Which of the following statements is CORRECT?
a.The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases.
b.An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life.
c.An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital.
d.We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV.
e.An NPV profile graph shows how a project's payback varies as the cost of capital changes.
2. 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 higher the WACC used to calculate the NPV, the lower the calculated NPV will be.
b. If a project's NPV is greater than zero, then its IRR must be less than the WACC.
c. If a project's NPV is greater than zero, then its IRR must be less than zero.
d. The NPVs of relatively risky projects should be found using relatively low WACCs.
e. A project's NPV is generally found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting the TV at the IRR to find its PV.
3. 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. If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.
b. The IRR calculation implicitly assumes that all cash flows are reinvested at the WACC.
c. The IRR calculation implicitly assumes that cash flows are withdrawn from the business rather than being reinvested in the business.
d. If a project has normal cash flows and its IRR exceeds its WACC, then the project's NPV must be positive.
e. If Project A has a higher IRR than Project B, then Project A must have the lower NPV.
4. Which of the following statements is CORRECT?
a. If two projects are mutually exclusive, then they are likely to have multiple IRRs.
b. If a project is independent, then it cannot have multiple IRRs.
c. Multiple IRRs can occur only if the signs of the cash flows change more than once.
d. 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.
e. For a project to have more than one IRR, then both IRRs must be greater than the WACC.
5. Which of the following statements is CORRECT?
a. The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR.
b. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the risk-free rate.
c. The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
d. The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period.
e. The NPV method assumes that cash flows will be reinvested at the WACC, while the IRR method assumes reinvestment at the IRR.
FIN 534 Week 6 Chapter 11
Directions: Answer the following five questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. Each question is worth five points apiece for a total of 25 points for this homework assignment.
1. Which of the following statements is CORRECT?
a. An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to decline.
b. The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.
c. Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.
d. Identifying an externality can never lead to an increase in the calculated NPV.
e. An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality.
2. Which of the following statements is CORRECT?
a. If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its customers. Thus, cannibalization is dealt with by society through the antitrust laws.
b. If cannibalization exists, then the cash flows associated with the project must be increased to offset these effects. Otherwise, the calculated NPV will be biased downward.
c. If cannibalization is determined to exist, then this means that the calculated NPV if cannibalization is considered will be higher than the NPV if this effect is not recognized.
d. Cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself.
e. If a firm is found guilty of cannibalization in a court of law, then it is judged to have taken unfair advantage of its competitors. Thus, cannibalization is dealt with by society through the antitrust laws.
3. Which of the following statements is CORRECT?
a. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
b. Corporations must use the same depreciation method (e.g., straight line or accelerated) for stockholder reporting and tax purposes.
c. Since depreciation is not a cash expense, it has no effect on cash flows and thus no effect on capital budgeting decisions.
d. Under accelerated depreciation, higher depreciation charges occur in the early years, and this reduces the early cash flows and thus lowers a project's projected NPV.
e. Using accelerated depreciation rather than straight line would normally have no effect on a project's total projected cash flows but it would affect the timing of the cash flows and thus the NPV.
4. Which of the following statements is CORRECT?
a. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 5 years or longer.
b. Corporations must use the same depreciation method for both stockholder reporting and tax purposes.
c. Using accelerated depreciation rather than straight line normally has the effect of speeding up cash flows and thus increasing a project's forecasted NPV.
d. Using accelerated depreciation rather than straight line normally has no effect on a project's total projected cash flows nor would it affect the timing of those cash flows or the resulting NPV of the project.
e. Since depreciation is a cash expense, the faster an asset is depreciated, the lower the projected NPV from investing in the asset.
5. Which of the following statements is CORRECT?
a. Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer.
b. If firms use accelerated depreciation, they will write off assets slower than they would under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.
c. If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.’
d. If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes.
e. Since depreciation is not a cash expense, and since cash flows and not accounting income are the relevant input, depreciation plays no role in capital budgeting.