Financial Management Theory And Practice 12th Edition By Eugene F. Brigham – Test Bank

CHAPTER 11
THE BASICS OF CAPITAL BUDGETING: EVALUATING CASH FLOWS

True/False

Easy:

(11.1) Capital budget Answer: b EASY
. A firm should never undertake an investment if accepting the project would lead to an increase in the firm’s cost of capital.

a. True
b. False

(11.2) PV of cash flows Answer: b EASY
. Because “present value” refers to the value of cash flows that occur at different points in time, a series of present values should not be summed to determine the value of a capital budgeting project.

a. True
b. False

(11.2) NPV Answer: b EASY
. 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. False

(11.3) IRR Answer: a EASY
. The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs) with the present value of the cash inflows.

a. True
b. False

(11.3) IRR Answer: b EASY
. Other things held constant, an increase in the cost of capital will result in a decrease in a project’s IRR.

a. True
b. False

(11.4) NPV and IRR Answer: b EASY
. If a project’s NPV exceeds its IRR, then the project should be accepted.

a. True
b. False

(11.4) Mutually exclusive projects Answer: a EASY
. Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV.

a. True
b. False

(11.4) Reinvestment rate assumption Answer: a EASY
. The NPV method’s assumption that cash inflows are reinvested at the cost of capital is more reasonable than the IRR’s assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method.

a. True
b. False

(11.5) Multiple IRRs Answer: a EASY
. Under certain conditions, a project may have more than one IRR. One such condition is when, in addition to the initial investment at time = 0, a negative cash flow (or cost) occurs at the end of the project’s life.

a. True
b. False

(11.5) Multiple IRRs Answer: b EASY
. The phenomenon called “multiple internal rates of return” arises when two or more mutually exclusive projects that have different lives are being compared.

a. True
b. False

(11.6) Modified IRR Answer: b EASY
. 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

(11.6) Modified IRR Answer: b EASY