smaller than the WAC, then its NP will be positive. . A project’s AIR is the discount rate that causes the PA of the inflows to equal the project’s cost. E.

If a project’s AIR is positive, then its NP must also be positive. 15. Which of the following statements is CORRECT? Assume that the project A project’s NP is generally found by compounding the cash inflows at the WAC to find the terminal value (TV), then discounting the TV at the AIR to find its PA. B. The higher the WAC used to calculate the NP, the lower the calculated NP will be. C. F a project’s NP is greater than zero, then its AIR must be less than the WAC. D. If a project’s NP is greater than zero, then its AIR must be less than zero. E. The Naps of relatively risky projects should be found using relatively low Wasps. 6. Which of the following statements is CORRECT? Assume that the project If Project A has a higher AIR than Project B, then Project A must have the lower NP. B. If Project A has a higher AIR than Project B, then Project A must also have a higher NP. C. The AIR calculation implicitly assumes that all cash flows are reinvested at the WAC. D. The AIR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business. . If a project has normal cash flows and its AIR exceeds its WAC, then the project’s NP must be positive. 17. Which of the following statements is CORRECT?

If a project with normal cash flows has an AIR greater than the WAC, the project must have a positive NP. B. If Project Ass AIR exceeds Project Bi’s, then A must have the higher NP. C. A project’s MIR can never exceed its AIR. If a project with normal cash flows has an AIR less than the WAC, the project must have a positive NP. E. If the NP is negative, the AIR must also be negative. 18. Which of the following statements is CORRECT? The MIR and NP decision criteria can never conflict. B. The AIR method can never be subject to the multiple AIR problem, while the MIR method can be. . One reason some people prefer the MIR to the regular AIR is that the MIR is based on what is generally a more reasonable assumption about the reinvestment rate than the regular AIR. D. The higher the WAC, the shorter the discounted payback period. E. The MIR method assumes that cash flows are reinvested at the crossover rate. 19. Which of the following statements is CORRECT? For independent projects, the NP, AIR, MIR, and discounted payback (using a payback requirement of 3 years or less) methods always lead to the same accept/ reject decisions for a given project. B.

For mutually exclusive projects with normal cash flows, the NP and MIR methods can never conflict, but their results could conflict with the discounted payback and the regular AIR methods. C. Multiple Iris can exist, but not multiple Mirrors. This is one reason some people favor the MIR over the regular AIR. D. If a firm uses the discounted payback method with a required payback of 4 years, then it will accept more projects than if it used as its cutoff criterion a regular payback of 4 years. . The percentage difference between the MIR and the AIR is equal to the project’s WAC. 20.

Which of the following statements is CORRECT? For a project with normal cash flows, any change in the WAC will change both the NP and the AIR. B. To find the MIR, we first compound cash flows at the regular AIR to find the TV, and then we discount the TV at the WAC to find the PA. C. The NP and AIR methods both assume cash flows can be reinvested at the WAC. However, the MIR method assumes reinvestment at the MIR itself. D. If two projects have the same cost, and if their NP profiles cross in the upper eight quadrant, then the project with the higher AIR probably has more of its cash flows coming in the later years. . Right quadrant, then the project with the lower AIR probably has more of its cash flows coming in the later years. 21 . Which of the following statements is CORRECT? One advantage of the NP over the AIR is that NP takes account of cash flows over a project’s full life whereas AIR does not. B. One advantage of the NP over the AIR is that NP assumes that cash flows will be reinvested at the WAC, whereas AIR assumes that cash flows are reinvested at the AIR. The NP assumption is generally more likely to be appropriate. C.

One advantage of the NP over the MIR method is that NP takes account of cash flows over a project’s full life whereas MIR does not. D. One advantage of the NP over the MIR method is that NP discounts cash flows whereas the MIR is based on undistorted cash flows. E. Since cash flows under the AIR and MIR are both discounted at the same rate (the WAC), these two methods always rank mutually exclusive projects in the same order. 22. McCall Manufacturing has a WAC of 10%. The firm is considering two armor, equally risky, mutually exclusive, but not repeatable projects.

The two projects have the same investment costs, but Project A has an AIR of 1 5%, while project B has an AIR of 20%. Which of the following statements is CORRECT? A. Each project must have a negative NP. Since the projects are mutually exclusive, the firm should always select Project B. Fifth crossover rate is 8%, Project B will have the higher NP. D. Only one project has a positive NP. If the crossover rate is 8%, Project A will have a higher NP than Project B. 23. Which of the following statements is CORRECT? Assume that the project A project’s MIR is always greater than its regular AIR.